Mortgages are a mainstay of home ownership. A mortgage enables a home buyer to increase his standard of living today based on his expected future income. The loan is paid back in monthly installments, and interest is charged on the loan balance until it is paid off. However, if the mortgagee is unable to pay the installments, the bank might force him to liquidate the property at a price below the its market value. A number of risks are associated with mortgages, from the view point of a consumer.
Uncertainty of Expected Future Income
Your future earnings are uncertain. During the term of the mortgage, you may find yourself unable to make payments and at risk of defaulting on the loan. Once you've lived in your own home, it can be difficult to reduce your standard of living by moving into an apartment. Rather than risk this, some people prefer to rent until their income rises and they can pay cash for a home.
Fixed Rate Mortgage Payments
Mortgages are long-term loans, and many have fixed interest rates. During the term of the mortgage, interest rates will fluctuate up and down. If prevailing interest rates decrease, the borrower still has to pay the higher rate in the mortgage contract.
Mortgage Refinancing
If market interest rates decrease, the borrower can refinance the loan at a lower rate. This implies that the mortgagee is protected if the interest rates decline considerably. This can be problematic; refinancing a mortgage is costly as it involves legal and transfer fees and the interest rates might decrease further resulting in the mortgagee to think that he should have waited for a bit longer before refinancing the mortgage.
Interest Rate
Finance theory suggests that mortgage loans would typically charge higher rates from the borrower due to their features. The call option that is provided to the mortgagee comes at a cost in the form of higher interest rates to the borrower. Also, as the mortgage is a long-term loan the chances of default on the loan are considerably higher when compared to short-term loans; to compensate for the additional default risk the lending institution charges a higher rate on the mortgage.
Market Value
If the mortgagee fails to pay the monthly installments on a timely basis, the lending institution can take legal action against the mortgagee. A court order can result in an auction of the property, to allow the bank recover the loaned amount. An auction sale fetches a substantially lower value for the property, as it needs to be sold in a haste. This can further squeeze the borrower at a time when he is already going through a financial squeeze.
Sources
"The Mortgage Encyclopedia: The Authoritative Guide to Mortgage Problems"; Jack Guttentag; 2010
"The Rise and Fall of the U.S. Mortgage and Credit Markets"; James Barth, Tong Li, Wenling Lu and Glenn Yago; 2009
"Personal Finance"; Thomas Garman and Raymand Forgue; 2007
"Securitization of Financial Assets"; Jason Kravitt; 1996
Muhammad Humayun - I am Muhammad, and I enjoy academic writing and research work. I strive to excel in life through hard work and dedication. I finished ...
Join the Conversation