What is Mortgage? | Definition, Types, Advantages and Disadvantages

The term ‘mortgage’ is sometimes used interchangeably with ‘collateral’, referring to the property or real estate assets of an individual against which one takes out a loan. The concept of the mortgage ensures that the borrower remains obligated to pay off the loan and the interest accrued in regular installments.

Mortgage may also refer to a common financial practice in the purchasing of real estate in which the buyer does not pay the entire amount in one go. Loans and interests are to be paid off till the entire sum has been paid and the individual gains ownership of the house or establishment.

Key Takeaways

1. A mortgage is a loan used to purchase a property or real estate, with the property serving as collateral for the loan.
2. Mortgages typically have a fixed interest rate and a set repayment term, with monthly principal and interest payments.
3. Failure to make mortgage payments can result in foreclosure, where the lender can take possession of the property and sell it to recover their investment.

Why are mortgages necessary?

1. It is necessary for the security of the lender (usually a bank). Upon inability to meet the required number of payments or in case of a defaulted loan, the lending authority is empowered to seize the mortgaged asset in order to avoid losses.
2. Mortgages often have a lot of flexibility with respect to the number of years before it has to be paid off or the rate of interest (fixed or adjustable). It provides the borrower with immediate financial assistance in the form of a loan while buying them enough time to pay it off.
3. Loans against real estate usually have no restrictions with respect to how the loan is made use of – whether to fund education, a wedding, or emergency expenses. Thus it is a necessary option of collateral that is helpful to the borrower.

Types of mortgages

1. Fixed rate – The borrower is required to pay the same rate of interest throughout the tenure, and the monthly installments do not differ from the first to the final one.
2. Adjustable rate – In this case, the interest rates remain constant for a certain period after which it begins to fluctuate according to market rates. Thus, the borrower may end up paying more in the long run than they had initially.

Advantages of a mortgage

1. By writing off mortgage interests, you can reduce your total annual payments significantly. This feature does not reduce the amounts due in installments but can reduce the payable income tax to a significant degree.
2. It is usually not possible for people to buy real estate for cash up front. Mortgages enable you to buy a house without having to pay the entire amount immediately.
3. Long term mortgages have lower interest rates, making it easier on the borrower.

Disadvantages of a mortgage

1. The burden of debt can generate a great amount of financial distress. In families of certain socioeconomic backgrounds this requires them not only to cut back on certain expenditures, but often they also have to compromise their standard of living.
2. If your property is mortgaged for a significant amount of time (15 to 30 years) it hampers other financial decisions and one’s ability to secure another major loan.
3. The value of the property itself may change over the years due to changing market rates. This has other undesirable implications on the loan taken.

References

1. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1551227
2. https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1538-4616.2011.00391.x