What is Mortgage? Types and Components

  • Soumyaa Rawat
  • Apr 04, 2021
  • Financial Analytics
What is Mortgage? Types and Components title banner

About Mortgage

 

The concept of mortgage defines mortgage as an activity wherein an individual  borrows money from a lender for a fixed period of time to purchase a property which acts as a collateral or security for the lender.

 

This concept can be understood in light of real estate and loans that the common masses apply for. A term that is used in day to day lives, mortgage is used to repay a financial obligation or a loan. 

 

When it comes to understanding about mortgage, people get confused between loan and real estate. However, a mortgage process simply revolves around a collateral security that is kept as a substitute for an equivalent financial value. 

 

It involves a legal agreement, also known as a mortgage deed, that takes place between the mortgagor (one who lends money) and mortgagee (one who borrows money). 

 

In order to apply for a mortgage, mortgagees are required to apply for the same. Although the process sounds easy, it is a bit complicated and involves great caution and care at every step of the way. 

 

When the question - what is a mortgage arises, one must obtain an in-depth knowledge of the concept. 

 

Let us explore further categories that will help us to get an in-depth knowledge about the same. But let us first understand the origin of the word ‘mortgage’.  


 

Roots of the Mortgage

 

An age-old concept, mortgage derives its meaning from the French word “mort” meaning dead, and Latin word “gage” meaning pledge. The roots of the word are derived from these 2 terms that together make the term-  dead pledge, which implies a contract that dies once the loan is paid back or fails to get deposited. 

 

Mortgage is an ancient concept that has been in practice ever since humans started taking loans from each other. The roots of the concept emerged back in the 15th century when laws started coming up in the Middle Ages. Till the 19th century, the concept has begun to evolve with more stringent laws coming up.  

 

The evolution of mortgage from deals between the emperor and the subjects to deals between two professionals has helped us to understand the way the mortgage interest rates have grown over the years. 

 

The history of mortgage reflects on the way the concept came into being and the timeline over which it has walked along. Before the era of the Great Depression (1930s), the mortgage deeds extended upto a span of 5-10 years. However, after the Great Depression, the mortgage deeds would extend upto a duration of 15-30 years due to the stark reduction in the real estate market. 

 

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Components of Mortgage

 

Here is a list of components of mortgage that will help you to develop a better understanding of the concept. In addition, it will also provide an insight into the elements that are involved in mortgaging a property or a real-estate commodity. 


 

The image explains the 4 components of mortgage that are involved in the process. 1. Principal Amount 2. Interest Rate 3. Security 4. Escrow Account

Components of Mortgage


  1. PRINCIPAL- When a mortgagee borrows a particular amount of money from the borrower or the mortgagor, that specific amount is considered to be the principal. Thus principal amount is said to be the sum amount that is equivalent to any property that is kept as a mortgage or a security. 

 

  1. INTEREST- Opposed to the Principal, the interest is the fee or amount that is charged on the principal when the mortgagee borrows money from the mortgagor. The interest can be a monthly charged or a yearly charged fee imposed on the principal amount that is to be repaid. 

 

  1. SECURITY- Another essential component of mortgage, security is a collateral element that is obtained from the mortgagee. Usually, when the mortgagee borrows a loan, s/he is required to provide a security that is equivalent to the principal borrowed. This acts as a security to the mortgagor. 

 

If in case the mortgagee fails to repay the principal, the security is forfeited by the mortgagee to the mortgagor. 

 

  1. ESCROW ACCOUNT- The escrow account, the fourth component from the list, is an account wherein the mortgagor deposits money collected from the mortgagee. These deposits, also known as taxes, are charged by the local government authorities on the real-estate property. 

 

A part of these taxes is collected by the mortgagor until the principal amount is repaid long with the interest. 

 

Other components that have a major role to play in the process of mortgage are down payment. 

 

  • It is the first installment that is paid by the mortgagor to the mortgagee in order to mark the onset of the mortgage deed. 

  • It is usually a major chunk of the principal amount as opposed to the following monthly installments that are comparatively lower. 

 

 

Types of Mortgage

 

Although mortgage is a complicated concept that could be initially hard for most to understand, there are different mortgage types that will help us understand the working of the concept in a better manner. 

 

Discover the various types of mortgage mentioned below. 

 

  1. REPAYMENT MORTGAGE

 

The first kind of all, repayment mortgages are the standard concept wherein the principal amount is repaid by the mortgagee in a number of installments. The mortgagor, in this concept, intends to repay the amount as decided with the mortgagor. 

 

The interest is added to the principal amount and is divided into a number of installments that are paid throughout the defined time period of the mortgage deed. Until the borrowed money is paid back, the property acts as a mortgage or security, and stays in possession of the mortgagor. 

 

 

  1. INTEREST-ONLY MORTGAGE

 

The second type, the interest-only mortgage is a different concept as compared to the first one. Under this concept, the mortgagee pays the interest rate to the mortgagor. As opposed to the repayment mortgage, the interest-only mortgage involves the mortgagee paying just the interest rate and nothing else. 

 

Once the mortgage deed comes to an end, the mortgagee then pays off the principal amount and so, the deed dies. While the mortgagee only pays the interest over the deed, s/he is allowed to invest the property somewhere else. The profit earned from this investment is then accumulated to pay off the principal amount at the end of the deed. 

 

 

  1. FIXED-RATE MORTGAGE

 

As the name itself suggests, the concept of fixed-rate mortgage is the 3rd type of mortgage. It involves the payment of the principal amount along with the interest that is fixed. 

 

As agreed by both the parties, the interest rate remains the same or fixed throughout the deed and perhaps the mortgagee is liable to pay the required amount on regular intervals. 

 

The fixed-rate mortgage can either be fixed for all the installments or it can be fixed for a certain period of time. Let us suppose that a mortgage is a 10-years long deed. 

 

Under the concept of fixed mortgage rate, the interest rate imposed on the regular installments will remain fixed or stable throughout the duration of the deed. 

 

 

  1. VARIABLE  RATE MORTGAGE

 

The concept of variable rate mortgage is a bit different from the fixed rate mortgage concept. As the name suggests, the variable rate mortgage involves the interest rate that can change from time to time. 

 

The variable rate mortgage concept majorly relies on the discretion of the mortgagor who decides the interest rate. The interest rate can be changed at regular intervals or can be changed on a monthly basis too, depending on the mortgagor's discretion.

 

There are a few subtypes of the variable rate mortgage concepts. These are- offset mortgage, flexible mortgage, capped rate mortgage, tracker mortgage, discounted rate mortgage, and standard variable rate mortgage. 

 

All these subtypes differ on the grounds of how often the interest rate fluctuates and on what terms. Different circumstances may lead to different subtypes of the process of mortgage.

 

Besides that, depending on the situation, various mortgage deeds can be categorized under various types of mortgage. 


 

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Which are the Parties involved in Mortgage?

 

While the concept of mortgage is an affair between two consenting parties, often more than two parties are involved in the whole process. Let us have a look at the professionals who are involved in the mortgage process. 

 

  1. A mortgage broker is a professional who breaks the deal between two parties- the mortgagor and the mortgagee. The broker, acting as a link in the mortgage broker process, is aware of all possible mortgagors who can extend their financial help to possible mortgagees. 

 

  1. A highly crucial link between the two parties, a professional broker can either be an individual or a whole firm. 

 

"Flatworld Solutions is one of the prominent mortgage services providers headquartered in India, offering comprehensive solutions to global mortgage brokers, mortgage lenders, real estate finance professionals, and mortgage experts." (From)

 

Such companies help their customers to mortgage property and ease down the process for efficient communication. 

 

  1. Bankers are yet another class of professionals that can be involved in the process of mortgage. More than often, individuals apply for mortgages from banks. Banks extend mortgage loans that serve a deed of upto 15 years and usually follow the concept of fixed rate mortgage. 

 

In general, common people usually get confused between a loan officer and a mortgage broker. 

 

  • While a mortgage broker job is an independent job, the job of a loan officer is linked to a bank that assigns financial loans to its customers. 

  • Another difference between the two is that the mortgage broker acts as a common point for the mortgagor and the mortgagee. Whereas, a loan officer simply approves an individual of a loan, if in case s/he is capable of borrowing the said principal amount. 

 

 

Conclusion

 

To sum up, the mortgage is a process that includes the borrowing and lending of a financial amount in place of a property kept as a security. The process involves a mortgagee and a mortgagor who together pay their consent to a mortgage deed or deal that remains active or alive until the principal amount is successfully repaid. 

 

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The mortgagee is liable to forfeit his/her property if the same fails to repay the amount within the given time. As different types of mortgage exist, the two parties can determine the terms and conditions and act as per their discretion. 

 

Lastly, the mortgage process has many components attached to it that together build the process. All components are equally vital for the process and perhaps the age-old concept has a strong foundation attached to its functioning. 

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