How Mortgages Work

By: Bob Miles

A mortgage is created when someone uses real estate to secure a promise to repay a debt. For example, if you borrow money from a bank and give the bank permission to sell your house to pay off the debt if you don't pay it back yourself, then you have created a mortgage on your house. Since most people can't afford to pay cash for a house, most people create what is known as a purchase money mortgage on their house (at least their first house anyway). This means that the bank uses the house as security for your promise to repay the money they loaned you to buy the house in the first place. The mortgage is the document used to create this security interest. The one who borrowed the money is called the mortgager, and the one who loaned the money (the bank in this case) is called the mortgagee.

The main advantage of a mortgage for the mortgagee is that if you don't pay back the loan, they don't have to worry whether they can find you or not or if you have enough money to pay the debt. The main advantage for the mortgager is that he can get a loan that way that he might not be able to get otherwise - he can borrow $100,000 on an annual salary of $50,000 and total savings of $10,000, even though without his new house as security there's no way the bank would have loaned him that much money.

If you mortgage your house and then default on the underlying loan (fail to pay it back according to the terms of the loan agreement), what will the bank do? Well, it's unlikely that the president of the bank is going to move in. Instead, the bank will sell the house (most likely through a judicial sale) and take the money that you own them out of the proceeds. If the proceeds are not less than what you owe them (which is unlikely if they have competent loan officers), then you will still owe them the difference (and the debt will be unsecured, since you don't own the house anymore). If, on the other hand, there is money left over after the mortgage is paid and the expenses of the sale are covered, you get to keep it, assuming that there are no other mortgages on the house Actually it does get a bit more complex than this, but I'm sure you get the basic idea.

DISCLAIMER: The following is intended for reference purposes only and does not constitute legal advice.

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