Financial Literacy: What is a Mortgage? How do mortgages work?

Financial Literacy posts are designed to be more than just a simple definition, they are aimed at putting financial concepts into easily understandable terms and to give an example or two to demonstrate the answers.

Today we ask: What is a Mortgage?

By definition a mortgage is pledging a property to a lender as security in return for a mortgage loan. While a mortgage is not an actual debt it is evidence of a debt and is the legal instrument used to transfer an interest in land from an owner to a lender on condition that it will be given back to the owner once the terms of the mortgage have been satisfied.

I am a big fan of pictures so we shall use a few to show what happens.

Let’s take the example of ‘Joe’ who wants to buy a house. He must save up a deposit as loans require ‘equity’ it gives the bank some security in the sense that it means the person is vested in the purchase (they stand to lose something if it all goes belly up).

how a mortgage works

So we can see from the picture that what actually happens is that when you buy a house two sales and purchases happen, the seller sells to Joe (1st sale) and obviously Joe purchases the property on the other end of that transaction (1st purchase – but it’s not a ‘closed deal’ yet) then Joe sells to the bank (2nd sale/purchase) and for doing this he gets money for the asset (the house) and he gives this to the seller in order to close the first purchase.

It is within this process that the ‘evidence of a debt’ or Mortgage occurs, it is the paper evidence of that debt (where the bank gave out the money) occuring and it contains the obligations required in order to satisfy it.

That’s about as simple as I can put it, if you still don’t understand then drop me an email (you can do this via an enquiry on our homepage) and I can try to break it down further. The key to becoming financially literate is taking complex ideas like mortgages and trying to look at them in the simplest manner possible, hopefully we achieved this today!

Comments

  1. t’s obvious we need to do a better job teaching people about money. I’ve done some work with Junior Achievement. They have a lot of programs in this area. Here’s their site, for anyone who is interested http://www.ja.org.

  2. thanks for that comment vaneessa, i checked it out and ja.org looks like a great idea, hopefully we’ll see something like this in europe too!

  3. Well Karl, there actually is a JA in Ireland! this is their link http://www.juniorachievement.ie/

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