Mortgages: Key Phrases

Adjustable rate mortgages (ARMs) are also common.  Under an ARM, the interest rate rises and falls over the term of the loan in accordance with prevailing market conditions.  The parties may agree to hedge against extreme interest rate fluctuations by establishing ceiling and floor limits.

A balloon mortgage, less common but not unheard of in the residential mortgage market, exists when a substantial payment is required at the end of the term of the loan to cover the unamortized loan principal.

Default occurs when the mortgagor fails to perform an obligation secured by the mortgage.  The most common event of default is the mortgagor's failure to timely pay monthly principal and interest installments.  A mortgagor's failure to insure the property or to pay property taxes can also constitute an event of default.  However, the use of escrow accounts has reduced the frequency with which this type of default occurs.  Finally, construction difficulties or physical damage or destruction to the property by the mortgagor, constituting "waste," can also be considered an event of default.

Most mortgages and underlying promissory notes contain an acceleration clause providing that the occurrence of an event of default accelerates the debt, making the entire debt immediately due and payable.  Most residential mortgage lenders are required to provide that the mortgagee must give the mortgagor notice of impending acceleration and the opportunity to avoid it by curing the default.  In most states, the commencement of a foreclosure proceeding constitutes notice of impending acceleration.

Mortgages also often provide for acceleration in the event the mortgagor transfers any interest in the mortgaged property without the mortgagee's consent.  These clauses, referred to as due-on-sale clauses, protect the mortgagee from being forced to do business with persons other than the mortgagor with whom the mortgagee initially contracted.  When a mortgagor desires to transfer the mortgaged property, the mortgagee has the option to either accelerate the debt or consent to the transaction conditioned on the grantee's assumption of the mortgage and payment obligation, possibly also with a transfer fee requirement and/or an increased interest rate.