What is a Mortgage?
What is a mortgage? Mortgage is a word lenders use to describe a formidable pile of legal documents you have to sign to get the money you need to buy or refinance real property. What’s real property? It’s dirt — plain old terra firma and any improvements (homes, garages, cabanas, swimming pools, tool sheds, barns, or other buildings) permanently attached to the land.
Mortgages aren’t used only to facilitate home purchases. They’re used whenever people acquire any kind of real property, from vacant lots to commercial real estate such as shopping centers and the Empire State Building.
In case you’re curious, anything that isn’t real property is classified as personal property. Moveable or impermanent possessions such as stoves, refrigerators, dishwashers, washers and dryers, window treatments, flooring, chandeliers, and fireplace screens are examples of personal property items that are frequently included in the sale of real property.
Mortgages encumber (burden) real property by making it security for the repayment of a debt. A first mortgage ever so logically describes the very first loan secured by a particular piece of property. The second loan secured by the same property is called a second mortgage, the third loan is a third mortgage, and so on. You may also hear lenders refer to a first mortgage as the senior mortgage. Any subsequent loans are called junior mortgages. Money imitates life.
This type of financial claim on real property is called a lien. Proper liens invariably have two integral parts:
- Promissory note: This note is the evidence of your debt, an IOU that specifies exactly how much money you borrowed as well as the terms and conditions under which you promise to repay it.
- Security instrument: If you don’t keep your promise, the security instrument gives your lender the right to take steps necessary to have your property sold to satisfy the outstanding balance of the debt. The legal process triggered by the security device is called foreclosure.
From a lender’s perspective, each junior mortgage (subsequent mortgage after the first loan on the property) is increasingly risky, because in the event of a foreclosure, mortgages are paid off in order of their numerical priority (seniority). In plain English, the second mortgage lender doesn’t get one cent until the first mortgage lender has been paid in full. If a foreclosure sale doesn’t generate enough money to pay off the first mortgage, that’s tough luck for the second lender. Due to the added risk, lenders charge higher interest rates for junior mortgages.