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Table of Contents
1 Bank.......................................................................................................................................................5
1.1 What Does a Bank Mean?................................................................................................................5
1.2 Central Banks...................................................................................................................................5
1.3 Special Purpose Banks.....................................................................................................................6
1.4 Investment Bank..............................................................................................................................6
1.5 Retail Banks.....................................................................................................................................7
2 Retail Banking and some of the Product lines....................................................................................8
2.1 Accounts...........................................................................................................................................8
2.1.1 Savings Bank Account .............................................................................................................9
2.1.2 Current Account........................................................................................................................9
2.1.3 Overdraft Account...................................................................................................................10
2.1.4 Joint account...........................................................................................................................10
2.1.5 An Individual Savings Account (ISA) ...................................................................................10
2.1.6 Retirement savings Account....................................................................................................10
2.2 Deposits..........................................................................................................................................10
2.2.1 Fixed deposits / Term deposits................................................................................................11
2.2.2 Recurring Deposits .................................................................................................................11
2.2.3 Treasury deposits.....................................................................................................................11
2.3 Cards...............................................................................................................................................11
Credit Cards........................................................................................................................................12
2.3.1 Visa and Master card...............................................................................................................12
2.3.2 Uniform shape and size...........................................................................................................13
2.3.3 Luhn algorithm........................................................................................................................13
2.3.4 Major Industry Identifier.........................................................................................................14
2.3.5 Interest charges in Credit Cards .............................................................................................14
2.3.6 Credit card Frauds...................................................................................................................15
2.3.7 Life Cycle of a Payment .........................................................................................................16
Charge Cards...................................................................................................................................17
2.4 Money / Fund Transfer...................................................................................................................17
2.4.1 Bank wire transfer...................................................................................................................18
2.5 Foreign exchange ..........................................................................................................................19
2.6 Wealth management / Asset Management.....................................................................................20
2.7 Insurance Services..........................................................................................................................20
2.8 Mutual funds .................................................................................................................................21
2.9 Loan products / Lending................................................................................................................21
3 Different Means of Conducting a Banking Business.......................................................................21
3.1 Direct banking/ Personal Banking / Branch Banking....................................................................21
3.2 ATM banking..................................................................................................................................22
3.3 Phone banking................................................................................................................................22
3.4 Mobile banking..............................................................................................................................23
3.5 Internet / E-banking.......................................................................................................................24
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3.5.1 Security in E-banking .............................................................................................................25
4 Technology in Banking.......................................................................................................................26
4.1 Why Use Computers? ...................................................................................................................26
4.2 Cheque Truncation System............................................................................................................28
4.3 Core Banking.................................................................................................................................29
5 Technological risk factors...................................................................................................................30
6 Retail banking products in Denmark................................................................................................31
6.1 Retail banking ...............................................................................................................................31
6.1.1 E-banking....................................................................................................................................31
6.1.2 Accounts......................................................................................................................................32
6.1.3 Loans and credit..........................................................................................................................32
6.1.4 Credit cards.................................................................................................................................32
6.1.5 Personal Loans............................................................................................................................32
6.1.6 Mortgage loans............................................................................................................................32
6.1.7 Investments.................................................................................................................................33
6.1.8 Online trading accounts .............................................................................................................33
6.1.9 Pensions......................................................................................................................................33
6.1.10 Insurance...................................................................................................................................33
6.1.11 Private banking..........................................................................................................................34
7 Credit Rating Agencies and Lending................................................................................................34
7.1 Credit rating agencies in different geographies.............................................................................34
8 Lending ...............................................................................................................................................35
8.1 Credit..............................................................................................................................................35
8.2 Consumer Credit............................................................................................................................36
9 Types of Lending.................................................................................................................................36
9.1 Secured Lending............................................................................................................................36
9.2 Unsecured Lending........................................................................................................................37
10 Mortgage Lending.............................................................................................................................39
10.1 Mortgage lender...........................................................................................................................39
10.2 Borrower......................................................................................................................................40
10.3 Needs for lending / borrowing.....................................................................................................40
11 Mortgage............................................................................................................................................40
11.1 Simplified Mortgage Process flow chart......................................................................................41
11.2 Types of Mortgage Lenders .........................................................................................................42
11.2.1 Mortgage Banker...................................................................................................................42
11.2.2 Mortgage Brokers..................................................................................................................42
11.3 Mortgage Insurance......................................................................................................................43
11.4 Repayment Schedule / Term ........................................................................................................43
11.5 Equated Monthly Installments (Calculation)...............................................................................43
11.6 The Mortgage Loan Process ........................................................................................................43
Loan Origination ............................................................................................................................43
Loan Processing .............................................................................................................................44
Underwriting ..................................................................................................................................44
Loan Closing ..................................................................................................................................44
Post Closing/Shipping ....................................................................................................................45
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Quality Control ..............................................................................................................................45
11.7 The Process flow Diagram in a Mortgage Lending Process........................................................45
11.8 Technology in Mortgage Industry................................................................................................45
11.8.1 Electronic Customer Relationship Management (ECRM) ...................................................46
11.8.2 Data Mining Systems ...........................................................................................................46
11.8.3 Automated Underwriting Systems (AUS) ............................................................................46
11.9 Life Of A Mortgage Loan ............................................................................................................46
Loan Origination ............................................................................................................................47
Lending Institutions .......................................................................................................................47
Underwriting the Loan ...................................................................................................................47
Researching the Ability to Pay .......................................................................................................47
Researching the Willingness to Repay ...........................................................................................47
Researching the Value of the Property ...........................................................................................47
11.10 The Life of a Loan in Good Standing .......................................................................................49
11.11 Exceptions to Loans in Good Standing .....................................................................................50
11.12 Foreclosure ................................................................................................................................51
11.13 Bankruptcy ................................................................................................................................51
11.14 Loan Servicing...........................................................................................................................52
12 A brief understanding of Mortgage Industry in different economies..........................................52
12.1 India.............................................................................................................................................52
12.1.1 Important Concepts regarding mortgages in India................................................................53
12.1.2 The important concepts regarding mortgage:.......................................................................53
12.1.3 Refinancing ..........................................................................................................................53
12.2 Denmark.......................................................................................................................................53
12.2.1 The Balance Principle...........................................................................................................54
12.2.2 Property registration and the granting of a loan....................................................................54
12.2.3 Foreclosure............................................................................................................................54
12.2.4 Comparison with the US system...........................................................................................55
12.2.5 Business................................................................................................................................55
13 Important Terms and their meanings.............................................................................................56
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1 Bank
Banks manage the customer’s accounts, pay out checks that have been drawn on the bank by
account holders, and also perform the collection of checks deposited in their customers'
accounts.
The borrowing process of banks is carried out by receiving funds in savings accounts, current
accounts and receiving deposits (which are only a few of the examples), as well as through
issuance of debt securities, such as bonds and banknotes (issuance of bank notes is an activity
of the Central bank).
Banks offer a comprehensive variety of payment facilities, and a bank account is regarded as
indispensable by the majority of governments, business enterprises, and individuals.
There are different kinds of banks in any geographical area and some of them are as listed
below, the naming convention though may be different in different parts of the world.
• Central Banks
• Special Purpose Banks
• Investment Banks
• Retail Banks
Investment banking is a fundraising method through which governments and companies issue and sell
securities in order to raise capital. Two common methods of collecting funds from the public are by
capital market (selling stock) and venture capital (a type of private equity). Investment banking
involves both a sell side and a buy side. The former is related to trading and promoting securities, while
the latter is regarding dealing with investors and funds.
Investment banking is in contrast with commercial banking, where the bank receives deposits from
clients, and loans directly to individuals and organizations. It was previously illegal for a bank to be
both commercial and investment in nature; however the Gramm-Leach-Bliley Act of 1999 has now
legalized such a condition.
Investment banks commonly offer consulting and advisory services for clients. Topics of advice may
cover circumstances such as mergers, acquisitions, public offerings, and others. Advice on financial
issues may also touch services such as trading of commodities, derivatives, equity securities, fixed
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income, and foreign currencies.
• Issuance of accounts (eg: Savings, Current) for acceptance of funds from customers.
• Acceptance of funds on deposits (eg: Term deposits, Current deposits, Recurring deposits)
• Honor payments with the help of online banking, telegraphic transfers and other methods
• Issuance of bank checks and bank drafts
• Safe custody of important documents and other valuable items in safe deposit vaults or safe
deposit boxes
• Providing retail loans, commercial loans and mortgage loans to the general public and
organizations. These loans could be installment loans, overdrafts or others
• Issuance of banknotes, such as promissory notes
• Offering performance bonds, guarantees, letters of credit, and other types of documents related
to underwriting commitments for securities
• Brokerage services related to the Capital Markets.
• Foreign exchange services
• Act as brokers for Mutual Funds
• Insurance products from insurance agencies, with which they have a tie up or an agreement.
The services offered by the banks are evolving with many new product lines being added to the list and
this is due to the competition to serve the customer and achieve a larger market share. The
technological advancement in the banking industry only helps in this motive of the banks.
There are different types of retail banks in various economies of the world and a few types are
as listed below.
Retail banking aims to be the one-stop shop for as many financial services as possible on behalf of
retail clients. Some retail banks have even made a push into investment services such as wealth
management, brokerage accounts, private banking and retirement planning. While some of these
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ancillary services are outsourced to third parties (often for regulatory reasons), they often interwine
with core retail banking accounts like checking and savings to allow for easier transfers and
maintenance
In a more understandable terminology, the Retail banking could also be known as “Banking services
offered to the general public”. In contrast with Wholesale Banking or corporate banking, retail banking
is a high volume business with many service providers competing for market share. Some retail
banking services, for example, credit cards, are among the most profitable services offered by financial
institutions and because of competition; the benefits of such services could vary from bank to bank.
2.1 Accounts
A bank account is a financial account with a banking institution, recording the financial transactions
between the customer and the bank and the resulting financial position of the customer with the bank.
Broadly, accounts opened with the purpose of holding credit balances are referred to as deposit
accounts; whilst accounts opened with the purpose of holding debit balances are referred to as loan
accounts.
Some accounts are defined by their function rather than nature of the balance they hold. Bank accounts
designed to process large numbers of transactions may offer credit and debit facilities and therefore do
not sit easily with a polarized definition. These transactional accounts are called by different names in
different countries: in the U.S. and Canada, they are called "checking accounts"; in the UK, they are
termed "current accounts".
There are so many options now available to savers that it is difficult to know where to begin. What sort
of savings account is best for you depends upon several factors - for example, how long you can tie
your cash up for, how quickly you are likely to need access and whether you pay tax or not and these
are only a few of the options. Without going into a very large array of account types, lets only see a few
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of the Bank accounts that are by and large the most widely available across geographies and a few
value added types provided by banks.
Most of the banks would pay interest to you on the minimum balance held between the 10th and
30th/31st of every month, though this could vary from country to country based on the regulations of
the central bank.
Now let's see a simple example from our own accounts, the normal Indian savings account holder.
Suppose you have nil in your account as on April 10 th. On April 11th you deposit Rs.100, 000 in your
account. If you withdraw the funds on May 31st, there is no interest paid to you for the entire term of 51
days.
You may wonder why but the reason according to the bank's calculation is that the minimum balance
between April 10th (nil) and April 30th (Rs 100,000) is nil, so no interest is paid for April. Similarly
between May 10th (Rs 100,000) and May 31st (nil), the minimum balance is nil and hence you earn no
interest for May as well.
Basically it implies that the bank gets to use your money for 51 days free of cost. Therefore, the banks
have the option of leveraging these zero-cost funds and lend them at higher rates of interest. This is one
of the most important sources of their profits.
As per Central banks directive banks are not allowed to pay any interest on the balances maintained in
Current accounts. However, in case of death of the account holder his legal heirs are paid interest at the
rates applicable to Savings bank deposit from the date of death till the date of settlement. Because of
the large number of transactions in the account and volatile nature of balances maintained, banks
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usually levy certain service charges for operating a Current account.
Joint accounts are often created in order to avoid probate. If two individuals open a joint account and
one of them dies, the other person is entitled to the remaining balance and liable for the debt of that
account.
A Joint Account is a temporary bank account normally being used between 2 parties entering into a
transaction where 1 party needs a security for the fulfillment of the transaction and the other party has
to pay the sum (deposit), being the security for the other party. Any payment from the Joint Account or
return of the deposit from the joint account will only be possible if both parties sign a joint written
instruction to the bank. It is not possible that only one of the both parties gives instruction for payments
of the joint account. Because (European) banks are not very interested in opening joint accounts,
because they are normally used for one transaction only, there are specialized parties or companies,
taking care of such accounts as trustees. A joint account will normally be closed or ended after the
foreseen transaction has been closed and ended. Joint accounts are used in transactions were large sums
of money are involved and a very useful alternative for letters of credit or escrow accounts
2.2 Deposits
Bank Deposits include money invested in insured bank accounts, some of which could be Fixed
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Deposits, Term Deposits, Certificates of Deposit, Treasury deposits and others.
Under these types of deposits, the person has to usually deposit a fixed amount of money every month
(usually a minimum of Rs.100/- p.m., the Indian scenario and this could vary depending on the banks
in every country). Any default in payment within the month attracts a small penalty. However, some
Banks besides offering a fixed installment RD, have also introduced a flexible / variable RD. Under
these flexible RDs the person is allowed to deposit even higher amount of installments, with an upper
limit fixed for the same e.g. 10 times of the minimum amount agreed upon.
Such accounts are normally allowed for maturities ranging from 6 months to 120 months. A Pass book
issued where the person can get the entries for all the deposits made by him / her and the interest
earned. Premature withdrawal of accumulated amount permitted is usually allowed (however, penalty
may be imposed for early withdrawals). These accounts can be opened in single or joint names.
Nomination facility is also available, which means that in the untimely death of the account holder, the
relative whose has been nominated by the account holder will receive the money.
2.3 Cards
There are a variety of cards available in the current banking system. Some of these card products
include Credit cards, Debit Cards, ATM cards, Charge Cards, Prepaid cards, Smart Cards, Cheque
guarantee cards etc.,
We will discuss the Credit cards which are widely used by a majority of the banks customers and is one
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of the very important money earners for a bank.
Credit Cards
In financial term, credit card is a financial instrument, which can be used again and again to purchase goods or
borrow money and use services on credit, up to a pre-defined limit. Credit cards could be included as a product
under the Loan product line, because these are kind of short term loans from the bank, with an option to pay
back at a later date in installments. But considering the size of the customer base, the scope of business for banks
(note that this is a major profit center in banking business) and the banks having separate divisions created to
manage these set of customers, they have been listed here as a separate product line. These Cards operates on the
simple principle of "BUY NOW and PAY LATER". Credit cards are also popularly known as Plastic Money and
facilities the holder to buy products / services on credit, and then pay later on within about 45 to 50 days. You
can pay back the amount due within the credit period allowed or you can pay the minimum balance (ranging
between 5-10 per cent) and pay the rest later on which the bank charges interest at about 3 per cent p.m.( which
could again vary from country to country). The issuer of the card grants a line of credit to the consumer (or the
user) from which the user can borrow money for payment to a merchant or as a cash advance to the user.
There are different types of Credit cards used / popular in different countries across the globe. Some of
such credit cards are: Secured Credit Cards, Travel Credit Cards, Rewards Credit Cards, Airline Credit
Cards, Business Credit Cards, Cash Back credit cards, Instant Approval Credit cards, Low Interest
Credit Cards
In 2006, according to The Nilson Report, Visa held 44% of the credit card market share and 48% of the
debit card market share in the United States.
Visa has been at the forefront of electronic payments since its inception. From the first revolving credit
card platform to neural networks and mobile payments, Visa has pioneered the growth and
development of this fast-moving industry. Visa’s payment platforms are increasingly the backbone of
global commerce, enabling the swift and secure transfer of value and information among financial
institutions, individuals, businesses and government entities.
Visa provides financial institution customers with a comprehensive suite of electronic payment
products and services. Visa's product platforms encompass credit, debit, cash access and prepaid
products for consumers, businesses and governments.
Visa product platforms enable customers to develop and customize their own payment programs to
meet the needs of their geographic markets. Visa also offers customers issuer processing in support of
debit and prepaid platforms.
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Visa also offers a broad range of value-added services such as enhanced risk management, dispute
processing, loyalty and other information-based services, which are enabled by a centralized global
processing platform.
MasterCard Worldwide is a multinational corporation based in Purchase, New York, United States.
Throughout the world, its principal business is to process payments between the banks of merchants
and the banks of purchasers that use its "MasterCard" brand debit and credit cards to make purchases.
MasterCard Worldwide has been a publicly traded company since 2006. Prior to its initial public
offering, MasterCard Worldwide was a membership organization owned by the 25,000+ financial
institutions that issue its card.
It was originally created by Raymond Tanenhaus and Stanley Benovitz, two entrepreneurs in
Louisville, KY, and later sold in 1966 to United California Bank (which did go through a lot of merger)
as a competitor to the BankAmericard issued by Bank of America, which is now the VISA credit card
and issued by Visa Inc.
The formula verifies a number against its included check digit, which is usually appended to a partial
account number to generate the full account number. This account number must pass the following test:
• Counting from the check digit, which is the right most, and moving left, double the value of
every second digit.
• Sum the digits of the products together with the undoubled digits from the original number.
• If the total ends in 0 (put another way, if the total modulo 10 is congruent to 0), then the number
is valid according to the Luhn formula; else it is not valid.
Double every second digit, from the rightmost: (1×2) = 2, (8×2) = 16, (3×2) = 6, (2×2) = 4, (9×2) = 18
Sum all the individual digits (digits in parentheses are the products from Step 1):
6 + (2) + 7 + (1+6) + 9 + (6) + 7 + (4) + 9 + (1+8) + 4 = 70
Take the sum modulo 10: 70 mod 10 = 0 (means the sum is divisible by 10); the account number is
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valid. Is yours a valid credit card number? Try it out yourself
If you look at an American Express card, you’ll see it starts with a 3, a throwback to their
travel/entertainment roots.
The first six digits will correspond to the issuer, including the major industry identifier. 34xxxx/37xxxx
is for American Express, 4xxxxx is for Visa, 51-55xxxx is for MasterCard, and 6011xx is for Discover.
The rest of the digits (except the last one, which is a checksum digit) are your account number.
For example, if a user had a $1,000 transaction and repaid it in full within this grace period, there
would be no interest charged. If, however, even $1.00 of the total amount remained unpaid, interest
would be charged on the $1,000 from the date of purchase until the payment is received. The precise
manner in which interest is charged is usually detailed in a cardholder agreement which may be
summarized on the back of the monthly statement and could be different in different countries.
The general calculation formula most financial institutions use to determine the amount of interest to be
charged is
Where
APR = Annual Percentage Rate
ADB = Average Daily Balance
Number of days revolved = Number of days the amount revolved before the payment was made
Note: The number of day in a year could vary depending on the regulations of the central banks in the
respective regions.
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Financial institutions refer to interest charged back to the original time of the transaction and up to the
time a payment was made, if not in full, as RRFC or residual retail finance charge. Thus after an
amount has revolved and a payment has been made, the user of the card will still receive interest
charges on their statement after paying the next statement in full (in fact the statement may only have a
charge for interest that collected up until the date the full balance was paid...i.e. when the balance
stopped revolving).
Account numbers are often embossed or imprinted on the card, and a magnetic stripe on the back
contains the data in machine readable format. Fields can vary, but the most common include:
The mail and the Internet are major routes for fraud against merchants who sell and ship products, and
impacts legitimate mail-order and Internet merchants.
One of the most prevalent fraud methods to collect account details is Skimming. Skimming is the theft
of credit card information used in an otherwise legitimate transaction. It is typically an "inside job" by a
dishonest employee of a legitimate merchant. The thief can procure a victim’s credit card number using
basic methods such as photocopying receipts or more advanced methods such as using a small
electronic device (skimmer) to swipe and store hundreds of victims’ credit card numbers. Common
scenarios for skimming are restaurants or bars where the skimmer has possession of the victim's credit
card out of their immediate view. The thief may also use a small keypad to unobtrusively transcribe the
3 or 4 digit Card Security Code which is not present on the magnetic strip.
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2.3.7 Life Cycle of a Payment
Life cycle of a online payment using a credit card and the Step by Step description of the
activity, an example.
Step 1: The merchant submits a credit card transaction to the Authorize.Net Payment Gateway (one of
the many payment gateway service providers) on behalf of a customer via secure Web site connection,
retail store, MOTO center or wireless device.
Step 2: Authorize.Net (A Payment Gateway service provider) receives the secure transaction
information and passes it via a secure connection to the Merchant Bank’s Processor.
Step 3: The Merchant Bank’s Processor submits the transaction to the Credit Card Network (a system
of financial entities that communicate to manage the processing, clearing, and settlement of credit card
transactions).
Step 4: The Credit Card Network routes the transaction to the Customer’s Credit Card Issuing Bank.
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Step 5: The Customer’s Credit Card Issuing Bank approves or declines the transaction based on the
customer’s available funds and passes the transaction results back to the Credit Card Network.
Step 6: The Credit Card Network relays the transaction results to the Merchant Bank’s Processor.
Step 7: The Merchant Bank’s Processor relays the transaction results to Authorize.Net.
Step 8: Authorize.Net stores the transaction results and sends them to the customer and/or the
merchant. This step completes the authorization process – all in about three seconds or less!
Step 9: The Customer’s Credit Card Issuing Bank sends the appropriate funds for the transaction to the
Credit Card Network, which passes the funds to the Merchant’s Bank. The bank then deposits the funds
into the merchant’s bank account. This step is known as the settlement process and typically the
transaction funds are deposited into your primary bank account within two to four business days.
A charge back is an event in which money in a merchant account is held due to a dispute relating to the
transaction. Charge backs are typically initiated by the cardholder. In the event of a chargeback, the
issuer returns the transaction to the acquirer for resolution. The acquirer then forwards the chargeback
to the merchant, who must either accept the chargeback or contest it.
Charge Cards
Charge cards, also called travel and entertainment cards, are a little different from credit cards. Charge
cards, such as American Express and Diners Club, have no credit limit. You can usually charge as much
as you want, but are required to pay off your entire balance when your bill arrives.
It is similar to a credit card, except that the contract with the card issuer requires that the cardholder
must each month pay charges made to it in full—there is no "minimum payment" other than the full
balance. Since there is no loan, there is no official interest. A partial payment (or no payment) results in
a severe late fee (as much as 5% of the balance) and the possible restriction of future transactions and
risk of potential cancellation of the card.
In contrast, a credit card is a revolving credit instrument which does not need to be paid off in full; no
late fee is charged as long as the minimum payment is made, which carries a balance forward as a loan
charging interest. Many people are not aware of this distinction however, and often the two terms are
used interchangeably to describe any card which can be used as payment.
Many charge cards have the option for users to pay for some purchases over time. Eg: American
Express charge card customers, for instance, can enroll in the Extended Payment Option (internally
referred to as EXPO) to be able to pay for purchases over $200 over time, or in Sign & Travel to be
able to pay for eligible travel-related expenses over time. These are only examples.
There are forms of electronic transfer that are distinct from wire transfer. EFTS (Electronic Funds
Transfer System) is one such system. This is the system you use when you give your bank account
number and routing information to someone you owe money and that party transfers the money from
your account. It is also the system used in some payments made via a bank's online bill payment
service. EFTS transfers differ from wire transfers in important legal ways. An EFTS payment is
essentially an electronic personal check, whereas a wire transfer is more like an electronic cashier's
check.
• The person wishing to do a transfer (or someone who they have appointed and empowered
financially to act on their behalf) goes to the bank and gives the bank the order to transfer a
certain amount of money. IBAN (International Bank Account Number) and BIC (Bank
Identifier Code) code are given as well so the bank knows where the money needs to be sent to.
• The sending bank transmits a message, via a secure system (such as SWIFT or Fed wire), to the
receiving bank, requesting that it effect payment according to the instructions given.
• The message also includes settlement instructions. The actual transfer is not instantaneous:
funds may take several hours or even days to move from the sender's account to the receiver's
account.
• Either the banks involved must hold a reciprocal account with each other, or the payment must
be sent to a bank with such an account, a correspondent bank, for further benefit to the ultimate
recipient.
Banks collect payment for the service from the sender as well as from the recipient. The sending bank
typically collects a fee separate from the funds being transferred, while the receiving bank and
intermediate banks through which the transfer travels deduct fees from the money being transferred so
that the recipient receives less than when the sender sent.
Banks collect a cost for the transfer effected as a transaction charge depending on the kind of transfer.
Real time gross settlement systems (RTGS) are a Electronic funds transfer mechanism where transfer
of money takes place from one bank to another on a "real time" and on "gross" basis. Settlement in
"real time" means payment transaction is not subjected to any waiting period. The transactions are
settled as soon as they are processed. "Gross settlement" means the transaction is settled on one to one
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basis without bunching with any other transaction. Once processed, payments are final and irrevocable.
• The RTGS System is an electronic gross settlement system (i.e. settlement of transactions by
transfer)
• Payment orders could be initiated only by the paying participant while the Central bank can
debit and credit participants’ accounts (i.e. commercial banks and primary dealers)
• Payment instructions will be submitted by SWIFT – a payment message gateway. The paying
bank will send the payment message to the Central Bank through the SWIFT network using a
computer based terminal.
• All payment instructions sent to the RTGS system will be processed and settled individually
throughout operating hours;
• Under normal circumstances, payments will be debited to the paying participant’s Settlement
Account and reach its receiving participant within seconds provided that the sending bank has
sufficient balance in its account to make the payment. This makes the funds immediately
available to the receiver;
• Participants may assign one of several predefined priorities to their payment orders;
• Each payment instruction will be settled individually on a first in first out basis (FIFO) in
accordance with their priority and the order of arrival, without netting debits against credits;
• If the balance in the Settlement Account of the sending members is insufficient to settle the
payment, payment orders will be queued pending incoming payments or until daylight
(intraday) liquidity facility is made available to the participants by the Central Bank.
• When the system cannot settle payments through the normal sequential settlement process, the
gridlock resolution will clear backlogs of queued payment orders;
• The RTGS system will have international standards for risk control in large value fund transfer
systems;
• Participants could utilize the Central Bank’s Intra-day Liquidity Facility;
• Offers premium payment and settlement services. All participants can monitor the status of
their accounts and payments in real time, make enquiries and manage their queues via their
participant browser workstation
If there are no payment orders in the payment queue with the same or high priority and the particular
participant has enough funds to settle the payment, the System will settle that payment immediately by
debiting the paying participant’s account and crediting the receiving participant’s account simultaneous
within a few seconds.
Foreign exchange banks throughout the world participate and play a big role in forex, although their
roles have been greatly reduced from yesteryear. John Atkin points out in his book The Foreign
Exchange Market of London that "The Bank had long used a mixture of nods, winks and arm twisting
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to influence the behavior of participants in the domestic money and banking markets." It is no secret
that Foreign exchange banks dominate the top level of access for the best Forex spread. Using their big
pool of clients along with their own accounts, inter-bank market made up more than half of all Forex
transactions
Banks have different forex products like Travelers cheques, foreign currency cash, foreign currency
drafts, overseas cheque deposits etc.
Banks do not have total control over foreign exchange rates as they fluctuate according to as actual
monetary flow, budget, trade deficits, changes in GDP growth and interest rates and other economic
conditions. In foreign exchange platforms, virtually everyone get access to major news at the same
time, and banks are no different. Nevertheless, banks still gain the upper hand from monitoring the
trend of their customers' order flow.
Apart from normal banks, central banks also participate in the foreign exchange market to regulate
currencies in protection of their economy. Central banks or and national banks serve a dominant role in
controlling inflation, interest rates and money supply. Since a country's currency rates have direct
implications on its economy through the trade balance, almost all central banks tend to intervene to
influence the value of their currencies. This is known as managed float.
Financial institutions and Banks are leveraging the wealth management and asset management to
launch new products-such as dual currency deposits, principal protected deposits, range accrual
deposits and mutual funds - with a distinct time-to-market advantage to reach out to the customers and
provide value added service to them. The solutions are these days integrated with the core banking and
CRM solutions, to ensure unique customer definition, a single, unified view of the customer's portfolio
across asset classes and seamless flow of transactions. This helps banks capitalize on their customer
base to create additional revenue streams, by offering HNWI (High Net Worth Individuals) and the
mass affluent extended products and services.
Banks across the globe have tied up with Insurance companies or have their own subsidiary companies
created to sell insurance products to their customers as value added services and have created a separate
line of business.
Eg: The passage of the Gramm-Leach-Bliley Act in the US, banks there have been provided the
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authority to sell insurance. These days’ bankers and agents are increasingly being thrown together,
either as competitors or partners.
For eg:
• Housing or Mortgage loans (which will be covered in detail in the later section)
• Car loans
• Personal loans
• Consumer durable loans
• Education loans
• Loans against share
• Financing against gold etc.,
The age of ledgers or manual entries has been replaced by computers. And branches are interconnected
so that customers can access their accounts at ease being anywhere. The Branch banking experience is
also going over a very rapid change with technology. The long queues at the teller counters have been
replaced by a very quick and rapid service by the banking personnel. Cheque deposit machines and
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cash deposit machines are slowly replacing the manual way of depositing with a teller and this in turn
is also reducing the chances of manual errors.
To encourage customers to embrace the technology and overcome their trepidations about putting their
checks into a machine's slot rather than a teller's hands, banks originally didn't charge customers any
fees for using ATMs. (Indeed, in time, some banks started charging customers for not using ATMs,
through so-called "human teller fees" - a charge for each time a customer uses a teller for a service that
could be performed by an ATM.) The main advantage of using an ATM is the fact that you can have
access to the cash in your bank account whenever you need it. If, for instance, you are at a store that
does not take checks or credit cards but it has an ATM, you can withdraw the money for your purchase.
This also means you can travel anywhere without cash. If the location has an ATM and you have your
ATM card, you can access your money instantly.
Today's ATMs are not just machines you can use to access cash. On some ATMs you can transfer funds
between accounts, buy stocks, check account balances and even buy stamps. All of these features can
be accessed with one debit card or credit card and a PIN number. If you take measures to protect your
PIN and account information, having access to an ATM is very convenient and makes life's little
emergencies far less challenging, but be sure you know the fees associated with ATM use before you
use one
Most telephone banking uses an automated phone answering system with phone keypad response or
voice recognition capability. To guarantee security, the customer must first authenticate through a
numeric or verbal password or through security questions asked by a live representative (see below).
With the obvious exception of cash withdrawals and deposits, it offers virtually all the features of an
automated teller machine: account balance information and list of latest transactions, electronic bill
payments, funds transfers between a customer's accounts, etc.
Usually, customers can also speak to a live representative located in a call center or a branch, although
this feature is not guaranteed to be offered 24/7. In addition to the self-service transactions listed
earlier, telephone banking representatives are usually trained to do what was traditionally available
only at the branch: loan applications, investment purchases and redemptions, cheque book orders, debit
card replacements, change of address, etc.
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Some of the key features of phone banking and are not restricted to…
One way to classify these services depending on the originator of a service session is the ‘Push/Pull'
nature. ‘Push' is when the bank sends out information based upon an agreed set of rules, for example
your banks sends out an alert when your account balance goes below a threshold level. ‘Pull' is when
the customer explicitly requests a service or information from the bank, so a request for your last five
transactions statement is a Pull based offering.
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3.5 Internet / E-banking
Internet banking (also referred as E-banking) is the latest in this series of technological wonders in the
recent past involving use of Internet for delivery of banking products & services.
E-banking is changing the banking industry and is having the major effect on banking relationships.
Banking is now no longer confined to the branches were one has to approach the branch in person, to
withdraw cash or deposit a cheque or request a statement of accounts. Through E-banking, any inquiry
or transaction is processed online without any reference to the branch (anywhere banking) at any time.
Providing Internet banking is increasingly becoming a "need to have" than a "nice to have" service. The
E-Banking, thus, now is more of a norm rather than an exception in many developed countries due to
the fact that it is the cheapest way of providing banking services.
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A successful Internet banking solution offers the below listed services and are not limited to only those.
Features including secured access and consolidated view of all accounts with the bank and others are
being added to the list every now and then in line with technological advancements.
The Internet has leveled the playing field and afforded open access to customers in the global
marketplace. Internet banking is a cost-effective delivery channel for banks. Consumers are embracing
the many benefits of Internet banking. Access to one's accounts at anytime and from any location via
the World Wide Web is a convenience unknown a short time ago. Thus, a bank's Internet presence
transforms from 'brochure ware' status to 'Internet banking' status once the bank goes through a
technology integration effort to enable the customer to access information about his or her specific
account relationship. The six primary drivers of Internet banking includes, in order of primacy are:
Two-factor, or multi-factor authentication is exactly what it sounds like. Instead of using only one type
of authentication factor, such as only things a user KNOWS (login IDs, passwords, secret images,
shared secrets, solicited personal information, etc), two-factor authentication requires the addition of a
second factor, the addition of something the user HAS or something the user IS.
Two-factor authentication is not a new concept. Two-factor authentication is used every time a bank
customer visits their local ATM machine. One authentication factor is the physical ATM card the
customer slides into the machine. The second factor is the PIN they enter. Without both, authentication
cannot take place. This scenario illustrates the basic parts of most multi-factor authentication systems;
the "something you have" + "something you know" concept.
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"Existing authentication methodologies may also involve three basic “factors” as the security is the top
most agenda in an e-banking environment and is again evolving with technology.
• Something the user knows (e.g., password, PIN);
• Something the user has (e.g., ATM card, smart card); and
• Something the user is (e.g., biometric characteristic, such as a fingerprint).
Authentication methods that depend on more than one factor are more difficult to compromise than
single-factor methods."
Some manufacturers also offer a One Time Password (OTP) token. These have an LCD screen which
displays a pseudo-random number consisting of 6 or more alphanumeric characters (sometimes
numbers, sometimes combinations of letters and numbers, depending upon vendor and model).
This pseudo-random number changes at pre-determined intervals, usually every 60 seconds, but they
can also change at other time intervals or after a user event, such as the user pushing a button on the
token. Tokens that change after a pre-determined time are called time-based, and tokens that require a
user event are referred to as sequence-based (since the interval value is the current sequence number of
the user events, i.e. 1, 2, 3, 4, etc.). When this pseudo-random number is combined with a PIN or
password, the resulting passcode is considered two factors of authentication (something you know with
the PIN/password, and something you have from the OTP token). There are also hybrid-tokens that
provide a combination of the capabilities of smartcards, USB tokens, and OTP tokens.
Online security for E-banking, Mobile banking is upgraded every now and then to enable a secure
environment for customers to use the online services or anywhere banking services.
4 Technology in Banking
There are numerous place in the above pages that you would have seen a note that the banking
experience is evolving over the time with the advent of new technology. Computers and technology
have hundreds of uses in the modern world from space missions to microwave ovens. One industry that
uses computers and technology to the largest extent and invests in technology all the time is finance
and banking!
Computers play a huge part in getting and sharing information, which is why the computer industry is
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often referred to as the Information Technology, or the I.T. industry.
Computers can make fast calculations and carry out instructions efficiently and more quickly than
people - so transactions that would have once taken several minutes or longer, are now done in seconds.
The use of computers in banking first began in the early 1950s, when the first large commercial
computer was built for Bank of America. Initially, computers were used to process check transactions
through Magnetic Ink Character Recognition. With the introduction of the first automated
clearinghouse in the early 1970s, electronic funds transfer (EFT) was made possible, and the ATM was
introduced. Current statistics show that workers in the finance industry use computers more than any
other industry. Banks increasingly have turned toward ATM and other computer technology to reduce
the high costs associated with maintaining traditional “brick and mortar” branches staffed by tellers.
ATM transactions, along with transactions made by telephone; have replaced transactions formerly
made with human tellers.
With the introduction of EFT in the early 1970s came the use of ATM’s to process financial
transactions. The first ATM was installed at a bank in Valdosta, Georgia, in 1971.Initially, ATM’s
served as cash dispensers, but as customer acceptance increased, EFT networks expanded. ATM’s
appeared not only at bank locations but in shopping centers, stadiums, airports, and other locations
where people gather. By 1995, 9.7 billion transactions were processed at 123,000 ATM terminals. Cash
withdrawals remain the most widely used ATM transactions; however, many banks are adding a
collection of services to help encourage use of ATM’s, because ATM transactions cost less than teller
transactions.
The banks in India started from a disparate IT infrastructure in general and moved over to consolidation
and virtualization of databases and servers gradually over the years in order to achieve efficiency, cost
reduction, improvement in customer services and to address the issues arising from competition from
the other market players. Use of technology in a large but judicious way provides relief in the form of
more effective work processes, reduced costs of processing and the capability to handle relatively large
transaction volumes with remarkable ease. The Core Banking concept to a great extent emerged from
this centralization process and has since received a complete and focused attention from all the banks
for its rapid implementation. The banks have also undergone a massive change in terms of
improvement in the IT Communication network which has greatly facilitated not only the networking
of the internal communication processes but the integration with the external payment systems
gateways as well.
In regard to the implementation of ‘Core Banking’ and ‘Electronic Banking’ banks have made
considerable progress in recent years as far as the centralization of customers’ accounts is concerned;
however, we can also think of making it more useful by expanding the coverage of Core Banking
Systems (CBS) and all the essential services / banking products like treasury, Customer Relationship
Management (CRM), Corporate Banking, Management Information Systems (MIS), etc. getting
seamlessly integrated into the present CBS. The offering of electronic banking service channels like
Internet Banking, Mobile Banking, real time fund transfer, ATM Applications and other forms of
upcoming electronic banking channels have become important vehicles of offering banking services in
a cost-efficient manner with wide geographical spread; enhancing the banks’ reputation and brand
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building addressing the competitive forces as well.
Also seen are the developments in the communication network and messaging system in India as a
whole in the form of Indian Financial Network (INFINET), Structured Financial Messaging System
(SFMS), VSAT connectivity, cable and leased line connection, fiber optics channels, etc. There have
been marked improvements in the Indian payment and settlement systems in the form of popularizing
and strengthening of Real Time Gross Settlement (RTGS), Centralized Fund Management System
(CFMS), Electronic Clearing System (ECS), National Electronic Fund Transfer (NEFT), Cheque
Truncation, National Financial Switch (NFS), developments and initiatives at Clearing Corporation of
India Ltd. (CCIL) platform, ATMs, electronic banking channels etc. to name a few.
Some of the popular technologies that have been implemented since the computer revolution in banks
are as below....
Core banking
Customer relationship management
Cheque Truncation System
CUG networks
Kiosks / new delivery channels
Risk management
Wireless Technologies
Smart cards
Data Centers / DM / DW
Call Centers/Help Desks
Resource management
Internet / electronic banking
Lets now see a few of the popular technologies below, which I think has brought about a major change
in the way banks operate.
CTS promises to bring multiple benefits to customers by substantially reducing the time taken to clear
the cheques as well as to the banks by enabling them to offer better customer services and increasing
operational efficiency by cutting down on overheads in physical clearing. In addition, CTS also offers
better reconciliation and fraud prevention. CTS uses cheque image, instead of the physical cheque
itself, for clearing of the cheque. The cheque image is truncated at the presenting bank. Subsequently,
the cheque image moves through various steps in the cheque-clearing cycle and transactions are settled
on the basis of images and electronic data.
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4.3 Core Banking
Core banking is a general term used to describe the services provided by a group of networked bank
branches. Bank customers may access their funds and other simple transactions from any of the
member branch offices.
Core Banking is normally defined as the business conducted by a banking institution with its retail and
small business customers. Many banks treat the retail customers as their core banking customers, and
have a separate line of business to manage small businesses. Larger businesses are managed via the
Corporate Banking division of the institution. Core banking basically is depositing and lending of
money.
Normal core banking functions will include deposit accounts, loans, mortgages and payments. Banks
make these services available across multiple channels like ATMs, Internet banking, and branches
The advancement in technology, especially internet and information technology has led to new ways of
doing business in banking. These technologies have cut down time, working simultaneously on
different issues and increasing efficiency. The platform where communication technology and
information technology are merged to suit core needs of banking is known as Core Banking Solutions.
Here computer software is developed to perform core operations of banking like recording of
transactions, passbook maintenance, and interest calculations on loans and deposits, customer records,
balance of payments and withdrawal are done. This software is installed at different branches of bank
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and then interconnected by means of communication lines like telephones, satellite, internet etc. It
allows the user (customers) to operate accounts from any branch if it has installed core banking
solutions. This new platform has changed the way banks are working.
Phishing
Skimming
SQL Injection
Advance Fee frauds
Database and Server Hacking
Network attacks
Denial of Service attack
Web Defacing
Cross Site scripting
IP Spoofing
Man-in the Middle Attacks etc.
have resulted in huge losses for the banks and customers across the globe.
Credit card frauds are also on the rise. Large numbers of customers’ accounts and credit card holders’
accounts have been compromised in the past resulting in not only financial loss, but also legal risk and
reputational loss in the market. These electronic windows irrespective of the usage percentage and
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pattern have opened a new gate into the banks’ Information Systems’ components which can be
exploited by hackers, inside employees or even ex-employees to name a few. Money Laundering risk
through electronic channel and its countering is also a challenging task for the banking and financial
system. Though Indian financial system has not been affected to that extent from these risk factors as
compared to its counterpart abroad, the strengthening of the electronic banking channel by the banks
and systems’ participants will greatly assist in banks’ and financial institutions’ efforts for sustaining
and consolidating the business growth and above all maintaining confidence.
The local and regional banks tend to cater for the retail banking market, while the larger banks also
specialize in merchant banking and corporate finance. There is tough competition with the insurance
companies also diversifying into traditional bank areas, such as consumer lending and project finance.
The banks, in turn, are expanding into pension and insurance provision.
• Retail banking
• Corporate banking
• Institutional services
We will only cover the Retail banking aspects of Denmark in the below pages.
6.1.1 E-banking
The main features of online banking systems, though not all of them are available in English in the
region and in every bank.
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6.1.2 Accounts
These are the main features of most accounts; however, not all are included in every account are
• Consumer loan
• Car loan
• Home equity loan
• Mortgage loan
Banks have experts who will explain options, help choose the right type of loan, and then customize it
to fit the family's circumstances. Depending on where the customer lives, these are some of the loans
available:
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6.1.7 Investments
The financial markets are becoming both more complex and more accessible every year. Some people
like to research specific investments themselves, while others prefer to rely on the experts.
Whatever the needs may be, banks in this region have experts who will help – with personal advisory
services, collective investing options and online trading facilities. Banks here will offer products that
can pool the customer's savings with others to reduce expenses, volatility and risk. The mutual funds,
or unit trusts products, offer many advantages:
6.1.9 Pensions
The pension plans of these banks provide customers, who want an active retirement, a private scheme
that can give more financial freedom after retirement, if planned wisely.
• Annuity pensions
• Capital pensions
• Unit-linked schemes
• Investment pools
• Annuities
• Group life insurance
6.1.10Insurance
Banks offer expert advice that matches personal and financial circumstances with the right insurance
cover. Depending on where the customer lives, banks offer a wide range of covers through partnerships
with leading insurance providers:
While the services vary from country to country depending on national regulations, these are some of
the areas in which banks provide specialized advisory services:
• Investment management
• Portfolio management agreements
• Insurance
• Pensions
• Private companies
• Trusts and foundations.
A credit rating estimates the credit worthiness of an individual, corporation, or even a country. It is an
evaluation made by credit bureaus of a borrower’s overall credit history. Credit ratings are calculated
from financial history and current assets and liabilities. Typically, a credit rating tells a lender or
investor the probability of the subject being able to pay back a loan. However, in recent years, credit
ratings have also been used to adjust insurance premiums, determine employment eligibility, and
establish the amount of a utility or leasing deposit.
A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates or
the refusal of a loan by the creditor.
8 Lending
8.1 Credit
What is Credit? Credit is the provision of resources (such as granting a loan) by one party to another
party where that second party does not reimburse the first party immediately, thereby generating a debt,
and instead arranges either to repay or return those resources (or material(s) of equal value) at a later
date. It is any form of deferred payment. The first party is called a creditor, also known as a lender,
while the second party is called a debtor, also known as a borrower.
The word credit is used in commercial trade in the term "trade credit" to refer to the approval for
delayed payments for purchased goods. Credit is sometimes not granted to a person who has financial
instability or difficulty.
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8.2 Consumer Credit
Consumer credit can be defined as money, goods or services provided to an individual in lieu of
payment. Common forms of consumer credit include
• Credit cards,
• Store cards,
• Motor (auto) finance,
• Personal loans (installment loans),
• Retail loans (retail installment loans) and
• Mortgages.
This is a broad definition of consumer credit and corresponds with the Bank of England's definition of
"Lending to individuals".
The cost of credit is the additional amount, over and above the amount borrowed, that the borrower has
to pay. It includes interest, arrangement fees and any other charges. Some costs are mandatory,
required by the lender as an integral part of the credit agreement. Other costs, such as those for credit
insurance, may be optional. The borrower chooses whether or not they are included as part of the
agreement.
Interest and other charges are presented in a variety of different ways, but under many legislative
regimes lenders are required to quote all mandatory charges in the form of an annual percentage rate
(APR). The goal of the APR calculation is to promote ‘truth in lending’, to give potential borrowers a
clear measure of the true cost of borrowing and to allow a comparison to be made between competing
products.
9 Types of Lending
Lending can be of two types – secured Lending and Unsecured Lending
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9.2 Unsecured Lending
Unsecured Lending is a loan which is made without any collateral. These can be fixed amounts like
personal loans or a revolving line of credit like credit cards (called revolving because customer can
borrow any amount up to a certain limit and pay flexibly)
Unsecured lending is, thus, riskier than secured lending; hence, the reason that personal loans, etc., are
priced at higher rate of interests than home loans. Competition also determines the rate of interest
charged. For example, in consumer durables lending in India, most goods are financed at zero percent
rate of interest but only with stamp fees.
Loans with specific assets pledged as collateral are secured loans. No assets are pledged with unsecured
loans. In the absence of any Collateral, a loan is made under the assumption that it is essentially risk
free. An unsecured loan is, therefore, only appropriate when the borrower has established record of
honoring loan commitments and has shown the financial capacity to honor the loan commitments when
it comes due.
The risk free criterion for unsecured loans also disqualifies most loans with long maturity. Unsecured
loans are based on the borrower's current financial strength. As the maturity of the loan extends beyond
one year the (or operating cycle) the risk increases. For this reason, the unsecured loans are normally
used only to finance current assets, which are converted to cash within one year. In contrast the long-
term loan repayment depends on continued profitability in upcoming years, and there is always risk that
a borrower's financial status might deteriorate before the loan matures.
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Retail Lending
Corporate Lending
Priority Sector Lending
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10 Mortgage Lending
A mortgage is the transfer of an interest in property to a lender as a security for a debt - usually a loan
of money. While a mortgage in itself is not a debt, it is the lender's security for a debt. It is a transfer of
an interest in land (or the equivalent) from the owner to the mortgage lender, on the condition that this
interest will be returned to the owner when the terms of the mortgage have been satisfied or performed.
In other words, the mortgage is a security for the loan that the lender makes to the borrower.
The cost to the borrower is measured by the annual percentage rate (APR), which is an effective annual
rate of interest and fees paid by the borrower.
In many countries, though not all, it is normal for home purchases to be funded by a mortgage. Few
individuals have enough savings or liquid funds to enable them to purchase property outright. In
countries where the demand for home ownership is highest, strong domestic markets have developed,
notably in Ireland, Spain, the United Kingdom, Australia and the United States.
The lender loans the money and registers the mortgage with the title to the property. The borrower
gives the lender the mortgage as security for the loan, receives the funds, makes the required payments
and maintains possession of the property. The borrower has the right to have the mortgage discharged
from the title once the debt is paid. If the mortgagor fails to repay the loan according to the conditions
set forth by the lender, then the mortgagee reserves the right to foreclose on the property.
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10.2 Borrower
Borrower is a party who mortgages property. A mortgagor owes the obligation secured by the
mortgage. Generally, the debtor / borrower must meet the conditions of the underlying loan or other
obligation and the conditions of the mortgage. Otherwise, the debtor usually runs the risk of foreclosure
of the mortgage by the creditor to recover the debt. Typically the debtors will be the individual home-
owners, landlords or businesses who are purchasing their property by way of a loan.
• To diversify investments and reduce overall risk by using only part of the available funds for
any one investment. However the mortgage loan enables him to purchase more assets than he
would otherwise been able to, and therefore in general increases investment risk rather than
reducing it.
• To invest the borrowed funds at a higher rate of interest (yield) than the borrowing rate; for
example, a sum is borrowed at an annual interest rate of 7% per year and used to invest in a
project that returns 10% per year. This is likely to be speculative and there is usually a
possibility that the project may turn out to return less than 7% per year or to lose money.
• To free up equity for other purposes; for example, a commercial enterprise may prefer to use
funds to purchase inventory or equipment instead of investing only in land and buildings.
• To obtain a tax benefit. In some countries (such as Canada), mortgage interest is not tax
deductible, but loans made for investment purposes are.
11 Mortgage
What Is a Mortgage? A mortgage, also called a deed of trust, is a legal document that pledges
property as security for the repayment of a loan. If the borrower does not comply with the loan
repayment terms, the mortgage gives the lender the right to take ownership of the property and then sell
the property in order to satisfy the debt.
The great jurist Sir Edward Coke, has explained why the term mortgage comes from the Old French
words Mort meaning "dead" and gage meaning "pledge". It seemed that it had to do with the
doubtfulness of whether or not the mortgagor will pay the debt. If the mortgagor does not, then the land
pledged to the mortgagee as a security for the debt "is taken from him forever, and so dead to him upon
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condition, and if he doth pay the money, then the pledge is dead as to the mortgagee. This etymology,
as understood by 17th-century attorneys, of the Old French term mortgage, which we adopted, may
well be correct. The term has been in English much longer than the 17th century, being first recorded in
Middle English with the form mortgage and the figurative sense "pledge" in a work written before
1393.
We will now see some the mortgage process flow, some of the important terminologies in the Mortgage
world and the EMI calculation.
Person seeking a loan from the lender to purchase a new home or refinance an existing mortgage.
Lender originates, processes, fund and closes the loan; sells the loan to the secondary
market investor.
.
The loan servicer (can be the mortgage lender) administers the loan
through its life on behalf of the secondary market investor
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11.2 Types of Mortgage Lenders
Mortgage lenders are broadly classified as mortgage bankers and mortgage brokers. The primary
discerning feature between the two is the origin of the funds utilized to fund the mortgage loans.
At the time of closing, the money necessary to fund the loan transaction is provided by the wholesale
lender. Mortgage brokerages are typically smaller companies than mortgage bankers and do not have
the same degree of public recognition enjoyed by mortgage bankers.
Before the principal is provided you will need to make a DOWN PAYMENT. A down payment is the
percentage you will put towards the principal. The amount of the down payment will often depend on
the cost of the home. Once you pay off the principal, the home is yours.
The next term you will need to know is INTEREST. Interest is a percentage that you are charged to
borrow a certain amount of money. This Interest could either be a Fixed Interest or a Variable
Interest as the case may be. The principal and interest makes up the majority of your monthly
payments or EMI (EQUATED MONTHLY INSTALLMENTS). Amortization is the method by
which your loan is reduced over a given period of time. Your payments for the first few years will
cover the interest, while payments made later will be applied towards the principal.
A portion of your mortgage payments can be placed in an ESCROW account in order to go towards
insurance, taxes, or other expenses. Taxes are the amount of money that you have to pay to your state
or government.
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11.3 Mortgage Insurance
Mortgage Insurance is another important term that you will hear in the real estate community, though
this is Optional in most economies. However, in some countries, you will not be allowed to close on
your mortgage if you don't have insurance for your home. Home insurance covers your home against
floods, fire, theft, or other problems.
The formula for calculation of EMI given the loan, term and interest rate is:
(1+r)^n - 1
p = principal (amount of loan), r = rate of interest per installment period, i.e., if interest is 12% p.a. r =
12, n = no. of installments in the tenure, ^ denotes whole to the power.
The buyer then begins the mortgage process with the chosen lender. The mortgage lender will take the
borrower application, process the borrower credit and property details, render a loan decision and then
close and fund the loan.
Loan Origination
Mortgage lenders employ loan originators, often referred to as loan officers, who are responsible for
the loan origination function. Loan officers typically generate income through commissions earned on
the loans they originate. Although technical knowledge is an essential loan officer attribute,
accomplished sales skills are equally important.
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Loan Processing
After completion of duties the loan officer will forward the loan file to the loan processor. The loan
processor is responsible for:
• Review of application and file documents - The loan processor must conduct a thorough review
of the loan file to insure loan program conformity and regulatory compliance.
• Order out of file documents - The loan processor will assess the file documentation
requirements and order necessary documents such as the credit report and appraisal. Some
lenders employ junior processors or order out clerks who assist the loan processor with this
function.
• Follow up and review of incoming file documentation - As new file documents are received, the
loan processor will review each item to verify that the file continues to meet the program
requirements.
• File submission to underwriter - Once the file is complete, the loan processor will assemble the
documentation and present the file to the loan underwriter for a loan decision.
Underwriting
The process of evaluating the loan request and determining whether to approve or deny the loan is
referred to as underwriting. Mortgage lenders employ underwriters who perform this function.
Underwriters are seasoned mortgage professionals who possess exceptional technical and analytical
skills. Typical underwriter duties are:
• Assess credit risk - The underwriter will review the applicant's credit, income and assets to
determine the likelihood of loan default.
• Evaluate loan collateral - The property appraisal and related documents will be scrutinized by
the underwriter to determine whether the property represents adequate collateral for the loan.
• Insure regulatory compliance - The underwriter will review file documents to verify regulatory
compliance.
• Verify conformity with investor requirements - The underwriter will confirm that the loan meets
all guidelines established by the designated secondary market investor.
• Render loan decision - The loan request will be approved or denied by the underwriter. In some
cases, the underwriter may "suspend" the loan decision while awaiting additional
documentation necessary to complete the decision analysis.
Loan Closing
If the loan is approved by the underwriter the file will be forwarded to the loan closer who will prepare
the file for closing. The loan closer is responsible for:
Quality Control
Quality control is an essential part of the mortgage process. Quality control is necessary to ensure regulatory
compliance, investor compliance, underwriting prudence and conformity with the lender's internal policies and
procedures. Lenders will typically perform a quality control review of 10% of all loan applications including
closed loans, denied loan applications and those loan applications withdrawn by the applicant.
Loan Processing
Underwriting
Loan Closing
Post Closing/Shipping
Quality Control
On a go forward, we will more deeply talk about the US Mortgage Industry as they follow a
more comprehensive approach to the Mortgage industry. Also, most economies in the world
follow the US model.
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• List the technological resources used in the mortgage process.
Today, technology is integral to any business. The mortgage industry has been heavily impacted by the
growing technology.
Fueled by low interest rates, mortgage volume has escalated to unprecedented levels in recent years.
Fluctuating volume levels, frequent rate changes and arduous regulatory compliance responsibilities
present constant challenges to the modern day mortgage lender. Technology has become an invaluable
component of the loan process and is continually enhanced to meet the demands of the industry.
Paperless transactions are quickly becoming the norm.
Loan Origination
The loan origination participants include a seller, a buyer and a lending institution. The process begins
when that seller places for sale an asset already owned. An asset is defined, as anything owned by a
person or organization having monetary value. For the mortgage banking industry an asset would
generally refer to a house, some commercial property or an office building. A buyer approaches the
seller with an offer to purchase the asset. Generally a real estate broker acts as an intermediary between
the buyer and the seller.
Lending Institutions
Once the buyer and seller have agreed on a price, the buyer approaches a lending institution to obtain
the funds necessary to purchase the asset. Lending institutions include regulated institutions such as
commercial banks, savings institutions, and credit unions and other primary lenders such as mortgage
bankers and mortgage brokers.
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the property performed by a person qualified by education, training, and experience to estimate the
value of real and personal property.
If the lender is satisfied with the borrower’s ability and willingness to pay the loan and the value of the
property is sufficient to minimize any loss on the part of the borrower in the event of default, the lender
approves the loan. The borrower will repay the loan with monthly payments that include a portion of
the principal (which is the original loan amount), plus interest. The period allotted for repayment is
generally 30 years, although loans are also made for periods of 10, 15, or 25 years.
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11.10 The Life of a Loan in Good Standing
Loan servicing may be thought of as a time line. From the transfer of servicing by the loan originator to
the final loan payment, loan follows a flow of processing that reflects the sequential steps needed to
safeguard the investor’s interest.
Pass Monthly
Loan Loan Servicing Payment
Origination Underwriting
Processing
Fail
Loan Loan
Loan application Deboarding
Rejected Closing
In this section, you will learn step by step what occurs with a loan when it is in good standing.
As long as the borrower abides by the terms of the mortgage, the loan service follows a “normal” set of
servicing activities. Once the transfer of servicing is complete and the loan is boarded, the normal
activities associated with servicing include monthly billing, recording of payments, investor remittance,
investor reporting and the payment of taxes, hazard insurance and mortgage insurance. Loans in which
the borrower abides by the terms of the agreement are considered to be “in good standing” and will
generate revenue for both the investor and the company servicing the loan.
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11.11 Exceptions to Loans in Good Standing
In this section, you will learn step by step what occurs with a loan when the loan is an exception to
good standing.
Pass Monthly
Loan Loan Servicing
Underwriting Payment
Origination
Processing
No Payments 90 days
Fail
Borrower files Foreclosure
Loan application Bankruptcy Sale
Rejected
Loan Loan
Deboarding Closing
When a borrower fails to abide by the loan agreement extra steps must be taken to ensure the safety of
both the investor’s and the loan servicer's expected revenue. Examples of exceptions that jeopardize
either the investor’s interest or servicing income include borrower delinquency, borrower bankruptcy,
delinquent property taxes or unpaid hazard insurance. When these situations occur, corrective action
must be taken by the company servicing the loan to either return the loan to good standing or to find
additional means of protecting the security of the investment
When a loan is in default, the loan servicer must report delinquencies.
Of all the functions performed in loan administration, none can be any more important than managing
delinquent accounts. A residential mortgage is generally classified as delinquent if it is 30 days past
due. Technically, a residential loan is delinquent the day after its due date, which is generally the first of
the month. However, uniform instruments allow for mortgage payments to be received up to the fifteen
days after the due date with no late fee added and no additional interest due. If payment is received
more than fifteen days after the due date, the lender may impose a late fee. Late fees vary in accordance
with the loan type but can be as much as 5% of the principal and interest payment due.
When a borrower has become delinquent, the loan servicer has two primary obligations. The first is
referred to as delinquency reporting to provide details on the status of the loan to those parties that may
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be affected by the delinquency. The second is to attempt collection of the debt or safeguard the
investor’s interest by other means such as foreclosure.
It is the servicer's obligation to report the delinquency condition to the investor, credit bureau and
Mortgage insurance company.
11.12 Foreclosure
After all attempts to cure default fail, a servicer must move to foreclose and protect the investment. It is
important for lenders to realize that when they foreclose on mortgage, they are only fulfilling their
fiduciary responsibility to protect the funds loaned, which are originally the savings of individuals,
whether in the form of passbook savings or life insurance. The steps taken to recover a property, and
force a sale that will recuperate loaned funds are called demand and ultimately foreclosure.
A mortgage instrument is usually worded in such a manner that the lender has certain options in the
event of default. One option provided by the mortgage is to immediately accelerate all future payments.
While accelerating the entire debt may not be the best avenue for the lender and is certainly not the best
alternative for the borrower, it is the first step that may ultimately lead to foreclosure when loan
resolution appears to be unlikely. A demand letter is sent to the borrower, advising the borrower of the
delinquency, accelerating the terms of the loan, and informing the borrower of the lender’s intent to
foreclose. The demand letter must be sent out 30 days prior to undertaking foreclosure proceedings.
Foreclosure is a legal proceeding in which a property is sold to pay the outstanding debt in case of
default. The servicer of a defaulted mortgage loan generally starts foreclosure proceedings if:
Three full installments are owed on a government loan or as few as two full installments are
owed on a conventional loan, if the investor is aggressive in its collection requirements
The property has been abandoned
The borrower has indicated an unwillingness to honor the mortgage obligation
A tenant occupies the property, but the rental income is not being applied to the mortgage
Foreclosure often results in judicial proceedings. The action is much like any other civil suit in that the
case must be brought in court, alleging that a mortgage was executed by the borrower and describing
the specific property used as security for the loan. The court is charged with protecting the best
interests of all parties involved. If the decision of the court is in favor of the lender, the remedy for the
lender will depend upon a number of considerations.
11.13 Bankruptcy
Bankruptcy is a court proceeding through which a person, firm, or corporation may be relieved of debt
after the surrender of any assets to the court.
A loan in bankruptcy is likely to become a classified asset - one in which the investor may not receive
the original profits projected on the loan. If a borrower files for bankruptcy, all attempts at collection
must stop. Any contact must be with the borrower’s attorney.
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11.14 Loan Servicing
After a mortgage banker sells a loan to an investor, the investor generally pays the mortgage banker a
fee for performing the various loan administration functions. This long-term stream of income (as
much as thirty years) makes the servicing function the most profitable aspect of mortgage banking. If
the originating lender chooses to sell the servicing rights along with the loan, the price paid by the
investor usually includes a servicing premium or additional amount paid over the principal for that
right to service the loan.
Loan servicing or residential loan administration can be defined as the total effort required performing
the day-to-day management of a residential mortgage. Effective loan administration should result in the
following:
• Rendering all of the required services to the borrower
• Protecting the security of the investor
• Producing a profit for the servicer
12.1 India
The types of mortgage that are accepted in the Indian mortgage industry for the facilitation of mortgage
loan are varied. Until recently, the Indian mortgage market was under the unorganized sector. The
Government of India liberal economic policy in the late 1990s the facilitated the entry of foreign
institutional investors (FIIs) and foreign direct investment (FII) in the Indian market. The Indian
markets which were previously closed to such investments registered tremendous economical growth
across all industry sectors.
In the last 15 years, the growth of the manufacturing industry in India propelled the growth of
infrastructure industry in India. Furthermore, with the growth of infrastructure industry in India, the
Indian mortgage loan industry witnessed tremendous growth. Today, the organized mortgage loan
sector of India is registering astronomical growth and it is estimated to be US$ 18 billion industry. The
Indian mortgage loan industry is consistently registering 20-50 % growth on a year-on-year basis, from
the year 2000 onwards.
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12.1.1Important Concepts regarding mortgages in India
Understanding the important concepts regarding mortgage is one of the major factors for customers
who opt to take out loans against mortgage.
Mortgage against loans is gaining popularity in India with the development of the economic conditions
and the increased activity on construction and related ventures. The Indian mortgage market is
experiencing a quick growth but the contribution factor of the mortgage industry i.e., the mortgage to
gross domestic product (GDP) ratio is very low in India in comparison with the other developed
countries.
12.1.3Refinancing
Refinancing is a very important concept pertaining to the mortgage against loan schemes. This scheme
emphasizes on the option of taking out another loan against mortgage is case there is insufficient funds
to pay off the first one. The refinancing concepts also have an advantage which is the interest rates are
lowered in case a customer takes out a refinance on mortgage. There are other advantages of
refinancing concept of mortgages, such as:
• The total sum of monthly payments by the customer gets reduced
• The total sum of interest paid by the customer during the term period of the loan is reduced
• The loan term period is reduced so as to enable the customer to repay the loan quickly
12.2 Denmark
The Danish mortgage system has proved very effective in providing borrowers with flexible and
transparent loans on conditions close to the funding conditions of capital market players.
Simultaneously, mortgage bonds transfer market risk from the issuing mortgage institution to bond
investors. Lastly, strict property appraisal rules, credit risk management by the mortgage institution,
and tight regulations including the so-called 'balance principle', have also historically shielded
mortgage bonds from default risk.
In Denmark, the mentioned Mortgage Credit Institutions (MCIs) are the only financial institutions
allowed to grant loans against mortgage on real property by issuing mortgage bonds. The scope of
activities allowed to MCIs is limited to the origination and servicing of mortgage loans, their funding,
exclusively through the issuance of mortgage bonds, and activities deemed accessory. As of 2007, there
are eight mortgage credit institutions active in the Danish mortgage market, some affiliated with
commercial banks.
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12.2.1The Balance Principle
The Danish Mortgage Credit Act imposes strict matching rules between the assets (e.g., mortgage
loans) and the liabilities (e.g., mortgage bonds) of mortgage credit institutions. Each new loan is in
principle funded by the issuance of new mortgage bonds of equal size and identical cash flow and
maturity characteristics, dubbed the balance principle or, the balanced book principle. The proceeds
from the sale of the bonds are passed to the borrower and similarly, interest and principal payments are
passed directly to investors holding mortgage bonds. Moreover, the Mortgage Credit Act establishes
strict lending rules which differ depending on the type of property financed. Maximum loan to value
(LTV) ratios and lending periods are set up for each category of property. While for all categories of
properties, the maximum lending period can be up to 30 years, maximum lending limits differ
significantly according to the nature of the mortgaged property. For owner-occupied homes, rental
properties, cooperative homes and housing projects, mortgage loans can represent up to 80 percent of
the value of the property. In contrast, maximum LTV ratios are limited to 70 percent for agricultural
properties, 60 percent for commercial real estate and secondary residences, and 40 percent for un-built
sites.
The first Danish Mortgage Act was passed in 1850, establishing new mortgage credit institutions which
were cast as (non-profit) associations. Loans against mortgages on real property are financed by issuing
bonds in series. Initially, borrowers were jointly liable for the liabilities of the corresponding pool of
mortgages. The system kept evolving thereafter, in particular in the early 1970s, when mortgage
financing was simplified and standardized. The last major round of reform took place in 1989, among
others authorizing commercial banks to own mortgage credit institutions. After 2001, the majority of
mortgage bonds were issued without the joint liability of borrowers.
12.2.3Foreclosure
In the event of non-payment of its mortgage-related obligations by the mortgagor, the mortgage bank
may put the property up for a forced sale. Forced sales are carried through by enforcement courts
(Fogedretten), which are part of the ordinary system of courts. Mortgagees will be covered in order of
priority and while uncovered mortgage loans will be deleted from the Land Register, the mortgagees
will keep their (uncovered) claim against the borrower as a personal claim. It typically takes no more
than six months from the time when the borrower defaults on the loan until a forced sale can be carried
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through. This is in contrast with France, say, where it can take several years to foreclose.
The human costs of turning a family into the street are mitigated through social housing. Denmark has
a total housing stock of 2.5 million housing units, of which 19 per cent belong to social housing
associations. The associations are subsidized by the government and municipalities in terms of reduced
interest and mortgage repayments and loan guarantees. Also the residents - as in other rented housing -
receive individual rent subsidies related to income, size of household and size of apartment. People in
acute need of housing can turn to the municipality for help if they are without possibilities to solve their
own housing problem.
98% of Danish mortgages are securitized to mortgage-backed securities and sold by the mortgage
originators.
12.2.5Business
• MCIs which obtain application data and review documentation and appraisals of originators
who propose mortgages.
• Each MCI, every day, issues new bonds valued at one cent each into an existing bond pool in an
amount equivalent to the new loans it makes that day. The money manager of the mortgage
institute decides when to sell the new bonds into the secondary market since they are identical
to other bonds in the same series.
• In event of a rise or drop in interest rates, a new bond pool may be started at a rate ½ percent
different than its predecessor, but the yields are equivalent.
• The bond prices trade and are quoted at day end and there is inter day pricing. The amount of
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cash transferred by the mortgage institute to the originator (borrower) is based on the number of
bonds issued and their previous day’s quote.
• Every time a loan balance is reduced, an equivalent number of bonds are identified by lottery
and converted into a different bond also with a one cent par value (that will convert at par into
cash at the next payment date). This and the fact that originally bonds issued equal the full
amount of the loan, enforce the Balance Principal.
• Loan prepayments can be made by using cash with some advance notice requirements so the
bond market can anticipate what is coming. In effect a contract is made in advance that the cash
presented will be used for prepayment at the next payment date.
• Loans can also be prepaid using bonds. These bonds can be purchased at a discount if that’s
where they are trading, and receive prepayment credit at par. Loan prepayments in bonds
require presentation of bonds from the series that funded the loan. Bond investors do not see
loan prepayments with bonds to be a prepayment at all since the bonds eliminated due to the
prepayment do not include any bonds being held by the investor.
LTV
The loan-to-value (LTV) ratio expresses the amount of a first mortgage lien as a percentage of the total
appraised value of real property. For instance, if a borrower wants $130,000 to purchase a house worth
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$150,000, the LTV ratio is $130,000/$150,000 or 87%.
CLTV
Combined Loan To Value (ratio) (CLTV) is the proportion of loans (secured by a property) in relation
to its value.
The term "Combined Loan To Value" adds additional specificity to the basic Loan to Value which
simply indicates the ratio between one primary loan and the property value. When "Combined" is
added, it indicates that additional loans on the property have been considered in the calculation of the
percentage ratio.
The aggregate principal balance(s) of all mortgages on a property divided by its appraised value or
Purchase Price, whichever is less. Distinguishing CLTV from LTV serves to identify loan scenarios that
involve more than one mortgage. For example, a property valued at $100,000 with a single mortgage of
$50,000 has an LTV of 50%. A similar property with a value of $100,000 with a first mortgage of
$50,000 and a second mortgage of $25,000 has an aggregate mortgage balance of $75,000. The CLTV
is 75%.
Combined Loan to Value is an amount in addition to the Loan to Value, which simply represents the
first position mortgage or loan as a percentage of the property's value.
PITI
In relation to a mortgage, PITI (pronounced like the word "pity") is an acronym for a mortgage
payment that is the sum of monthly principal, interest, taxes, and insurance. That is, PITI is the sum of
the monthly loan service (principal and interest) plus the monthly property tax payment, homeowners
insurance premium, and, when applicable, mortgage insurance premium and homeowners association
fee. For mortgagers whose property tax payments and homeowners insurance premiums are escrowed
as part of their monthly housing payment, PITI therefore is the monthly "bottom line" of what they call
their "mortgage payment" (although actually, in more precise terms, it is a combined mortgage,-tax,-
and-insurance payment).
ARM
A loan with an interest rate that changes periodically in keeping with a current index, like one-year
treasury bills. Typically, however, ARMs cannot jump more than two percentage points per year or six
points above the starting rate.
Appraisal
Lenders usually require that the property be appraised by a qualified appraiser. The amount of the
appraisal is the maximum value on which the loan will be based. For eg: if the appraisal of a said
property is $100,000, the lender will loan 80 percent of value, the maximum mortgage would be
$80,000.
Balloon Payment
One payment, usually the last on a mortgage is larger than the others. In the case of second mortgages
held by the sellers often only interest is paid until the due date - then the entire amount borrowed (the
principal) is due.
Conventional Mortgage in US
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A mortgage loan not insured by HUD or guaranteed by the Veterans' Administration. It is subject to
conditions established by the lending institution and State statutes. The mortgage rates may vary with
different institutions and between states. (States have various interest limits.)
Deed
A formal written instrument by which title to real property is transferred from one owner to another.
The deed should contain an accurate description of the property being conveyed, should be signed and
witnessed according to the laws of the State where the property is located, and should be delivered to
the purchaser at closing day. There are two parties to a deed: the grantor and the grantee. (See also deed
of trust, general warranty deed, quitclaim deed and special warranty deed.)
Deed of Trust
Like a mortgage, a security instrument whereby real property is given as security for a debt. However,
in a deed of trust there are three parties to the instrument: the borrower, the trustee and the lender (or
beneficiary). In such a transaction, the borrower transfers the legal title for the property to the trustee
who holds the property in trust as security for the payment of the debt to the lender or beneficiary. If
the borrower pays the debt as agreed, the deed of trust becomes void. If, however, he defaults in the
payment of the debt, the trustee may sell the property at a public sale, under the terms of the deed of
trust. In most jurisdictions where the deed of trust is in force, the borrower is subject to having his
property sold without benefit of legal proceedings. A few States have begun in recent years to treat the
deed of trust like a mortgage.
Encumbrance
A legal right or interest in land that affects a good or clear title and diminishes the land's value. It can
take numerous forms, such as zoning ordinances, easement rights, claims, mortgages, liens, charges, a
pending legal action, unpaid taxes or restrictive covenants. An encumbrance does not legally prevent
transfer of the property to another. A title search is all that is usually done to reveal the existence of
such encumbrances, and it is up to the buyer to determine whether he wants to purchase with the
encumbrance or what can be done to remove it.
Escrow
Funds paid by one party to another (the escrow agent) to hold until the occurrence of a specified event,
after which the funds are released to a designated individual. In FHA mortgage a transaction, an escrow
account usually refers to the funds a mortgagor pays the lender at the time of the periodic mortgage
payments. The money is held in a trust fund, provided by the lender for the buyer. Such funds should be
adequate to cover yearly anticipated expenditures for mortgage insurance premiums, taxes, hazard
insurance premiums and special assessments
Hazard Insurance Protects against damages caused to property by fire, windstorms and other common
hazards.
HUD
U.S. Department of Housing and Urban Development. Office of Housing/Federal Housing
Administration within HUD insures home mortgage loans made by lenders and sets minimum
standards for such homes.
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Lien
A claim by one person on the property of another as security for money owed. Such claims may include
obligations not met or satisfied, judgments, unpaid taxes, materials or labor. (See also special lien.)
Mortgage Note
A written agreement to repay a loan. The agreement is secured by a mortgage, serves as proof of
indebtedness, and states the manner in which it shall be paid. The note states the actual amount of the
debt that the mortgage secures and renders the mortgagor personally responsible for repayment
Title
As generally used the rights of ownership and possession of particular property. In real estate usage,
title may refer to the instruments or documents by which a right of ownership is established (title
documents), or it may refer to the ownership interest one has in the real estate.
Title Insurance
Protects lenders or homeowners against loss of their interest in property due to legal defects in title.
Title insurance may be issued to a "mortgagee's title policy." Insurance benefits will be paid only to the
"named insured" in the title policy, so it is important that an owner purchase an "owner's title policy," if
he desires the protection of title insurance.
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