Mortgage

Open full sized image

Modern mortgages play an important role in maintaining the market in residential housing.

BrendelSignature

Mortgage, in Anglo-American, or common, law, any of a number of related devices whereby a debtor (mortgagor) secures a loan from a creditor (mortgagee) for the purchase of real estate (buildings or land) by using the purchased property as collateral. In some mortgage agreements the creditor is the nominal owner of the property until the loan is fully repaid; in others the debtor is the nominal owner, but the creditor has the right, if the debtor defaults on the loan, to seize the property and sell it to recover the outstanding debt (see foreclosure). Under both arrangements debtors retain possession of the property unless and until they default. The Anglo-American mortgage roughly corresponds to the hypothec in civil-law systems.

The modern Anglo-American mortgage is the direct descendant of a form of transaction that emerged in England in the later Middle Ages. The debtor conveyed (transferred) the ownership of land to the creditor subject to the condition that, if the debtor repaid the debt owed to the creditor by a certain time, the creditor would reconvey the land to the debtor. If the debtor failed to repay the debt by the time specified in the mortgage, the land became the creditor’s absolutely. This form of transaction was known, under different names, throughout the ancient world and medieval Europe. It is to be distinguished from types of security devices (also known in both ancient and modern times) in which the debtor gives the creditor possession but not ownership of the property (the pledge in civil-law systems and the gage of land in the early English common law) or in which the debtor does not give the creditor possession of the property but simply a right to satisfy the debt out of the property if the debtor fails to pay (the lien or hypothec).

The common-law mortgage of the late Middle Ages was thus a strong form of security. The history of its development is one of progressive loosening in favour of the debtor. Already at the end of the Middle Ages, it had become the practice for the creditor to allow the debtor to remain in possession of the land, and this practice developed into a right of debtors to retain possession so long as they were not in default on the debt.

Initially, the common-law courts interpreted the conditions in mortgages strictly. In the 16th and 17th centuries, however, the English equity courts intervened on the side of the debtor. Equity first gave the debtor a right to redeem the land by paying the outstanding debt, even after defaulting, so long as the payment was made within a “reasonable time.” In order to clear their title to the land after the debtor had defaulted, creditors brought “actions in equity” to foreclose the debtor’s “equity of redemption.” As a condition of granting the foreclosure, equity gave the debtor a right to the proceeds of the sale of the land to the extent that the sale realized more than the outstanding amount of the debt. In most Anglo-American jurisdictions, legislation in the 19th century extended the debtor’s right to redeem to a fixed period after the creditor had foreclosed. Finally, in many Anglo-American jurisdictions, legislation required that creditors sell the land at public sale after they had foreclosed, and in some of these jurisdictions the sale had to be conducted by a public official.

In the early modern period, security devices similar to mortgages of land were used with personal property, particularly by merchants, and in the 19th century use of this so-called “chattel mortgage” was common throughout the Anglo-American world. The development of the law of chattel mortgages followed a course different from that of mortgages of land, but in most jurisdictions the end result was similar. The creditor’s rights normally do not come into play unless and until the debtor defaults. Because the chattel mortgage was typically a device used by merchants, rather than ordinary citizens, there were fewer protections for the debtor in such transactions (typically, for example, there was no statutory right to redeem). Subsequently, however, the extensive use of chattel mortgage and similar security devices in consumer credit transactions led to an extensive body of regulatory law protecting the consumer’s interest. The mortgage is still the most widely used form of security device in transactions involving land in Anglo-American jurisdictions.

The mortgage serves as a means of promoting the best use of society’s finite resources: people and land. It provides for the ready transferability of land and for the improvement or working of that land by those unable to buy the property with their current resources. An elderly farmer wishing to retire can sell the farm to a younger farmer; the latter can mortgage the property in order to pay the seller full value and obtain sufficient monies to carry out personal plans for the farm.

Mortgages play an even more important role in maintaining the market in residential housing, since they permit individuals with relatively little personal credit to purchase a house by offering the house itself as security for the loan. In the United States, the federal government has supported this type of transaction by developing a secondary market in mortgages. Banks that have placed residential mortgages can sell them in the secondary market in order to raise capital to make further loans. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) were established in 1938 and 1970, respectively, to purchase residential mortgages from banks and to hold or resell them as securities to other investors. The operations of the secondary market have tended to make the law and practice of the various U.S. states more uniform, since the secondary market operates more efficiently if it is dealing with a standardized product. In 2007–08 the secondary market was threatened by drastic declines in the value of securities backed by subprime mortgage loans (see below), resulting in the global financial crisis of 2007–08 and the ensuing Great Recession (2007–09). (See also mortgage-backed security; subprime mortgage; subprime lending.)

In the United States residential mortgages may be classified according to the term of the loan (e.g., 15 years, 20 years, or 30 years); the amount of the required down payment on the property, expressed as a percentage of the property’s sale price; whether the interest rate is fixed or adjustable; and whether the mortgage is “prime” or “subprime.” A fixed-rate mortgage is one whose interest rate remains the same through the entire term of the loan, whereas an adjustable-rate mortgage (called an ARM) is one in which the interest rate is low—often below that of fixed-rate mortgages—for an initial period and then “floats,” or adjusts, with the federal funds rate. In general, fixed interest rates are higher for longer-term loans than for shorter-term loans. Subprime mortgages are extended to home buyers with poor, incomplete, or nonexistent credit histories, and the interest rates on such loans are accordingly higher than those on prime, or standard, mortgages.