Mortgages, Financial Management

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A mortgage may be defined as a pledge of property to secure a debt payment; in this context, we will use the term property to mean real estate. If the mortgagor (say, homeowner) fails to pay the lender (the mortgagee), the lender can foreclose the loan, seize the property and sell it in order to realize his dues.

Depending upon the terms of mortgage agreed upon between the lender and the borrower, mortgages can be classified into traditional and non-traditional mortgages.

Before discussing the features of the two mortgages, we will take a look at some of the important aspects of all mortgages. The lender usually examines the creditworthiness of a borrower by eliciting information on the following:

  • Details of the amounts outstanding on any other loans taken by the borrower.

  • Details of monthly/annual income of the borrower from all sources; and the net worth of the borrower.

The lenders in the US follow two basic rules of thumb to adjudge the adequacy of the income for paying the obligations under mortgage:

Rule 1: The total mortgage payment (principal and interest) should not exceed 25% of the borrower's total income less all payments owed to other obligations.

Rule 2: Total mortgage payments plus other housing expenses such as taxes, insurance, utilities and normal maintenance costs should not exceed 33% of the borrower's total income less all payments owed to other obligations.

It must be understood that the above percentages are not always rigidly applied - the percentages may be lowered if the lender is otherwise convinced of the borrower's net worth and liquidity and if the interest rates rise to a high level in tight money situations; also lenders do lower the percentages to maintain a certain level of business.


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