What Is a Mortgage?

Buying a home is a common financial goal for many Americans. Some have even called it “the American dream.” The process of buying a home can be complicated, though, and has many terms that get loosely thrown around. One of those terms is the word “mortgage.”

This article breaks down what a mortgage actually is.

1. Loan

Buying a home is likely one of, if not the most expensive purchase you will make in your lifetime. What happens if you do not have enough savings to purchase the home outright? In this case, you will need to borrow money in order to make the purchase. This is called a loan. A loan is when someone else (the lender) gives you (the borrower) money, and you agree to pay them back in the future, usually with interest.

2. Promissory Note

What if you forget the details of the loan? Or what if either the lender or borrower tries to change the terms of the loan? Problems like this can be solved by having a written, legal contract explaining the details of the loan (parties involved, payment schedule, interest rate, etc.). This written agreement to pay back the money you borrow is often called a promissory note. This helps just in case things don’t go as expected.

3. Collateral 

What if the lender is nervous the borrower won’t pay you the loan? One way for the lender to reduce their risk is to require the borrower pledge something of value as collateral. That way, if the borrower fails to make their payments, the lender can seize the collateral instead.

A loan that is backed by collateral is called a secured debt. A loan that is not backed by collateral is called an unsecured debt.

4. Lien

What if the borrower tries to sell the property that is being used as collateral before the loan is paid off? Or what if the borrower defaults on the loan, but refuses to willingly give up the collateral? This is where a lien comes in.

A lien gives the creditor a legal right to the collateral until the loan is paid off. This gives the lender legal recourse if the borrower doesn’t fulfill the terms of the promissory note. So the bank will have a lien on your home until you pay off your loan.

5. Mortgage/Trust Deed

How is the lien recorded? The document that records the lien is called a mortgage or trust deed. This is the official document that will usually be filed with your county clerk. If the borrower pays off the loan in its entirety, and satisfies all requirements of the promissory note, the lien will then be removed from the home and the borrower is said to have a clear title. If the borrower does not, then the lender will begin the foreclosure process.