Common Real Estate Finance Methods: Most people take out mortgage loans to help pay for real estate purchases just as people take out other loans to pay for other expenses. These complexities and the originations, processes and operations of mortgages are the subjects of this course.

This first module provides the basic knowledge, skills, and vocabulary needed to make sense of a mortgage loan.

Before Applying for a Mortgage

Buying a home is not only an exciting milestone for many people, it’s also a useful way to build financial stability and wellbeing.[1] However, purchasing real estate involves complex legal and financial issues. Taking out mortgages exposes home buyers to risks of default, foreclosure, and bankruptcy. As a result, everyone should understand the legal and financial liabilities associated with real estate ownership before making the decision to buy a home.

However, there are additional expenses mortgage borrowers must be ready to pay beyond the down payment.

Mortgage approval depends heavily on credit scores. Credit scores are composite scores that take into account six factors: percentage of available credit that is used, payment history, derogatory marks (such as collections or bankruptcies), average age of credit, total number of accounts held and number of recent “hard” credit inquiries.”[8] People seeking mortgages are wise to shore up their credit histories by paying off the debts they can and managing new loans to the best of their abilities.

Elements of a Mortgage Loan

Mortgage loans are the most common real estate financing method in the United States. and the mortgagee, the lender supplying the loan who receives the security interest.

A Promissory Note is a contract that formalizes the buyer’s promise to repay the loan made by the lender. The promissory note must be accompanied by a security instrument to create a mortgage interest.

Mortgage Payments

However, there are several variations on traditional mortgage loans.

Fixed-Rate and Adjustable-Rate Mortgages

“Convertible” ARM loans include options to convert the loan’s adjustable interest rate to a fixed one, typically for a fee. Combination Fixed Rate/ARM loans typically begin as a fixed-rate loan that converts to an adjustable rate after a set period. Interest-only ARMs require borrowers to pay interest on the loan, but not principal, for a fixed time, meaning that installment payments will increase once principal payments kick in. Payment-option ARMs are arrangements in which the interest rates are adjusted over time, but the minimum payments remain fixed.

Amortization and Balloon Payments

Payments made pursuant to a fixed-rate mortgage start as mostly interest payments because the principal balance is highest at the outset of the loan. Over time, while the amounts of the monthly payments remain the same, the principal contingent of each payment becomes higher and the interest contingent becomes lower, as the principal balance decreases. The last few mortgage payments on an amortized long-term loan are virtually all principal.

Rather than fully amortizing their loans, some home buyers prefer an amortization schedule with a balloon payment. Under this arrangement, installment payments made on the mortgage do not cover the entire principal and interest accrued.

Second Mortgages and Home Equity Loans

In most cases, borrowers can take out multiple mortgages on real estate. However, real estate lenders take on increased risk when issuing second mortgages, as mortgage superiority is based on which agreement was first in time. In other words, if the real estate owner defaults on a first mortgage and the property is foreclosed, the second mortgage is terminated. As a result, it can be very difficult to take out second or third mortgages. When lenders do agree to issue a second mortgage, they commonly require an estoppel certificate from the first mortgage lender.

An estoppel certificate requires the first mortgage lender to notify the second mortgage lender if a default occurs.

This gives the second mortgage holder an opportunity to recover before its rights are terminated by foreclosure.[22] Second mortgage lenders may also only provide loans to the extent that the total amount owed on the house is limited to a percentage of the home’s value. For example, a second mortgage lender may require that the homeowner maintain at least 20% equity in the house. If a house is worth $500,000, for example, and the homeowner already owes $340,000 on a first mortgage, the second mortgage lender may limit the amount of the second mortgage to $60,000 or less to ensure that the total value of the mortgages does not exceed 80% of the home’s value, or in this case, $400,000.

Second mortgages are often referred to as “home equity loans” because they require building up of equity before the banks will issue them. Some home equity loans are “revolving,” which means that the buyer may withdraw up to a maximum amount and will make monthly interest payments to cover the interest on the balance. The borrower may repay the principal at will, though many such loans require that the buyer commence paying principal after a given number of years.

Because these home equity loans behave like a line of credit, they are often called “home equity lines of credit” or HELOCs.

While in the process of making amortized payments on a loan, a buyer may choose to refinance, usually to take out more money or to take advantage of lower available interest rates. The refinancing process requires payment in full of the first mortgage and the simultaneous receipt of the new mortgage loan.

Homeowners often choose to borrow money against the equity in their homes (either through refinancing of a bigger loan or opening a home equity line of credit) to improve the property or consolidate more expensive debt.[24] Keep in mind that unsecured loans such as credit card debt usually charge much higher interest rates than mortgage loans. So, paying off high interest loans through money obtained from mortgages is often an excellent way to save money.

Reverse Mortgages

A reverse mortgage is a specialized loan available to those age 62 and over. Reverse mortgages raise issues regarding estate planning and insurance coverage beyond the financial and legal liabilities typically incurred when someone takes out a loan.


Mortgage agreements are the most common ways people finance their homes. Despite being so common, these transactions are very complex. They are subject to several consumer protection laws and financial regulations that are discussed throughout the remainder of this course. However, at the end of this preliminary discussion, you should have a basic grasp of the vocabulary and concepts relevant to mortgages.


[1] Mark W. Olson, Governor, Fed. Liz Pulliam Weston, Why It’s Smarter to Buy than Rent, MSN MONEY, Jan. 15, 2006,

[2] Loan-to-Value Ratio – LTV Ratio, Investopedia Real Estate Finance (2018),

[3] American Bar Association, Mortgage Loans, “Loan Features” (2018) available at

[4] Id.

[5] Homeowners Protection Act of 1998, 12 U.S.C.A. § 4901 et seq.

[6] American Bar Association, Residential Real Estate FAQs (2018) available at

[7] American Bar Association, Mortgage Loans, “Loan Features” (2018) available at

[8] Toddi Gutner, “Anatomy of a Credit Score,” Bloomberg Businessweek (Nov. 27, 2005) available at

[9] Cornell Law School, “Mortgage” Wex Legal Dictionary (2018) available at

[10] What is a Mortgage?, Consumer Financial Protection Bureau (February 2017), available at

[11] Definition, “Promissory Note.” American Bar Association, “Glossary,” Mortgage Loans (2018) available at

[12] In some jurisdictions, the mortgage security instrument is a “deed of trust,” but these documents serve the same function as a mortgage in other jurisdictions. Definition “Mortgage” Id.

[13] Hinkel, D., Essentials of Practical Real Estate Law 189 (6th ed. 2016).

[14]  Cornell Law School, “Encumbrance” WexLegal Dictionary (2018) available at

[15] Sean Becketti, Why America’s Homebuyers & Communities Rely on the 30-year Fixed-Rate Mortgage, Freddie Mac (April 2017).

[16] American Bar Association, “Glossary,” Mortgage Loans (2018) available at Common Real Estate Finance Methods.


[18] American Bar Association, Mortgage Loans, “Loan Features” (2018) available at

[19] American Bar Association, “Glossary,” Mortgage Loans (2018) available at

[20] Hinkel, supra note 14 at 194/

[21] American Bar Association, Mortgage Loans, “Loan Features” (2018) available at Common Real Estate Finance Methods

[22] American Bar Association, Mortgage Loans (2018) available at