In the case of a mortgage on a house, without a mortgage, a borrower could default on the mortgage and yet be able to keep the house. No financial institution would be willing to lend with such risk, leaving most people unable to buy a home without the money to do so. The mortgage makes it possible to lend and borrow.
For borrowers who aren’t sure what mortgage is, here’s an overview of what this term means and why it benefits both borrowers and lenders.
What is the mortgage?
A mortgage is the pledging of property as security for the purpose of securing a loan. The borrower does not pass title to the asset to the lender, but if the borrower fails to make loan payments as specified in the terms of the loan, the lender may take possession of the asset to recover his loss.
For a home or car loan, this may mean foreclosure or repossession for the borrower. With most mortgages and car loans, the mortgage is a standard requirement.
Mortgage is only used with secured loans, such as secured personal loans and mortgages. Often with these types of loans, the asset pledged has nothing to do with the purpose of the loan other than securing it. For example, a borrower can pledge jewelry, a vehicle, or even stocks or bonds as collateral for a secured personal loan.
Mortgage is also used for investing when investors buy stocks on margin or short. Short selling involves borrowing securities and requires the investor to open a margin account as collateral. Buying on margin involves borrowing money from a broker or bank to buy securities. The investor typically pledges securities or other investments as collateral.
How does the mortgage work?
Here’s a closer look at how mortgages work for getting a mortgage or car loan and investing.
Mortgage for mortgages and car loans
When borrowers enter into a loan agreement, they agree to repay the loan as stated in the loan agreement. However, a bank or lender will not risk lending thousands of dollars without one of two things: collateral of a high enough value to cover the loan or an extremely high interest rate. Lenders need a way to recoup their loss if a borrower defaults.
The borrower mortgages the house or vehicle in exchange for a loan at a reduced rate. If the borrower continues to make payments on time, they can live in the house or drive the car used to secure the loan.
However, if the borrower defaults on the loan, the creditor has the right under the loan agreement to seize the mortgaged property or repossess the mortgaged car. The lender can then sell the house or the car to recover the money that the borrower has not repaid.
Mortgage to invest
The mortgage works much the same way with the investment.
A broker will not lend money to an investor to buy on margin without some guarantee that he can get his money back if a margin call occurs and the investor suffers a loss. Thus, an investor can pledge other securities that he holds as collateral.
The investor retains all gains on securities purchased on margin, but in the event of a loss, the broker may take possession of the pledged securities and sell them to recoup the loss.
Why Should Borrowers Care About Mortgages?
The mortgage is an essential lending tool and probably makes lending possible by eliminating most of the risk for lenders. Since the lender can use the collateral to recoup any loss that may arise from the borrower’s default, they are not only willing to lend money, but can do so at an affordable rate. This is why secured loans can have much better rates and terms than unsecured loans.
This, of course, is important to borrowers because it often means the ability for a borrower to get loan approval for a high-value asset at an affordable rate.
However, the borrower should understand that missed payments or failure to pay will result in foreclosure of the mortgaged property by the lender.
Mortgage is the pledging of collateral to secure a loan, and it can be a double-edged sword for borrowers.
By providing security, the borrower can usually obtain reasonable loan rates and terms that allow them to own and use a high-value home, vehicle, or other asset while repaying the loan. However, it also allows the lender to seize the item if the borrower defaults.
When entering into a loan agreement, it is essential that borrowers understand all the terms of the loan and whether the mortgage is applicable. This is true when taking out a secured loan or an investor loan for margin trading and short selling with a brokerage account.
FAQsHere are answers to common mortgage questions.
- What is a sample mortgage?
- An example of a mortgage is the purchase of a car. When a borrower gets a car loan, the new car is usually used as collateral to secure the loan.
- The borrower can own and use the car as long as they make the payments according to the loan agreement. If the borrower stops making payments, the lender can repossess the car to sell it to recover the outstanding loan balance.
- What is a pledge and a mortgage?
- To pledge an asset is to provide it as collateral to secure a loan. The actual pledging of the asset is called collateral. The pledged asset remains in the possession of the borrower, but the lender can claim ownership if the borrower defaults on the loan.
- What is the difference between guarantee and mortgage?
- A collateral is something of significant value that a borrower pledges to a lender to secure a loan. The deed of pledge of the guarantee is called the mortgage.
- What is a Letter of Mortgage?
- A letter of mortgage is a general term for a written agreement that authorizes a lender to take possession of a pledged asset to secure a loan in the event of default by the borrower.
- The name of this document will vary by industry and type of loan. The term is most often used in international trade. The financial industry may use other terms for this document, such as pledge agreement or pledge deed.
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