Additional Information on Mortgages
Mortgage information and terminology for the UK and US
Mortgage is the generic term for a loan secured by a
real property. As with other types of loans, mortgages have an
interest rate and are scheduled to amortize over a set period of
time; typically 30 years. All types of real property can, and
usually are, secured with a mortgage and bear an interest rate
that is supposed to reflect the lender's risk.
Mortgage lending is the primary mechanism used in many countries
to finance private ownership of residential property. Although the
terminology and precise forms will differ from country to
country, the basic components tend to be similar:
Property: the physical residence being financed. The
exact form of ownership will vary from country to country, and
may restrict the types of lending that are possible.
Mortgage: the security created on the property by the lender,
which will usually include certain restrictions on the use or
disposal of the property (such as paying any outstanding debt
before selling the property).
Borrower: the person borrowing who either has or is creating an
ownership interest in the property.
Lender: any lender, but usually a bank or other financial
institution.
Principal: the original size of the loan, which may or may not
include certain other costs; as any principal is repaid, the
principal will go down in size.
Interest: a financial charge for use of the lender's money.
Foreclosure or repossession: the possibility that the lender has
to foreclose, repossess or seize the property under certain
circumstances is essential to a mortgage loan; without this
aspect, the loan is arguably no different from any other type of
loan.
Many other specific characteristics are common to many markets,
but the above are the essential features. Governments usually
regulate many aspects of mortgage lending, either directly
(through legal requirements, for example) or indirectly (through
regulation of the participants or the financial markets, such as
the banking industry), and often through state intervention
(direct lending by the government, by state-owned banks, or
sponsorship of various entities). Other aspects that define a
specific mortgage market may be regional, historical, or driven
by specific characteristics of the legal or financial system.
Mortgage loan basics
Mortgage loans are generally structured as long-term loans,
the periodic payments for which are similar to an annuity and
calculated according to the time value of money formulae. The
most basic arrangement would require a fixed monthly payment
over a period of ten to thirty years, depending on local
conditions. Over this period the principal component of the loan
(the original loan) would be slowly paid down through
amortization. In practice, many variants are possible and common
worldwide and within each country. Lenders provide funds against property to earn interest income,
and generally borrow these funds themselves (for example, by
taking deposits or issuing bonds). The price at which the
lenders borrow money therefore affects the cost of borrowing.
Lenders may also, in many countries, sell the mortgage loan to
other parties who are interested in receiving the stream of cash
payments from the borrower, often in the form of a security (by
means of a securitization). In the United States, the largest
firms securitizing loans are Fannie Mae and Freddie Mac, which
are government sponsored enterprises. Mortgage lending will also take into account the (perceived) riskiness of the mortgage loan, that is, the likelihood that the
funds will be repaid (usually considered a function of the
creditworthiness of the borrower); that if they are not repaid,
the lender will be able to foreclose and recoup some or all of
its original capital; and the financial, interest rate risk and
time delays that may be involved in certain circumstances. More recently, mortgage loan brokers have expanded their
businesses to include a web presence. There is now even a market
for standard web templates which are used by brokers who want to
quickly develop an online component to their business. Mortgage loan types
There are many types of mortgages used worldwide, but several
factors broadly define the characteristics of the mortgage. All
of these may be subject to local regulation and legal
requirements.
Interest: interest may be fixed for the life of the loan
or variable, and change at certain pre-defined periods; the
interest rate can also, of course, be higher or lower.
Term: mortgage loans generally have a maximum term, that is, the
number of years after which an amortizing loan will be repaid.
Some mortgage loans may have no amortization, or require full
repayment of any remaining balance at a certain date, or even
negative amortization.
Payment amount and frequency: the amount paid per period and the
frequency of payments; in some cases, the amount paid per period
may change or the borrower may have the option to increase or
decrease the amount paid.
Prepayment: some types of mortgages may limit or restrict
prepayment of all or a portion of the loan, or require payment
of a penalty to the lender for prepayment.
The two basic types of amortized loans are the fixed rate
mortgage (FRM) and adjustable rate mortgage (ARM) (also known as
a floating rate or variable rate mortgage). In many countries,
floating rate mortgages are the norm and will simply be referred
to as mortgages; in the United States, fixed rate mortgages are
typically considered "standard." Combinations of fixed and
floating rate are also common, whereby a mortgage loan will have
a fixed rate for some period, and vary after the end of that
period.
In a fixed rate mortgage, the
interest rate, and hence periodic payment, remains fixed for the
life (or term) of the loan. In the U.S., the term is usually up
to 30 years (15 and 30 being the most common), although longer
terms may be offered in certain circumstances. For a fixed rate
mortgage, payments for principal and interest should not change
over the life of the loan, although ancillary costs (such as
property taxes and insurance) can and do change.
In an adjustable rate mortgage, the interest rate is generally
fixed for a period of time, after which it will periodically
(for example, annually or monthly) adjust up or down to some
market index. Common indices in the U.S. include the Prime Rate,
the London Interbank Offered Rate (LIBOR), and the Treasury
Index ("T-Bill"); other indices are in use but are less popular.
Adjustable rates 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.
Since the risk is transferred to the borrower, the initial
interest rate may be from 0.5% to 2% lower than the average
30-year fixed rate; the size of the price differential will be
related to debt market conditions, including the yield curve.
Additionally, lenders in many markets rely on credit reports and
credit scores derived from them. The higher the score, the more
creditworthy the borrower is assumed to be. Favourable interest
rates are offered to buyers with high scores. Lower scores
indicate higher risk for the lender, and higher rates will
generally be charged to reflect the (expected) higher default
rates.
A partial amortization or balloon loan is one where the amount
of monthly payments due are calculated (amortized) over a
certain term, but the outstanding principal balance is due at
some point short of that term. This payment is sometimes
referred to as a "balloon payment" or bullet payment. The
interest rate for a balloon loan can be either fixed or
floating. The most common way of describing a balloon loan uses
the terminology X due in Y, where X is the number of years over
which the loan is amortized, and Y is the year in which the
principal balance is due.
Other loan types:
- Assumed mortgage
- Balloon mortgage
- Blanket loan
- Bridge loan
- Budget loan
- Buy down mortgage
- Commercial loan
- Equity loan
- Foreign National mortgage
- Graduated payment mortgage loan
- Hard money loan
- Jumbo mortgages
- Package loan
- Participation mortgage
- Reverse mortgage
- Repayment mortgage
- Seasoned mortgage
- Term loan or Interest-only loan
- Wraparound mortgage
- Negative amortization loan
- Non-conforming mortgage
Loan to value and down payments
Upon making a mortgage loan for purchase of a property,
lenders usually require that the borrower make a down payment,
that is, contribute a portion of the cost of the property. This
down payment may be expressed as a portion of the value of the
property (see below for a definition of this term). The loan to
value ratio (or LTV) is the size of the loan against the value
of the property. Therefore, a mortgage loan where the purchaser
has made a down payment of 20% has a loan to value ratio of 80%.
For loans made against properties that the borrower already
owns, the loan to value ratio will be imputed against the
estimated value of the property.
The loan to value ratio is considered an important indicator of
the riskiness of a mortgage loan: the higher the LTV, the higher
the risk that the value of the property (in case of foreclosure)
will be insufficient to cover the remaining principal of the
loan.
Value: appraised, estimated, and actual
Since the value of the property is an important factor in
understanding the risk of the loan, determining the value is a
key factor in mortgage lending. The value may be determined in
various ways, but the most common are:
Actual or transaction value: this is usually taken to be
the purchase price of the property. If the property is not being
purchased at the time of borrowing, this information may not be
available.
Appraised or surveyed value: in most jurisdictions, some
form of appraisal of the value by a licensed professional is
common. There is often a requirement for the lender to obtain an
official appraisal.
Estimated value: lenders or other parties may use their
own internal estimates, particularly in jurisdictions where no
official appraisal procedure exists, but also in some other
circumstances.
Equity or homeowner's equity
The concept of equity in a property refers to the value of
the property minus the outstanding debt, subject to the
definition of the value of the property. Therefore, a borrower
who owns a property whose estimated value is $400,000 but with
outstanding mortgage loans of $300,000 is said to have
homeowner's equity of $100,000.
Payment and debt ratios
In most countries, a number of more or less standard measures
of creditworthiness may be used. Common measures include payment
to income (mortgage payments as a percentage of gross or net
income); debt to income (all debt payments, including mortgage
payments, as a percentage of income); and various net worth
measures. In many countries, credit scores are used in lieu of
or to supplement these measures. There will also be requirements
for documentation of the creditworthiness, such as income tax
returns, pay stubs, etc; the specifics will vary from location
to location. Many countries have lower requirements for certain
borrowers, or "no-doc" / "low-doc" lending standards that may be
acceptable in certain circumstances.
Standard or conforming mortgages
Many countries have a notion of standard or conforming
mortgages that define a perceived acceptable level of risk,
which may be formal or informal, and may be reinforced by laws,
government intervention, or market practice. For example, a
standard mortgage may be considered to be one with no more than
70-80% LTV and no more than one-third of gross income going to
mortgage debt. A standard or conforming mortgage is a key concept as it often
defines whether or not the mortgage can be easily sold or
securitized, or, if non-standard, may affect the price at which
it may be sold. In the United States, a conforming mortgage is
one which meets the established rules and procedures of the two
major government-sponsored entities in the housing finance
market (including some legal requirements). In contrast, lenders
who decide to make nonconforming loans are exercising a higher
risk tolerance and do so knowing that they face more challenge
in reselling the loan. Many countries have similar concepts or
agencies that define what are "standard" mortgages. Regulated
lenders (such as banks) may be subject to limits or higher risk
weightings for non-standard mortgages. For example, banks in
Canada face restrictions on lending more than 75% of the
property value; beyond this level, mortgage insurance is
generally required (as of April 2007, there is a proposal to
raise this limit to 80%).
Repaying the capital
There are various ways to repay a mortgage loan; repayment
depends on locality, tax laws and prevailing culture. Capital & interest
The most common way to repay a loan is to make regular
payments of the capital (also called principal) and interest
over a set term. This is commonly referred to as (self)
amortization in the U.S. and as a repayment mortgage in the UK.
A mortgage is a form of annuity (from the perspective of the
lender), and the calculation of the periodic payments is based
on the time value of money formulas. Certain details may be
specific to different locations: interest may be calculated on
the basis of a 360-day year, for example; interest may be
compounded daily, yearly, or semi-annually; prepayment penalties
may apply; and other factors. There may be legal restrictions on
certain matters, and consumer protection laws may specify or
prohibit certain practices.
Depending on the size of the loan and the prevailing practice in
the country the term may be short (10 years) or long (50 years
plus). In the UK and U.S., 25 to 30 years is the usual maximum
term (although shorter periods, such as 15-year mortgage loans,
are common). Mortgage payments, which are typically made
monthly, contain a capital (repayment of the principal) and an
interest element. The amount of capital included in each payment
varies throughout the term of the mortgage. In the early years
the repayments are largely interest and a small part capital.
Towards the end of the mortgage the payments are mostly capital
and a smaller portion interest. In this way the payment amount
determined at outset is calculated to ensure the loan is repaid
at a specified date in the future. This gives borrowers
assurance that by maintaining repayment the loan will be cleared
at a specified date, if the interest rate does not change.
Interest only
The main alternative to capital and interest mortgage is an
interest only mortgage, where the capital is not repaid
throughout the term. This type of mortgage is common in the UK,
especially when associated with a regular investment plan. With
this arrangement regular contributions are made to a separate
investment plan designed to build up a lump sum to repay the
mortgage at maturity. This type of arrangement is called an
investment-backed mortgage or is often related to the type of
plan used: endowment mortgage if an endowment policy is used,
similarly a Personal Equity Plan (PEP) mortgage, Individual
Savings Account (ISA) mortgage or pension mortgage.
Historically, investment-backed mortgages offered various tax
advantages over repayment mortgages, although this is no longer
the case in the UK. Investment-backed mortgages are seen as
higher risk as they are dependent on the investment making
sufficient return to clear the debt. It is not uncommon for interest only mortgages to be arranged
without a repayment vehicle, with the borrower gambling that the
property market will rise sufficiently for the loan to be repaid
by trading down at retirement (or when rent on the property and
inflation combine to surpass the interest rate).
No capital or interest
For older borrowers (typically in retirement), it may be
possible to arrange a mortgage where neither the capital nor
interest is repaid. The interest is rolled up with the capital,
increasing the debt each year.
These arrangements are variously called reverse mortgages,
lifetime mortgages or equity release mortgages, depending on the
country. The loans are typically not repaid until the borrowers
die, hence the age restriction. For further details, see equity
release.
Interest and partial capital
In the U.S. a partial amortization or balloon loan is one
where the amount of monthly payments due are calculated
(amortized) over a certain term, but the outstanding capital
balance is due at some point short of that term. In the UK, a
part repayment mortgage is quite common, especially where the
original mortgage was investment-backed and on moving house
further borrowing is arranged on a capital and interest
(repayment) basis.
Foreclosure and non-recourse lending
In most jurisdictions, a lender may foreclose the mortgaged
property if certain conditions - principally, non-payment of the
mortgage loan - obtain. Subject to local legal requirements, the
property may then be sold. Any amounts received from the sale
(net of costs) are applied to the original debt. In some
jurisdictions, mortgage loans are non-recourse loans: if the
funds recouped from sale of the mortgaged property are
insufficient to cover the outstanding debt, the lender may not
have recourse to the borrower after foreclosure. In other
jurisdictions, the borrower remains responsible for any
remaining debt. In virtually all jurisdictions, specific
procedures for foreclosure and sale of the mortgaged property
apply, and may be tightly regulated by the relevant government;
in some jurisdictions, foreclosure and sale can occur quite
rapidly, while in others, foreclosure may take many months or
even years. In many countries, the ability of lenders to
foreclose is extremely limited, and mortgage market development
has been notably slower.
Mortgage lending: United States
United States mortgage process
In the U.S., the process by which a mortgage is secured by a
borrower is called origination. This involves the borrower
submitting an application and documentation related to his/her
financial history and/or credit history to the underwriter. Many
banks now offer "no-doc" or "low-doc" loans in which the
borrower is required to submit only minimal financial
information. These loans carry a slightly higher interest rate
(perhaps 0.25% to 0.50% higher) and are available only to
borrowers with excellent credit.
Sometimes, a third party is involved, such as a mortgage broker.
This entity takes the borrower's information and reviews a
number of lenders, selecting the ones that will best meet the
needs of the consumer.
Loans are often sold on the open market to larger investors by
the originating mortgage company. Many of the guidelines that
they follow are suited to satisfy investors. Some companies,
called correspondent lenders, sell all or most of their closed
loans to these investors, accepting some risks for issuing them.
They often offer niche loans at higher prices that the investor
does not wish to originate.
If the underwriter is not satisfied with the documentation
provided by the borrower, additional documentation and
conditions may be imposed, called stipulations. The meeting of
such conditions can be a daunting experience for the consumer,
but it is crucial for the lending institution to ensure the
information being submitted is accurate and meets specific
guidelines. This is done to give the lender a reasonable
guarantee that the borrower can and will repay the loan. If a
third party is involved in the loan, it will help the borrower
to clear such conditions.
The following documents are typically required for traditional
underwriter review. Over the past several years, use of
"automated underwriting" statistical models has reduced the
amount of documentation required from many borrowers. Such
automated underwriting engines include Freddie Mac's "Loan
Prospector" and Fannie Mae's "Desktop Underwriter". For
borrowers who have excellent credit and very acceptable debt
positions, there may be virtually no documentation of income or
assets required at all. Many of these documents are also not
required for no-doc and low-doc loans.
Credit Report
1003 — Uniform Residential Loan Application
1004 — Uniform Residential Appraisal Report
1005 — Verification Of Employment (VOE)
1006 — Verification Of Deposit (VOD)
1007 — Single Family Comparable Rent Schedule
1008 — Transmittal Summary
Copy of deed of current home
Federal income tax records for last two years
Verification of Mortgage (VOM) or Verification of Payment (VOP)
Borrower's Authorization
Purchase Sales Agreement
1084A and 1084B (Self-Employed Income Analysis) and 1088
(Comparative Income Analysis) - used if borrower is
self-employed
Predatory mortgage lending
There is concern in the U.S. that consumers are often victims of
predatory mortgage lending. The main concern is that
mortgage brokers and lenders, operating legally, are finding
loopholes in the law to obtain additional profit. The typical
scenario is that terms of the loan are beyond the means of the
borrower. The borrower makes a number of interest and principal
payments, and then defaults. The lender then takes the property
and recovers the amount of the loan, and also keeps the interest
and principal payments, as well as loan origination fees.
Option ARM
An option ARM provides the option to pay as little as the
equivalent of an amortized payment based on a 1% interest
rate, (please note this is not the actual interest rate). As a
result, the difference between the monthly payment and the
interest on the loan is added to the loan principal; the loan at
this point has negative amortization. In this respect, an option
ARM provides a form of equity withdrawal (as in a cash-out
refinancing) but over a period of time.
The option ARM gives a number of payment choices each month (for
example, the equivalent of an amortized payment were the
interest rate 1%, interest only based on actual interest rate,
actual 30 year amortized payment, actual 15 year amortized
payment). The interest rate may adjust every month in accordance
with the index to which the loan is tied and the terms of the
specific loan. These loans may be useful for people who have a
lot of equity in their home and want to lower monthly costs; for
investors, allowing them the flexibility to choose which payment
to make every month; or for those with irregular incomes (such
as those working on commission or for whom bonuses comprise a
large portion of income).
One of the important features of this type of loan is that the
minimum payments are often fixed for each year for an initial
term of up to 5 years. The minimum payment may rise each year a
little (payment size increases of 7.5% are common) but remain
the same for another year. For example, a minimum payment for
year 1 may be $1,000 per month each month all year long. In year
2 the minimum payment for each month is $1,075 each month. This
is a gradual increase in the minimum payment. The interest rate
may fluctuate each month, which means that the extent of any
negative amortization cannot be predicted beyond worst-case
scenario as dictated by the terms of the loan.
Option ARM mortgages have been criticized on the basis that some
borrowers are not aware of the implications of negative
amortization; that eventually option ARMs reset to higher
payment levels (an event called "recast" to amortize the loan),
and borrowers may not be capable of making the higher monthly
payments; and that option ARMs have been used to qualify
mortgages for individuals whose incomes cannot support payments
higher than the minimum level.
Costs
Lenders may charge various fees when giving a mortgage to a
mortgagor. These include entry fees, exit fees, administration
fees and lenders mortgage insurance. There are also settlement
fees (closing costs) the settlement company will charge. In
addition, if a third party handles the loan, it may charge other
fees as well.
The United States mortgage finance industry
Mortgage lending is a major category of the business of finance
in the United States. Mortgages are commercial paper and can be
conveyed and assigned freely to other holders. In the U.S., the
Federal government created several programs, or government
sponsored entities, to foster mortgage lending, construction and
encourage home ownership. These programs include the Government
National Mortgage Association (known as Ginnie Mae), the Federal
National Mortgage Association (known as Fannie Mae) and the
Federal Home Loan Mortgage Corporation (known as Freddie Mac).
These programs work by buying a large number of mortgages from
banks and issuing (at a slightly lower interest rate)
"mortgage-backed bonds" to investors, which are known as
Mortgage Backed Securities (MBS).
This allows the banks to quickly relend the money to other
borrowers (including in the form of mortgages) and thereby to
create more mortgages than the banks could with the amount they
have on deposit. This in turn allows the public to use these
mortgages to purchase homes, something the government wishes to
encourage. The investors, meanwhile, gain low-risk income at a
higher interest rate (essentially the mortgage rate, minus the
cuts of the bank and GSE) than they could gain from most other
bonds.
Securitization is a momentous change in the way that mortgage
bond markets function, and has grown rapidly in the last 10
years as a result of the wider dissemination of technology in
the mortgage lending world. For borrowers with superior credit,
government loans and ideal profiles, this securitization keeps
rates almost artificially low, since the pools of funds used to
create new loans can be refreshed more quickly than in years
past, allowing for more rapid outflow of capital from investors
to borrowers without as many personal business ties as the past.
Mortgages in the UK
UK mortgage terminology
Mortgage types
The UK mortgage market is one of the most innovative and
competitive in the world. Unlike other countries there is no
intervention in the market by the state or state funded entities
and virtually all borrowing is funded by either mutual
organisations (building societies and credit unions) or
proprietary lenders (typically banks). Since 1982, when the
market was substantially deregulated, there has been substantial
innovation and diversification of strategies employed by lenders
to attract borrowers. This has led to a wide range of mortgage
types.
As lenders derive their funds either from the money markets or
from deposits, most mortgages revert to a variable rate, either
the lenders standard variable rate or a tracker rate, which will
tend to be linked to the underlying Bank of England (BoE) repo
rate (or sometimes LIBOR). Initially they will tend to offer an
incentive deal to attract new borrowers. This may be:
A fixed rate; where the interest rate remains constant for a set
period; typically for 2, 3, 4, 5 or 10 years. Longer term fixed
rates (over 5 years) whilst available, tend to be more expensive
and therefore less popular than shorter term fixed rates.
A capped rate; where similar to a fixed rate, the interest rate
cannot rise above the cap but can vary beneath the cap.
Sometimes there is a collar associated with this type of rate
which imposes a minimum rate. Capped rate are often offered over
periods similar to fixed rates, e.g. 2, 3, 4 or 5 years.
A discount rate; where there is set margin reduction in the
standard variable rate (e.g. a 2% discount) for a set period;
typically 1 to 5 years. Sometimes the discount is expressed as a
margin over the base rate (e.g. BoE base rate plus 0.5% for 2
years) and sometimes the rate is stepped (e.g. 3% in year 1, 2%
in year 2, 1% in year three).
A cash back mortgage; where a lump sum is provided (typically) as
a percentage of the advance e.g. 5% of the loan.
To make matters more confusing these rates are often combined:
For example, 4.5% 2 year fixed then a 3 year tracker at Bank of
England rate
plus 0.89%.
With each incentive the lender may be offering a rate at less
than the market cost of the borrowing. Therefore, they typically
impose a penalty if the borrower repays the loan; this used to
be called a redemption penalty or tie-in, however since the
onset of Financial Services Authority regulation they are
referred to as an early repayment charge.
Self Cert Mortgage
Mortgage lenders usually use salaries declared on wage slips to
work out a borrower's annual income and will usually lend up to
a fixed multiple of the borrower's annual income. Self
Certification Mortgages, informally known as "self cert"
mortgages, are available to employed and self employed people
who have a deposit to buy a house but lack the sufficient
documentation to prove their income.
This type of mortgage can be beneficial to people whose income
comes from multiple sources, whose salary consists largely or
exclusively of commissions or bonuses, or whose accounts may not
show a true reflection of their earnings. Self cert mortgages
have two disadvantages: the interest rates charged are usually
higher than for normal mortgages and the loan to value ratio is
usually lower.
100% Mortgages
Normally when a bank lends a customer money they want to protect
their money as much as possible, they do this by asking the
borrower to pay a certain percentage of the loan in the form of
a deposit.
100% mortgages are mortgages that require no deposit (100% loan
to value). These are sometimes offered to first time buyers, but
almost always carry a higher interest rate on the loan.
UK mortgage process
UK lenders usually charge a valuation fee, which pays for a
chartered surveyor to visit the property and ensure it is worth
enough to cover the mortgage amount. This is not a full survey
so it may not identify all the defects that a house buyer needs
to know about. Also, it does not usually form a contract between
the surveyor and the buyer, so the buyer has no right to sue if
the survey fails to detect a major problem. For an extra fee,
the surveyor can usually carry out a building survey or a
(cheaper) "homebuyers survey" at the same time.
Mortgage insurance
Mortgage insurance is an insurance policy designed to protect
the mortgagee (lender) from any default by the mortgagor
(borrower). It is used commonly in loans with a loan-to-value
ratio over 80%, and employed in the event of foreclosure and
repossession.
This policy is typically paid for by the borrower as a component
to final nominal (note) rate, or in one lump sum up front, or as
a separate and itemized component of monthly mortgage payment.
In the last case, mortgage insurance can be dropped when the
lender informs the borrower, or its subsequent assigns, that the
property has appreciated, the loan has been paid down, or any
combination of both to relegate the loan-to-value under 80%.
In the event of repossession, banks, investors, etc. must resort
to selling the property to recoup their original investment (the
money lent), and are able to dispose of hard assets (such as
real estate) more quickly by reductions in price. Therefore, the
mortgage insurance acts as a hedge should the repossessing
authority recover less than full and fair market value for any
hard asset.
Islamic mortgages
The Sharia law of Islam prohibits the payment or receipt of
interest, which means that practising Muslims cannot use
conventional mortgages. However, real estate is far too
expensive for most people to buy outright using cash: Islamic
mortgages solve this problem by having the property change hands
twice. In one variation, the bank will buy the house outright
and then act as a landlord. The homebuyer, in addition to paying
rent, will pay a contribution towards the purchase of the
property. When the last payment is made, the property changes
hands.
Typically, this may lead to a higher final price for the buyers.
This is because in some countries (such as the United Kingdom
and India) there is a Stamp Duty which is a tax charged by the
government on a change of ownership. Because ownership changes
twice in an Islamic mortgage, a stamp tax may be charged twice.
Many other jurisdictions have similar transaction taxes on
change of ownership which may be levied.
An alternative scheme involves the bank reselling the property
according to an instalment plan, at a price higher than the
original price.
All of these methods are still compensating the lender as if
they were charging interest, but the loans are structured in a
way that in name they are not, but they share the financial
risks involved in the transaction with the homebuyer.
Other Terminologies
Like any other legal system, the mortgage business sometimes
uses confusing jargon. Below are some terms explained in brief.
If a term is not explained here it may be related to the legal
mortgage rather than to the loan.
Advance This is the money you have borrowed plus all the
additional fees.
Base Rate In UK, this is the base interest rate set by the Bank
of England. In the United States, this value is set by the
Federal Reserve and is known as the Discount Rate.
Bridging Loan This is a temporary loan that enables the borrower
to purchase a new property before the borrower is able to sell
another current property.
Disbursements These are all the fees of the solicitors and
governments, such as stamp duty, land registry, search fees,
etc.
Early Redemption Charge / Pre-Payment Penalty / Redemption
Penalty This is the amount of money due if the mortgage is paid
in full before the time finished.
Equity This is the market value of the property minus all loans
outstanding on it.
First time buyer This is the term given to a person buying
property for the first time.
Loan Origination Fee A charge levied by a creditor for
underwriting a loan. The fee often is expressed in points. A
point is 1 percent of the loan amount.
Sealing Fee This is a fee made when the lender releases the
legal charge over the property.
Subject To Contract This is an agreement between seller and
buyer before the actual contract is made.
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