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Mortgages & Foreclosures Basics
A mortgage is a transfer of an interest in real estate as security for the repayment of a loan. A typical mortgage transaction involves a home purchaser borrowing money from a lender and entering into a written agreement with the lender to the effect that the real estate is collateral for the loan. If the homeowner defaults on the loan, the lender is entitled to "foreclose" on the real estate and have it sold to reduce the debt. Depending on the terms of the agreement, the lender may then be entitled to pursue the homeowner for payment of any deficiency.
A borrower, or mortgagor, obtains a mortgage loan through a process of application and commitment. The borrower initiates the process by submitting an application to the lender, or mortgagee, and in some cases paying a nonrefundable fee. The lender conducts a risk evaluation to determine whether a mortgage loan will be granted. In the risk analysis, the lender evaluates both the borrower's financial position and the value of the real estate. If the lender determines the risk to be acceptable, the lender will issue a loan commitment detailing the loan amount, repayment terms, interest rate, and other pertinent conditions. Because the commitment will normally contain terms and conditions not found in the loan application, it typically constitutes a counteroffer to make a loan. When the borrower accepts the commitment, a binding contract for a mortgage loan is created.
Residential mortgage loans usually bear interest at a fixed annual percentage rate over a period of fifteen or thirty years. The interest rate is determined by the prevailing market conditions at the time the loan is made. A lender may increase its yield beyond the stated interest rate by requiring the borrower to pay "points" at the time the loan is made. One point equals one percent of the loan amount. It may also be beneficial for the borrower to pay points in order to reduce the interest rate over the term of the loan.
Adjustable rate mortgages (ARMs) are also common. Under an ARM, the interest rate rises and falls over the term of the loan in accordance with prevailing market conditions. The parties may agree to hedge against extreme interest rate fluctuations by establishing ceiling and floor limits.
A balloon mortgage, less common but not unheard of in the residential mortgage market, exists when a substantial payment is required at the end of the term of the loan to cover the unamortized loan principal.
Default occurs when the mortgagor fails to perform an obligation secured by the mortgage. The most common event of default is the mortgagor's failure to timely pay monthly principal and interest installments. A mortgagor's failure to insure the property or to pay property taxes can also constitute an event of default. However, the use of escrow accounts has reduced the frequency with which this type of default occurs. Finally, construction difficulties or physical damage or destruction to the property by the mortgagor, constituting "waste," can also be considered an event of default.
Most mortgages and underlying promissory notes contain an acceleration clause providing that the occurrence of an event of default accelerates the debt, making the entire debt immediately due and payable. Most residential mortgage lenders are required to provide that the mortgagee must give the mortgagor notice of impending acceleration and the opportunity to avoid it by curing the default. In most states, the commencement of a foreclosure proceeding constitutes notice of impending acceleration.
Mortgages also often provide for acceleration in the event the mortgagor transfers any interest in the mortgaged property without the mortgagee's consent. These clauses, referred to as due-on-sale clauses, protect the mortgagee from being forced to do business with persons other than the mortgagor with whom the mortgagee initially contracted. When a mortgagor desires to transfer the mortgaged property, the mortgagee has the option to either accelerate the debt or consent to the transaction conditioned on the grantee's assumption of the mortgage and payment obligation, possibly also with a transfer fee requirement and/or an increased interest rate.
In general, the mortgagor can foreclosure on the mortgaged property any time after an event of default. There are two types of foreclosure proceedings, foreclosure by judicial sale and foreclosure by power of sale. Foreclosure by judicial sale is available in all states, and is the required foreclosure method in a number of jurisdictions. A foreclosure by judicial sale is subject to court supervision and is not final until the court confirms the sale. Foreclosure by power of sale serves the same purpose as foreclosure by judicial sale. However, statutes delineating detailed notice and sale procedures replace court supervision. If the foreclosure sale proceeds are insufficient to satisfy the underlying debt, the mortgagee can usually obtain a judgment against the mortgagor for the deficiency. Likewise, if the foreclosure sale results in a surplus, the mortgagor is usually entitled to seek payment from the mortgagee for the amount of the surplus.
In either type of foreclosure sale, it is important to conduct the foreclosure in accordance with the applicable law so that the mortgagor's "redemption" rights are curtailed so that whoever purchases the property at the foreclosure sale receives clear and unhindered title thereto.
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