UNIT 14: Real Estate Financing- Principles
ESSENTIAL ELEMENTS of a valid note
(1) term, (2) promise to pay, and (3) signature of the borrower(s). -A promissory note is a simple document that states the amount of the debt, the time and method of payment, and the rate of interest. -The note may also refer to or repeat several of the clauses, such as acceleration, that appear in the mortgage document.
nonjudicial foreclosure
(DEED OF TRUST) a foreclosure under power of sale in which the deed of trust does not have to be foreclosed through a court action. -give public notice of the intended auction -must be sold at auction -the trustee conducts the sale and the borrower has the right to redeem it -TRUSTEES DEED or SHERIFFS DEED is used to convey
Judicial Foreclosure
(MORTGAGE) allows the property to be sold by court order after the mortgagee has given sufficient public notice
Rights of the Lender:
- assign the mortgage debt (without borrowers consent) - assign the right to foreclose in case of default - assignment must be recorded **The note and mortgage cannot be assigned if the loan is in default.
NC Statutory right of redemption
-During the NC 10-day statutory redemption period after the auction (the upset bid period), a NC mortgagor (borrower) can try to raise the necessary funds to redeem the property. -During the upset bid period, any qualified bidder can submit an upset bid, a bid to purchase the property for an amount that exceeds the foreclosure sale price by a specific margin. -Each upset bid triggers a new 10-day period. If the defaulted borrower can pay all that is owed to the lender (including accrued interest and penalties plus cost of foreclosure sale) any time prior to confirmation of sale, the borrower redeems the property, receives legal title, and eliminates the previous winning bid. -The foreclosure sale becomes final at the end of any 10-day period when no new bid is filed and the borrower's right to redeem the property is terminated.
common components of an ARM:
-Note rate (contract rate) -Index (Publishing index) -Margin -Interest Rate Caps -Payment cap -Adjustment Period -Conversion option
usury law
-the illegal action or practice of lending money at unreasonably high rates of interest. -maximum interest rate on loans. **Usury laws are state laws, but federal law preempted state law in this situation when the Depository Institutions Deregulation and Monetary Control Act of 1980 specifically exempted from state interest limitations all federally-related residential first mortgage loans made after March 31, 1980. This Act was passed to continue the availability of mortgage loans in the early 1980s when interest rates hit 18% while most state usury limits were below that rate. Federally related loans are those made by federally chartered institutions or those insured or guaranteed by a federal agency. The exemption includes loans used to finance manufactured housing (the federal term for mobile homes) and the acquisition of stock in a cooperative housing corporation. North Carolina exempts all residential first deeds of trust from state usury laws.
promissory notes used by institutional lenders contain three additional provisions, which also appear in the mortgage or deed of trust:
1) Acceleration Clause 2) Prepayment Penalty Clause 3)Due-on-sale Clause
After the property is sold at the foreclosure sale, the proceeds are distributed in the following five-step order:
1)To pay all costs of the sale, including court costs or trustee fees, legal fees, advertising fees, et cetera 2)To pay any outstanding real and personal property taxes or assessments 3)To pay the mortgage(s) or deed(s) of trust debt (assuming this debt has first priority over any other liens) in order of recordation 4)To pay off any other liens in order of priority 5)To pay any surplus (equity) to the borrower
The borrower (mortgagor or grantor) is required to fulfill many obligations. These usually include
1- payment of debt 2-payment of real estate taxes 3-insurance kept up 4-maintenance of property 5-authorization from lender before alterations on the property -payment of the debt in accordance with the terms of the note; -payment of all real estate taxes on the property given as security; -maintenance of adequate insurance to protect the lender if the property is destroyed or damaged by fire, windstorm, or another hazard; -maintenance of the property in good repair at all times to not allow waste; and -lender authorization before making any major alterations or demolishing any building on the mortgaged property. **Failure to meet any of these obligations can result in a borrower's default on the note. When this happens, the acceleration clause allows the lender to call the note and mortgage or deed of trust due and payable. The loan documents may provide for a grace period (e.g., 30 days) for the borrower to correct the default, after which the lender has the right to foreclose the mortgage or deed of trust and collect on the note. The most frequent cause of default is the borrower's failure to meet monthly payment installments.
When a property is mortgaged the owner must sign 2 instruments:
1. The Promissory note (the financing instrument) 2. The Mortgage or DEED OF TRUST ( the security instrument)
prepayment penalty
A charge imposed on a borrower who pays off the loan principal early. This penalty compensates the lender for interest and other charges that would otherwise be lost
Power of Sale
A clause in a deed of trust allowing non-judicial foreclosure. -Nonjudicial foreclosure is made possible by the power-of-sale clause in the deed of trust. The power-of-sale clause gives the trustee the power to sell the property and use the proceeds to repay the debt. (Note that a mini-hearing is required before the clerk of the court; otherwise, the property cannot be sold.)
prepayment penalty clause
A clause in a mortgage contract that says if the mortgage is prepaid within a certain time period, a penalty will be assessed. The penalty is usually based on percentage of the remaining mortgage balance or a certain number of months worth of interest. THIS IS BECAUSE: -When a loan is paid in installments over a long term, the total interest paid by the borrower can exceed the principal of the loan. If such a loan is paid off before its full term, the lender collects less interest from the borrower. **NOT PERMITTED IN NC**
Deed in Lieu of Foreclosure
A deed given by the mortgagor to the mortgagee when the mortgagor is in default under the terms of the mortgage. This is a way for the mortgagor to avoid foreclosure. -"deed in lieu"= "title to the property instead" of - Foreclosure -This is sometimes known as a "friendly foreclosure" because it is accomplished by agreement rather than by civil action. **The MAJOR DISADVANTAGE to this manner of default settlement is that the mortgagee takes the real estate subject to all junior liens; foreclosure eliminates all such liens. Significant tax issues can arise when a deed in lieu of foreclosure is used. Competent legal or tax advice always should be obtained.
Discount Points
A fee charged by the lender at settlement that results in increasing the lender's effective yield on the money borrowed. One discount point equals one percent of the loan amount. -Mortgage points, also known as discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate. This is also called "buying down the rate," which can lower your monthly mortgage payments. -One point costs 1 percent of your mortgage amount (or $1,000 for every $100,000). Essentially, you pay some interest up front in exchange for a lower interest rate over the life of your loan. -In general, the longer you plan to own the home, the more points help you save on interest over the life of the loan. When you consider whether points are right for you, it helps to run the numbers. Here's an example:
Balloon Payment Loan
A final payment of a mortgage loan that is considerably larger than the required periodic payments because the loan amount was not fully amortized. -A loan that requires a balloon payment is called a partially amortized loan and is quite common in seller-financing situations. When sellers finance part or all of the purchase price, they often want to be cashed out—that is, have the seller financing paid off—within three to five years of the sale.
Amortized Loan
A loan in which the principal as well as the interest is payable in monthly or other periodic installments over the term of the loan.
direct reduction loan
A loan that requires a fixed amount of principal to be paid in each payment with the amount applied to interest varying as the balance is reduced.
Deficiency Judgment
A personal judgment levied against the borrower when a foreclosure sale does not produce sufficient funds to pay the mortgage debt in full. -If any surplus proceeds exist from the foreclosure sale after real estate taxes, the mortgage debt and all junior liens (second mortgage, mechanics' liens, et cetera) are paid off and expenses and interest are deducted. These proceeds (equity) are paid to the borrower. -In North Carolina, deficiency judgments are prohibited in certain cases, such as when a purchase money deed of trust (seller financing) is used. If the seller is holding a purchase money mortgage/deed of trust, the seller has a special priority in lien payoffs in the foreclosure.
negotiable instrument
A promissory note is usually a negotiable instrument—that is, a written promise or order to pay a specific sum of money. -An instrument is said to be negotiable when its holder, the payee, may transfer the right to receive payment to a third party. This may be accomplished by signing the instrument over to the third party or, in some cases, merely by delivering the instrument to that person. EXAMPLES of negotiable instruments: checks and bank drafts. ** It is important for the promissory note to be negotiable because lenders often sell their mortgage loans in the secondary mortgage market. ***To be negotiable, or freely transferable, an instrument must meet certain requirements of the law. The instrument must be in writing, made by one person to another, and signed by the maker. It must contain an unconditional promise to pay a sum of money on demand or at a set date in the future. In addition, the instrument must be payable to the order of a specifically named person or the bearer (whoever has possession of the note). Instruments that are payable to order must be transferred by endorsement; those payable to bearer may be transferred by delivery. A nonnegotiable note does not contain to order or to bearer but is payable to a named person. It is neither transferable nor assignable. The vast majority of real estate notes are negotiable, and therefore transferable.
secured debt
A secured debt instrument simply means that in the event of default, the lender can use the asset to repay the funds it has advanced the borrower. Common types of secured debt are mortgages and auto loans, in which the item being financed becomes the collateral for the financing.
statutory redemption period
A statutory time period after a foreclosure sale during which the borrower may still redeem the title.
Terms associated with interest rate adjustments may include all of the following EXCEPT
A) There is no maximum amount in which a lender may adjust the rate over the life of the loan. B) Regulations may allow a lender to adjust the interest rate on a monthly basis. C) The borrower may have the right to repay the loan in full without penalty whenever the interest rate changes. D) Adjustments are limited to one per period. A!!
A real estate loan payable in periodic installments that are sufficient to pay the principal in full during the term of the loan is called
A) a conventional loan. B) an amortized loan. C) a straight loan. D) a participation loan. B!!!! Explanation In an amortized loan, the loan installment payments of principal and interest pay for the entire mortgage debt over the set term period of the loan, thus eliminating the entire debt.
The purpose of a mortgage is to
A) create a lien on the property. B) provide security for the loan. C) convey title of the property to the lender. D) restrict the borrower's use of the property. B!!! Explanation A mortgage is a legal instrument that pledges security for a loan. When a lender lends a borrower money for a loan, the buyer must sign a promissory note for the amount borrowed and execute a mortgage to secure the debt owed to the lender.
The person who obtains a real estate loan by signing a deed of trust is called the
A) grantor. B) grantee. C) beneficiary. D) trustee. A!! Explanation The wording of the conveyance sets forth actions that the trustee may take if the borrower, known as the grantor/trustor, defaults under any of the deed of trust terms. In a deed of trust, the borrower conveys naked title or bare legal title (title without the right of possession) to the real estate as security for the loan.
A mortgagor is the one who
A) holds the mortgage. B) gives the mortgage. C) provides the mortgage funds. D) forecloses on the mortgage. B!!! Explanation The mortgagor is the borrower who requests and receives a loan and gives the mortgage as security for the debt. The institution that provides the funds and may hold the mortgage is the mortgagee.
Proceeds from a foreclosure sale first pay
A) outstanding property taxes. B) the cost of the foreclosure sale. C) mortgages in the order of recordation. D) junior liens in the order of recordation. B!!!! Explanation After the property is sold at the foreclosure sale, the proceeds are distributed in the following five-step order: (1) pay all costs of the sale; (2) pay any outstanding real and personal property taxes or assessments; (3) pay the mortgage(s) or deed(s) of trust debt; (4) pay off any other liens in order of priority; and (5) pay any surplus (equity) to the borrower.
The seller agrees to sell the property to the buyer for $100,000. The buyer was unable to qualify for a mortgage loan for this amount with a traditional lender, so the seller and buyer enter into a contract for deed. The interest the buyer has in the property under a contract for deed is
A) reversionary title B) equitable title. C) legal title. D) joint title. B!!! Explanation Equitable title gives a buyer the right to obtain absolute ownership of a property upon full payment of the purchase price when legal title is held in another's name The buyer under a contract for deed may demand that legal title be transferred to him when the purchase price is fully paid.
Acceleration Clause (in a mortgage)
Acceleration clauses are typically contingent on on-time payments. ... For example, assume a borrower with a five year mortgage loan fails to make a payment in the third year. The terms of the loan include an acceleration clause which states the borrower must repay the remaining balance if one payment is missed. -The loan documents may provide for a grace period (e.g., 30 days) for the borrower to correct the default, after which the lender has the right to foreclose the mortgage or deed of trust and collect on the note.
Satisfaction of Mortgage (AKA-deed of release, reconveyance deed, release of mortgage, or mortgage discharge)
An instrument issued by the mortgagee (Lender) when the mortgage has been paid in full. -By having this release entered in the public record, the owner shows that the mortgage lien has been removed from the property.
Seller Financing (Purchase money deed of trust)
Any financing arrangement where a seller takes a note and mortgage from the buyer for all or part of the purchase price of the property. -Seller Financing is a real estate agreement in which the seller handles the mortgage process instead of a financial institution. Instead of applying for a conventional bank mortgage, the buyer signs a mortgage with the seller. Owner financing is another name for seller financing. It is also called a purchase-money mortgage.
PITI
Each month, in addition to paying P&I, the borrower is normally required by the lender to pay one-twelfth of the annual real property taxes and one-twelfth of various annual insurance premiums, such as for homeowners, flood, or mortgage insurance policies. Principal, interest, taxes, and insurance is referred to as PITI. The taxes and insurance portion (TI) of the monthly payment is placed into the lender's escrow account and held until those bills are due. The lender receives the tax and insurance bills and pays those items from its escrow account on behalf of the borrower.
T/F?- A short sale occurs when a property owner does not make his scheduled loan payments on time.
FALSE- A short sale occurs when a property is sold for less than the amount owed on it. A short sale does not necessarily involve delinquent payments.
T/F?- In an assumption of a mortgage, the previous borrower is no longer responsible for the payment of the debt.
FALSE- In an assumption of the mortgage, the previous borrower remains responsible for the debt if the new borrower does not make the promised loan payments.
T/F?- In an adjustable-rate mortgage, both the interest rate and the debt service amount are set for the duration of the loan.
FALSE. In an adjustable-rate mortgage, the interest rate and the debt service amount can vary during the term of the loan. In a fixed-rate mortgage, the interest rate and the debt service are constant during the life of the loan.
T/F?- Discount points and loan origination fees refer to the same expense.
FALSE. -Discounts points and loan origination fees are both calculated as a percentage of the loan, but their purpose is different: -discount points are used to increase the lender's yield -the loan origination fee is a charge by the lender to fund the loan.
Foreclosure
Foreclosure is the process of selling the mortgaged real estate to repay the debt from the proceeds of the sale. -Such a default may include failure to make payments, destruction of all or part of the property, or failure to pay current insurance premiums or real property taxes. **Note that the PURPOSE of foreclosure is to cut off the borrower's equity of redemption rights.
Discount Points
Interest paid in advance; increases the yield for the bank. -one point equals 1% of the loan amount for the borrower and increases the yield for the investor approximately 1/8%.
Loan-to-Value Ratio (LTV)
Loan Amount(mortgage) ÷ Sales Price or Appraised Value (Whichever is less) -The lower the ratio of debt to value, the higher the down payment by the borrower will be. --For the lender, the higher down payment means a more secure loan, which minimizes the lender's risk. **EXAMPLE- if a property is worth $100,000, an 80% loan would equal $80,000, and the borrower would make a $20,000 down payment.
Negative Amortization
Occurs when the loan payment is not sufficient to cover the interest cost and results in the unpaid interest being added to the original balance, causing the loan amount to increase.
Graduated Payment Mortgage (GPM)
Payments begin below the normal, fully amortized payment and are then increased for a set period of years(when the mortgagors income is expected to have increased). Some lead to negative amortization. -flexible payment plan -common for first time home buyers and buyers in times of high interest rates
Lien Theory
Some states interpret a mortgage as being purely a lien on real property. The mortgagee thus has no right of possession but must foreclose the lien and sell the property if the mortgagor defaults.
T/F?-Balloon payment loans are also known as partially amortized loans.
TRUE- Balloon payment loans require periodical payments that will fully amortize the amount of the loan by the end of the term, so the final payment is larger than previous payments (a balloon payment). That is why this loan is also described as a partially amortized loan.
T/F?- In lien theory states, lenders use judicial foreclosure when mortgage payments are not paid.
TRUE- In lien theory states, when a mortgagor (borrower) does not make payments to the lender as promised, lenders will use judicial foreclosure to get a judge to put the property up for sale.
T/F?- The vast majority of residential mortgage loans are characterized by simple interest, which is paid in arrears.
TRUE. -Most residential loans are characterized by simple interest, which is paid in arrears rather than in advance.
principal
The amount of money borrowed
equity
The interest or value that an owner has in property over and above any indebtedness.
Note rate (contract rate).
The original rate charged, which is stated in the closing documents, is called the note rate. Index. The interest rate on the outstanding balance of the loan is increased or decreased according to the movements of a named publicly published index. A very popular index used by lending institutions is the short-term U.S. Treasury bill rate, but many other indices are available and used.
Equity of Redemption (before the sale)
The right of a borrower in default on a mortgage loan to reclaim the forfeited property prior to the foreclosure sale through payment in full of all debt and associated costs. -during the course of a foreclosure proceeding but before the confirmation of the foreclosure sale, the borrower pays the lender the total amount of back payments due, plus interest and costs, the foreclosure is stopped and the borrower retains the property.
Statutory Right of Redemption (after the sale)
The right of a defaulted property owner to recover the property after its sale by paying the appropriate fees and charges.
mortgage
To mortgage is when you take a loan and use your property as collateral. An example of mortgage is when you go to the bank and borrow money against your house. -2 party security instrument (mortgagor and lender)
T/F?- North Carolina is a title theory state.
True North Carolina is a title theory state where the mortgagor (borrower) transfers legal title but retains equitable title and has the right to possess and use the property.
Buying subject to or assuming a seller's mortgage
When a person purchases real estate that is subject to an outstanding mortgage or deed of trust, the buyer may take the property in one of two ways. 1) The property may be purchased subject to the seller's mortgage OR 2)the buyer may assume the seller's mortgage and agree to pay the debt.
Balloon Payment
a final loan payment that is much larger than the regular monthly payments (partially amortized fixed-rate mortgage)
Adjustable Rate Mortgage (ARM)
a mortgage with an interest rate that increases or decreases during the life of the loan. -Adjustable-Rate Mortgage illustrates the effect interest rate fluctuations and periodic caps have on an adjustable-rate mortgage. Obviously, without rate caps and payment caps, a mortgage's interest rate could fluctuate wildly over several adjustment periods, depending on the behavior of the index to which it is tied. In Adjustable-Rate Mortgage, the borrower's rate ranges from a low of 5.9% to a high of 9.5%. Such unpredictability makes personal financial planning difficult; borrowers are much more likely to default on an adjustable rate mortgage than a fixed-rate mortgage. On the other hand, if the loan had a lifetime rate cap of 7.5%, the borrower's rate would never go above that level, regardless of the index's behavior. Similarly, a lender would want a floor to keep the rate from falling below a certain rate (here, 6.5%). The shaded area in the figure shows how caps and floors protect against dramatic changes in interest rates.
Due on Sale Clause (Alienation Clause)
allows lender to prevent unapproved loan assumption (If borrower sells property without lenders approval, lender may demand immediate repayment of loan balance)
amortization chart
also in pages on laptop
promissory note
also known as the finance instrument -a written promise to pay a specified amount of money on demand or at a definite time
mortgage or deed of trust
also known as the security instrument. -The security instrument creates the lien on the property. The mortgage gives the creditor the right to foreclose (have the property sold to satisfy the debt) in the event the borrower defaults. The mortgage secures the promissory note. -a SPECIFIC lien on a piece of real estate used as collateral for a loan
Loan Origination Fee
an administrative fee charged to borrower by lender for generating the loan. -Unlike points, loan origination fees are not prepaid interest; they are an expense that must be paid to the lender, typically 1% of the loan amount regardless of any discount points that might also be charged.
Deed
conveys title
Deed of trust
creates a lien
Deed of Trust (Trust Deed)
in some states used instead of a mortgage deed -3 party instrument (grantor/trustor, third party(trustee), lender(beneficiary) -Note that the term mortgage loan is commonly used to refer to a loan secured by either a mortgage or deed of trust
simple interest
interest paid on the principal alone I=prt
Published Index
is a listing of stocks that is used to track the value of the stocks that make up the list. For example, the S&P 500 is an index containing the stocks of 500 corporations, most of which are American. This is the most watched index, because many investors think that the performance of this index indicates how well the economy is doing overall.
mortgage loan
loan to purchase real estate in which the property itself serves as collateral
Debt Service
the cash that is required to cover the repayment of interest and principal on a debt for a particular period
interest
the price paid for the use of borrowed money
Hypothecation
the process of pledging real property as security for a debt, without giving up possession of the property. -A pledge of security—a mortgage—cannot be effective legally unless there is a debt to secure. Both the note and the mortgage must be executed (signed) to create an enforceable mortgage loan.
yield
the return or profit on a loan
assignment
the transfer of contractual rights to a third party. -Assignment of contract occurs when a party to an existing contract transfers the contract's legal obligations to another party. As a basic example of an assignment of contract, if you sign a contract with a landscaping company to mow your lawn every two weeks and the landscaping company assigns your contract to another company in the area, the new company is assuming the obligations (mowing your lawn) and benefits (collecting payment) of the contract.
naked title or bare legal title
title WITHOUT the right of possession
right of defeasance
to have legal title to the property transferred back to him or her when the loan is paid in full.
Short Sale
transaction where the proceeds from the sale are not sufficient to fully satisfy the outstanding balance on the seller's existing mortgage(s), and the borrower lacks sufficient funds to make up the shortfall. -A short sale is similar to a deed in lieu of foreclosure and occurs when a lender agrees to discount the remaining loan balance in the following manner: subject to the lender's approval, the borrower sells the mortgaged property for less than the outstanding balance of the loan and cedes all of the proceeds to the lender in full satisfaction of any mortgage debt.
Term Loan/Straight Loan
usually an interest only loan with one principal payment at the end of the term. -Historically, such plans were used for construction loans and second mortgages, but consumers occasionally used them for residential first mortgage loans. Prior to the 1930s, the only form of mortgage loan available was the straight-payment loan, payable in full after a relatively short term, such as three years to five years. The high rate of foreclosure on such loans in the depression years prompted the introduction and use of the more manageable long-term amortized loans that are now the norm. -The popularity of term loans in recent years as first mortgages for primary residences in combination with very low or no down payment requirements is thought to have contributed to the huge number of foreclosures currently being experienced.
workout arrangement
workout arrangement will typically review factors that include the following: 1.Loan status: in default or default is imminent 2.Hardship: seller is facing hardship that is beyond the seller's control that will adversely affect ability to make mortgage payments 3.Seller's financial status: income documentation is generally required to determine if seller's resources are insufficient to make up any shortage 4.Brokerage fee: any brokerage fee owed by the seller is considered 5.Possibility of loan fraud: workout request is reviewed for fraud especially if default occurs in the first 12 months of the loan term 6.Property value: loan servicer or lender will typically obtain an appraisal to evaluate the feasibility of the workout request; sometimes a broker price opinion (BPO) is requested instead of an appraisal