Definition
A mortgage is a loan secured by real estate in which the borrower pledges the property as collateral to the lender. If the borrower fails to repay the loan according to the agreed terms, the lender has the legal right to foreclose and sell the property to recover the debt.
How a Mortgage Works
- The borrower receives funds to purchase or refinance property.
- The lender records a lien against the property.
- The borrower makes scheduled payments (principal and interest).
- If default occurs, the lender may initiate foreclosure.
Core Components
- Loan Amount: Total principal borrowed.
- Interest Rate: Cost of borrowing.
- Amortization: Schedule for repaying principal over time.
- Term: Length of time before maturity.
- Debt Service: Required periodic payment.
Types of Mortgages
- Fixed-Rate Mortgage: Interest rate remains constant.
- Adjustable-Rate Mortgage (ARM): Rate fluctuates over time.
- Interest-Only Mortgage: Payments initially cover only interest.
- Balloon Mortgage: Large lump-sum payment due at maturity.
- Non-Recourse Loan: Lender’s recovery limited to the collateral property.
Mortgage vs. Deed of Trust
In some states, a deed of trust is used instead of a traditional mortgage. Both secure a loan with real property, but foreclosure procedures differ.
Impact on Investors
- Creates financial leverage.
- Introduces refinancing and interest rate risk.
- Affects cash flow through debt service.
- Impacts returns such as levered IRR.
Key Underwriting Metrics
Common Risks
- Interest rate increases.
- Balloon payment refinancing risk.
- Cash flow shortfalls.
- Declining property values affecting LTV.
Investor Checklist
- Understand recourse vs non-recourse terms.
- Review amortization schedule.
- Model refinance assumptions at maturity.
- Stress test DSCR under downside scenarios.