What is a mortgage?
Foreclosing refers to the process of using an asset as collateral for a loan. It’s a way for lenders to protect themselves if the borrower doesn’t repay or breaches the loan agreement.
When you enter into a mortgage, you agree to use the asset as collateral or backing for your loan. However, literally nothing changes about the asset. You still have full possession and use of the asset. The lender does not gain any ownership or privileges. The lender only has rights over the asset if you default or fail to meet the terms of the loan for some other material reason.
Often, the asset in question is the object of the borrowed money. For example, with a car loan, the borrower agrees to use their car as collateral for the funds to purchase the car. The borrower gets ownership of the car, but if they can’t repay the loan, the lender can repossess the car.
Liens aren’t included with all types of loans. They only apply to secured loans. For example, most personal loans are unsecured, so you won’t see a lien. If you get a new credit card, you won’t have a lien. That means these lines of credit aren’t secured, and you don’t have to put anything up to back it.
Types of mortgage agreements
Mortgages are used in many different types of consumer financing.
Mortgage security interest
A lien is a common feature of a mortgage. When you take out a mortgage to buy a home, your home is used as collateral, not with your own money. You own the home, but a lender is the one who lends you the cash you need to buy it. The lender will want compensation if you don’t repay. As a result, your loan comes with a lien, which means the lender can repossess your home if you don’t live up to your agreement.
The definition of a mortgage explained above typically applies to other home-related loans as well. Mortgages play an important role in second mortgages, such as a Home Equity Line of Credit (HELOC) or a home equity loan. You borrow money based on the equity value of your property and agree to use your home as collateral to withdraw the funds.
Commercial Real Estate Mortgages
Mortgages are also fairly common with commercial real estate. If you are buying a commercial property, a lender may require you to put up your home or real estate as collateral.
Similarly, real estate loans for investment properties can also involve liens. In some cases, lenders won’t grant you a loan unless you provide multiple collateral, such as a rental property or a car in addition to your primary residence.
Mortgages on investments
This concept also applies to investing.
The mortgage here works a little differently than it does for a mortgage or other loans.
When you borrow money from a broker to invest in securities, the broker pledges the funds you lend to him. In other words, the securities act as collateral for the funds you lend. You will eventually have to repay the loan, but that’s not the only way you can put your assets at risk. If the value of your securities falls below a certain required amount, you can sell them, have your broker sell them, or agree to make up the difference with new funds to repay some of the funds you borrowed. This is called a margin call.
Other Loan Collateral
Foreclosures are most commonly seen with home loans and home equity loans, but they can also apply to other types of loans, such as:
- Car loans: You agree to use your car, motorcycle, RV, or other vehicle as collateral to secure the loan.
- Business Loans: If you take out a loan to purchase equipment for your company, you may agree to use that equipment (or other company asset) as collateral for the loan.
Why are mortgages important?
Liens are important because they’re part of a formal loan agreement, and if you don’t meet the terms of the loan (like making payments on a car or house), your property can be seized to cover your missed payments.
Knowing the definition of a mortgage is especially important when you become a homeowner. A mortgage is a foreclosed loan, which means that if you miss several mortgage payments in a row, the lender has the right to foreclose on your home, which could leave you with no place to live.
If you’re in financial trouble, consider prioritizing your bills based on which ones are encumbered. For example, you may want to pay off your home or car before your credit card payments to avoid losing valuable assets. Missing a credit card payment can lower your credit score and reduce your chances of getting a loan in the future, but these contracts don’t have encumbrances that require you to pledge something as collateral.
What are the benefits of a mortgage?
Since using your assets as collateral can have dire consequences, you may not think there are any benefits to mortgaging. However, there are some benefits. Some of the benefits of mortgaging include:
- Ease of financing: This reduces the lender’s risk and makes it more likely that a financial institution will provide financing.Large loans, such as six-figure mortgages, probably wouldn’t be feasible without a mortgage.
- Cheaper loans: Interest rates on secured loans tend to be lower than those on unsecured loans. They can be cheaper to borrow because the lender has collateral for the loan and has a chance to recoup their funds if you default. (However, secured loans often have longer terms, so while the interest rate may be lower, you may end up paying more in interest overall.)
- Ownership/Possession of Assets: The borrower retains ownership of the asset and there is no change or transfer of ownership.
Conclusion regarding mortgage
Taking out a loan against your assets through a mortgage can have significant consequences if you default on your payments or otherwise breach the terms. It’s important to be aware of the circumstances under which your assets may be seized.
If you find yourself in a position where you can’t make payments on a secured loan, discuss alternative repayment options or modifications with your lender as soon as possible. Early negotiations can reduce the need for additional borrowing, such as through payday loans, which will only put more strain on your finances.
