What in the world is a mortgage?

By Katie Penny


In law school, to illustrate mortgages, my professors always drew a diagram which resembled a kicked-over capital D. The two lines used to draw the D were arrows that represented the two transactions which had taken place, and it seemed simple enough. However, the amount of confusion about what mortgages actually are and the rights that they entail reveals that the simplicity of the diagram is a bit misleading. In light of the number of foreclosures taking place lately, and the fact that almost every homeowner in this country purchased their home with a loan and a mortgage, mortgages seem like an urgently pertinent topic.

The mortgage relationship at its simplest involves a borrower and a lender. The lender is usually a bank, so for simplicity’s sake, I will say “bank,” but anyone could be a lender to whom a mortgage is granted. Also, anyone could be a borrower, but in the most applicable case, it is a homeowner who has used the loan to purchase a residence.

In essence, when a simple mortgage has been granted, it means this: a bank loans a borrower money. To ensure that it will be able to get its money back, the bank gets the borrower to grant it a mortgage on the property the borrower is purchasing. [The bank gives you money; you give them a mortgage. These are the two lines of my D.] The loan debt is represented by a “promissory note,”—an IOU, if you will—and the borrower has a certain amount of time to pay back the debt, sometimes in installments or sometimes all at once. In exchange, the borrower/homeowner grants the bank a mortgage, which means the bank is “secured” for the amount of the loan through a right to the property on which the mortgage was granted—which is usually the very residence the loan was used to purchase.

In most simple homeowner mortgages, the mortgage document (which is separate from the promissory note) allows the bank to seize and sell the piece of property on which the mortgage was granted if the borrower goes into default on the loan. When the property is sold, the bank is entitled to take the outstanding amount of the loan out of the proceeds of the sale. That way, if you stop making payments on your loan, the bank has the right to take the property, sell it, and get the money you still owed.

I will now try to explain it yet again using actual numbers and names. Katie wants to purchase a house with a price of $250,000. She has 150,000 in the bank (ahh, sweet fantasy!!), but she needs someone to lend her the last $100,000. She goes to Moneybags Bank and they agree to lend her the $100,000 and give her 30 years to pay it back (with interest, of course) in monthly installments. To make sure they get their $100,000 back, Moneybags Bank demands a $100,000 mortgage on the house Katie is purchasing with the loan money. Katie signs the promissory note (this is the straight back of the capital D, by the way), and signs the mortgage (this is the potbelly bottom loop of the kicked-over capital D). She buys the house and moves in happily.

Unfortunately, after paying down $20,000 of the $100,000 debt, Katie finds herself unable to make a few loan payments. Because she has “defaulted” on her loan, the mortgage tied to that loan becomes enforceable by the bank. Moneybags Bank presents the promissory note and the mortgage to the court. If the mortgage and note documents have the proper requirements (and believe me, banks do not usually mess up on making sure mortgages have those requirements; they function on being able to enforce mortgages), the court orders the sheriff to “seize” Katie’s house (which usually just means putting a notice of seizure on the door) and the house is sold at a sheriff’s sale (basically, an auction at the courthouse.) The house sells for $120,000, despite its 300,000 value (since, though it increased in value while Katie owned it, property usually sells for much less than it is worth at a public auction). Katie still owed the bank $80,000 of her $100,000 loan, so the bank takes $80,000 of the $120,000 proceeds, and Katie—who, after all, put in $150,000 of the purchase price—gets the remaining $40,000.

When I say “this can get much more complicated,” I’m sure everyone who has watched the news in the past year would agree. You can grant multiple mortgages on your property, each tied to a different loan, and then when one of the loans is defaulted on, that mortgage becomes enforceable, but not necessarily the other ones (which are tied to other loans.) So older mortgages will stay “tied” to the property despite a sale, and some newer mortgages might be dissolved after the sale. Banks might grant mortgages, then sell the right to enforce the mortgages to other financial institutions. Sometimes, mortgages are not tied to specific loans, but rather to many different loans, or a line of credit. Sometimes there are collateral mortgages, but I don’t want to give anyone a headache.

At its most basic, taking out a loan and granting a mortgage means you give someone the right to sell your house out from underneath you if you do not make payments on the loan. If you take out a loan on which you know you will not be able to afford the monthly payments, do not be surprised when the lender exercises his rights and takes your property. It’s nice to get a loan and have cash in your hands, but when you grant a mortgage for that loan, believe me that you are not getting the money free. If you look up “money, strings attached” in the dictionary, you might just see a picture of my mortgage diagram.