But do you know how mortgages work behind the scenes? What’s actually going on from a lender’s standpoint? People have a lot of misconceptions about how mortgages work, and if you know what’s happening and why, it can help you make better decisions about your home.
Applying for a Mortgage
A mortgage is the largest loan most people will take out in their lifetimes, so there’s a lot that goes into applying for a mortgage. A lender will vet you very carefully. Ultimately, they want to make sure you’re able to repay the loan, and here’s how they assess that:
Credit check: Your credit score is sort of like your grade for how well you’ve repaid lenders in the past. It’s one of the most important pieces lenders consider. Your income: Lenders don’t just take your word for it when you tell them how much you make. They’ll want to see official documents such as pay stubs and tax returns to confirm it. Your debt: Any debt you have takes money away from what your lender could be getting, and sets an important tone for your ability to repay. That’s why your lender wants the details of each of your debts, which they’ll cross-reference with your credit report. Your savings: Lenders want to make sure that any down-payment savings you have are yours and yours alone, and that you didn’t borrow them. They’ll check your bank statements to look for anything that could be a financial gift, and if you have one, they may require a letter from the person who gave it to you.
Lenders don’t just vet you, though. They’ll look carefully at the property you want to buy, too. That’s because, for most lenders, your mortgage is actually a product that they create and sell to other companies. That way, they get an immediate return on the money they invested in your home, and they can go out and make another loan to someone else well before yours is paid off. For example, you might be working with a small local bank to get a mortgage, but as soon as it’s closed, they’ll likely sell it to one of the government-sponsored entities (GSEs) such as Fannie Mae or Freddie Mac. In fact, in 2021, more than 60% of all mortgages were eventually sold to one of these two GSEs. Depending on what type of loan you have and whom they plan to sell your mortgage to, your lender may need to make sure your home meets certain requirements. For example, if you’re getting a VA loan, your lender might hire a special appraiser to come out and make sure it meets minimum property requirements (MPRs) from the VA. Other types of loans, like USDA loans, may have similar requirements.
What Happens When You Take Out a Mortgage?
After the dust settles from all of the paperwork shuffling around when you buy a home, you’re considered the owner of the home. You can find the deed to your home—with your name on it—at your local county recording office. If you look up the deed, you’ll notice that your mortgage lender is listed in first-lien position. Rest assured; that doesn’t mean your lender owns your home, too. You own the home, and your lender owns the debt you used to buy it with. Having a lien on your home just means that someone else has a stake in your home’s value. If you sell your home while you still have a mortgage, your lender is first in line to be paid with the proceeds from the sale of your home. It’s a way to ensure they get repaid one way or another, especially because if you violate the terms of your agreements (like defaulting on your mortgage; your lender can force you into foreclosure, sell the home, and get their money back.
Liens and Other Ownership Issues
A mortgage lien isn’t the only type of lien that can be attached to your home’s title. When another type of lien gets added, such as if you take out a second mortgage, it can take a “junior” or “second” position. That means it’ll be paid after your first-line lien such as your first mortgage. It’s essentially a way for other creditors who might have a stake in your home to sort out among themselves who gets paid and in what order if your home is sold before you pay off the debt. Liens can be a serious issue because they can make it difficult or impossible to sell your home. Lenders are unlikely to give someone a mortgage to buy your home if it has a lien attached, for example.
Tax Lien
If you don’t pay your taxes, such as your federal taxes or property taxes, you might have a tax lien put on your home. In that case, the government is considered your creditor. This can happen in other cases, too, such as if you get a PACE loan to pay for things like solar panels. PACE loans are paid in a roundabout way via your property taxes, so they’re a type of property tax lien.
Judgment Lien
If you don’t pay other bills, such as medical bills, utilities, or your credit cards, your lender can sue you in court. If that happens, a judge might award them a judgment lien, which means that they now have a stake in your home should you sell it.
UCC Lien
If you finance expensive equipment to be installed on your home, such as solar panels, your lender might put a Uniform Commercial Code (UCC) lien on that equipment. That way, they’re staking a claim on a specific part of your home, separate from the rest.
Paying Off Your Mortgage
As you make your mortgage payments every month, you’ll slowly pay down the balance of your loan through a process called amortization. After your balance shrinks to zero and you have your mortgage payoff party, you should check with your lender and/or your county recording office to verify that your lender’s lien has been removed from your home. That will signal that you own your own home, free and clear of any other claims to it.
