THE ECONOMICS OF THE MORTGAGE INDUSTRY
Real properties (real estate) like buildings, lands, residences are generally acquired by a purchaser through taking a loan. The promise to repay this loan is backed by a security, where the borrower/chargor grants a mortgage or charge against its real property in favour of the lender/chargee. Incidentally, such a loan is called a mortgage loan secured by real property and stated thus in a document. In common usage, the word mortgage is mostly used to mean a mortgage loan.
This loan (known as financing) is usually obtained by first time home buyers and builders from a bank or other financial institution, either on his own or through some intermediaries charging for the service. Naturally, mortgages are different from one another; its characteristics, such as the amount, the loan period, interest rate, etc. vary to a great extent. The mortgage loan is quite common in most countries of the world, because people generally do not possess the money needed to purchase a home from their savings. However, for many homeowners, traditional bank mortgage loans are not a viable option. Many people decide to sell real estate notes to investors who are not interested in the risks associated with the stock market. Note investors often find that investments in notes are better because of the higher returns that come with buying notes compared to standard mortgage loans.
It is required practice in Ontario for the borrower and the lender, while negotiating a loan, to draft a commitment letter. Copies of this “commitment” are forwarded to the respective lawyers of the borrower/chargor and the lender/chargee. The lender’s lawyer thereafter sets out the conditions to be satisfied by the borrower before the money could be released; a standard provision of which is that the mortgage/charge must be registered. This mortgage/charge could be a valid first or second or third etc. charge subject only to certain approved encumbrances, registered on title to the real property used as security/collateral. Thus, mortgages are limitations or encumbrances on the rights to the real property similar to easements or rights of way.
In view of the above, Section 6(3) of Land Registration Reform Act says:
“Despite subsection (1) a chargor (borrower) and chargee (lender) are entitled to all the legal and equitable rights and remedies that would be available to them if the chargor (borrower) had transferred the land (real property) to the chargee (lender) by way of mortgage (charge), subject to a proviso for redemption.”
In other words, the purpose is to find a common ground between the different concepts of the registry and land titles systems by preserving the rights of the chargor and chargee while eliminating the need for a transfer of title to the real property. Hence, a mortgage, in all essence, allows for the lender to execute certain rights against the real property as if the lender owned it. It is this concept that allowed for the proliferation of the mortgage lending industry and thus the real estate housing market. Lenders are more secure and are allowed self-help remedies to collect and recover their loans including arrears and the costs in doing so. Without mortgages and the Mortgages Acta majority of us would be renters rather than home owners.
Generally, however, mortgage lending would also take into account the riskiness of the mortgage loan, which is a matter of perception. In other words, different lenders will take into account the likelihood that the funds would be repaid (usually considered a function of the creditworthiness of the borrower), and/or how they would be affected by the possibility that they are not repaid. In that event, the lender should be able to foreclose or take over the property and recoup some or all of its original loan/capital. Other matters of importance to the lenders are the financial and interest rate risks, and the time delays that could arise under certain circumstances. After-all, time is money! Hence, lenders are always looking for ways to minimize their risk. Adjustable/variable interest rate mortgages transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or prohibitively expensive. Also, lenders depend on credit reports and credit scores, and thus high scorers get lower interest rates. The low scorers, in view of their perceived riskiness, are charged higher interest rates.
Amortization or the scheduled repayment plan of a mortgage loan arrangement (like other loans) with a fixed or varying rate of interest, is normally continued over a period of 10 to 30 years. The interest earned is the profit or income of the lender. Structured like long-term loans usually, the repayments at scheduled intervals are like annuities or a terminating stream of fixed payments over a specified period of time and calculated according to the time value of money formula. Over this period, the principal component of the loan or the original amount would gradually diminish and vanish altogether towards the end. The lenders themselves borrow the money usually to provide mortgage loans. Consequently the price the lenders pay to get the money affects borrowing or the process of mortgaging. It is these economic fundamental parameters that dictate the growth and collapse of our mortgage lending industry and housing market, let alone the real estate industry as a whole. Indirectly, the more affordable the interest rates the more available loans will be, and thus the easier a buyer will be able to burden the debt associated with mortgaging a new real property purchase.
An offshoot of mortgage lending is when the lenders securitize their mortgages; when they sell the mortgage loan to other parties who are interested in receiving the stream of cash payments from the borrowers, often in the form of a financial security or instrument (securitization). Two such government backed firms in the United States, Fannie Mae and Freddie Mac, were very badly affected by the past two year economic meltdown.
Types of mortgages
All over the world, there are various kinds of mortgages, depending on local conditions and regulations. In Canada, they are not too different from those available in other countries, and the general features are listed as follows:
- Interest – interest may be fixed or changing (variable) at certain pre-defined periods, and thus the rate could be higher or lower.
- Duration – mortgage loans usually are for long periods/terms of 5 years. This is not to be confused with the amortization; the repayment schedule of interest or interest and principle, over a longer more affordable period of time.
- Payment amount and frequency – could change or the borrower may have the option to increase or decrease the amount paid. The most common examples are monthly or biweekly.
- Prepayment – generally, not encouraged by lenders and are with a penalty of some sort.
The next time your in the market for a mortgage, contact the lawyers at Levy Zavet PC to help you shop around for the best value while assisting your lender satisfy any conditions it may need met prior to committing or closing.