Contract indebtedness occurs when a lender and borrower have a legally binding contract because of debt. In other words, the lender has a right to seek collection of the debt if the borrower should default, or stop making payments. Contract indebtedness is most common in the mortgage industry, when a party is in debt to a lender from the purchase of a home mortgage loan. Additional types of contract indebtedness include leases and bonds, which have contracts to serve as confirmation of the debt.

What Is Indebtedness?

Being in a state of indebtedness means that you owe money or you're in debt to another party. A party is most likely in debt if they've received goods or services or borrowed money, with a promise to pay it back. You're most likely in a state of indebtedness if you've:

  • Borrowed money
  • Purchased items on a credit card
  • Issued bonds, notes, debentures, or other similar financial instruments
  • Issued a letter of credit or a trade letter of credit
  • Purchased property that hasn't been paid for or is in a deferred state
  • Logged accounts/trade payables
  • Been secured by a lien on an asset
  • Guaranteed someone else's indebtedness
  • Acquired interest expense
  • Become or have been in a partnership or joint venture that is indebted

The state of being indebted does not include having any:

  • Liability regarding local, state, federal, foreign, or any other taxes
  • Contingent obligations regarding appeal bonds, surety bonds, performance guarantees, or performance bonds

Remember, indebtedness isn't the same thing as not paying. For example, if someone purchases a home with a mortgage and continuously meets their monthly obligation, they're considered to be indebted.

Debt-to-Income Ratio

A debt-to-income ratio is used to provide a snapshot of someone's overall financial health. The amount of debt is divided by the total amount of income. Lenders will use the ratio to determine if a borrower will be able to meet the financial obligation of a mortgage. For example, someone with a low debt-to-income ratio is more likely to make their payments on time, while someone with a high debt-to-income ratio may have a more difficult time making the payments.

A debt-to-income ratio of about 43 percent is the current standard for borrowers to meet in order to be approved for a mortgage. In other words, the borrower's total debts cannot exceed 43 percent of their income. A borrower should try to illustrate to the lender that he is a financially responsible individual. A borrower that applies with a high credit score is more likely to get approved for a mortgage.

What Is Mortgage Contract Indebtedness?

For the average borrower and lender, a mortgage is considered a significant financial obligation. A mortgage contract may play an important role in determining an outcome if a problem or dispute arises during the course of the loan.

Mortgage contract indebtedness occurs when an individual or business purchases a home from a lender with a mortgage. Also, opening up a home equity line of credit or a home equity loan is considered being in a state of mortgage contract indebtedness.

Types of Mortgage Contract Indebtedness

When a mortgage contract is signed, the borrower agrees to become indebted by this loan. Today, there are a wide variety of mortgage loan options available, meaning there are numerous types of mortgage indebtedness. A mortgage contract provides legal proof that a debt has been incurred, regardless of the interest rate, penalties and fees, or the length of the loan.

Mortgage Contract Indebtedness Terms and Uses

The elements of a mortgage contract will govern any discrepancies that occur during the course of the mortgage. For example, a mortgage contract will likely include a guarantee by the borrower to pay all legal fees that a lender may incur in defending the mortgage contract, as during a foreclosure.

Mortgage borrowers are protected by state laws. For example, in Ohio, the borrower is only liable for legal fees if the mortgage exceeds $100,000. A mortgage contract can be used in a court of law to demonstrate either party's failure to comply, for example, when a lender raises the interest rate beyond the maximum allowable rate (as stated in the mortgage contract). Furthermore, if a borrower declares bankruptcy, a lender may refer to the mortgage contract to request repayment from a bankruptcy court.

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