Ch. 12 - Real Estate Finance

If you owe $12,000 on a loan and you pay $1,080 interest, what would your interest rate be? $1,080 (interest paid) ÷ by $12,000 (loan amount) = .09 or 9%. (interest rate)

$1,080 (interest paid) ÷ by $12,000 (loan amount) = .09 or 9%. (interest rate)

Down Payment

A buyer usually wants to pay a certain amount "down" on the mortgage to keep the loan payments low. For example, a buyer may wish to pay $20,000 in cash and borrow the remainder in a loan. The amount of money the borrower has to spend will determine the down payment. The Earnest Money Deposit is part of the down payment and/ore closing costs, but not all of it. The balance of the down payment is paid at closing.

Discount points:

A discount point is pre-paid interest. A lender charges discount points to make more money on a loan. One point equals one percent of the loan amount. These extra points are not included in the loan and may be charged to obtain a lower-than-market rate for the borrower or a better yield (profit) on the loan for the lender. For example, one point on a $100,000 loan is $1000. It is important for the real estate professional to understand how discount points affect the actual interest paid and to note the rate so that when the buyer reviews the truth in lending with his or her closing statement they can understand the actual costs of borrowing.

Short Sale

A short sale is an agreement with the lender to accept an amount that may be less than is owed on the loan - based on current market conditions. The seller who wants to participate in a short sale must prove a hardship. Examples of a hardship would be: loss of employment or a mandated job transfer, a medical issue, or a substantial reduction in income. The reason the lender will participate in a short sale is because it prevents a property from being foreclosed and may, in fact, be less expensive; especially, if a buyer is waiting. Loan modification programs were also introduced in 2008 that allowed property owners to rework their mortgages at lower payments and rates to assist them in retaining their homes.

Property Liens

As was discussed in the chapter about deeds, the priority of liens is important in foreclosure. A first mortgage always takes priority over other mortgage liens such as home improvement loans, second mortgages etc. However, a first mortgage does not take priority over taxes or the cost of sale. Lien priority is established in 713, Florida Statutes. The priority of liens in foreclosure is important: it indicates who gets paid first. Property taxes (These do not have to be recorded.) Ad Valorem Taxes Special Assessment Taxes All other liens are based on the time of recording: Usually first in the lineup is the First mortgage (only because it is normally filed first before any other liens).

Alternative financing methods

Assumption of a mortgage Assumption or Subject to Mortgage: Novation

Types of wrap around mortgages

Buydown financing: Bridge loan:

If the interest on a loan at 9% for 8 months was $5,400, what was the amount of the loan?

First divide $5,400 by 8 to see how much interest is per month so it can be annualized. $5,400 ÷ 8= $675 per month. Multiply the interest times 12 months to get annualized interest ($675 x 12= $8,100). This is the annualized interest. Put into the formula: Annualized interest $8,100 ? | Interest Rate 9% Annualized interest of $8,100 ÷ interest rate of 9% = loan amount of $90,000.

Which form of financing would be the greatest risk to the buyer? Wraparound mortgage Buydown mortgage Installment land contract mortgage Second mortgage

Installment land contract mortgage

In an installment land contract, what type of title did the seller retain until the loan was paid? Legal Equitable Tenancy on common Joint tenancy

Legal

Escrow (impound) account:

Most lenders require the borrower put money in a special account for the payment of taxes and insurance (and sometimes private mortgage insurance). This assures the lender that the taxes and insurance will be paid while the borrower has a loan. The federal government has rules regarding the amount of money allowed to be escrowed by the lender. More about the amount of money allowed will be in the Lending Law section.

Mrs. Smith paid $7200 in interest this year on her loan. The rate is 5%. What is her loan amount?

Put $7200 in the calculator first; divide by 5%. $7200 ÷ .05 or 5% = $144,000 is the loan amount. You can just enter 5 and the percent key on your calculator to put in the interest rate. To check your math, take $144,000 times 5% and you should get the annualized interest of $7200 per year.

Ronald defaulted on his home mortgage payments. The lender obtained a court order to foreclose on the property. At the foreclosure sale, Ronald's house sold for $29,000 and the unpaid balance of his loan is $40,000. What must the lender do to recover the $11,000 Ronald still owes? Sue for damages. Sue for specific performance. Seek a deficiency judgment. Seek a lis pendens.

Seek a deficiency judgment.

junior mortgage.

The mortgage in the secondary position

Buydown financing:

The payment is subsidized at the beginning by a builder or other party for a 3 to 5-year period. Thereafter, the purchaser takes over and pays the regular payment amount. This is a financing technique used to reduce the monthly payment for the borrower during the initial years. Usually the cost to the builder is built into the home. Payments on the loan will increase after the subsidy ends.

Which BEST describes an owner's equity in the property? The value of the property The value over and above the outstanding mortgage balance The amount of equitable redemption The amount of the commission owed on the sale

The value over and above the outstanding mortgage balance

A satisfied loan

When the loan backed by a mortgage is paid in full. All mortgage satisfactions are filed with the clerk of court for the county where the property is located and provided to the mortgagee within 60 days of the final payment. Failure to release the lien could result in a suit from the mortgagor to the mortgagee.

Principal

When used in a money reference, principal is the loan amount borrowed or the remainder of the amount owed.

two types of security instruments for a real estate loan

a mortgage and a Note. Each of these instruments has specific rights and responsibilities and they should not be confused with each other. A mortgage is the security interest of the lender in the property, which may entail restrictions on the use or disposal of the property. Restrictions may include requirements to purchase home insurance and mortgage insurance, or pay off outstanding debt before selling the property.

An instrument that evidences one person owing another money is collateral. chattel. a note. a mortgage.

a note.

There are two parts to a mortgage loan

a pledge (or promise to pay) and the collateral.

title theory

also known as a deed of trust state, the borrower gives l title through a deed of trust to the lender, who is referred to as the beneficiary during the time of the loan. The borrower keeps a possessory right to the home and holds an "equitable title". With a deed of trust, a third party trustee is involved and holds "naked title" to the property. This means the trustee can sell the property without court action in a case of default.

Hypothecation

an alternate term used when one pledges to secure a loan with something of value. The property that the buyer is purchasing is hypothecated to secure the mortgage.

A clause in a mortgage releasing the indebtedness once the loan is paid off is defeasance. alienation. subordination. acceleration.

defeasance.

Equity

difference between the amount owed on the property and the value of the property. When the seller sells the property, after all the costs have been subtracted, the remaining money is the equity. The equity may be used to reinvest in other property or taken in cash.

Foreclosure would terminate statutory redemption rights. all rights of redemption by the borrower. equitable right of redemption. assignment and novation.

equitable right of redemption.

mortgage (or deed of trust)

is obtained by pledging property as collateral and promising to repay the loan with payments and times agreed upon with the mortgagee. A mortgage is an encumbrance upon a property. The word mortgage or Mortgage Instrument is a loan secured by real property. To mortgage a property is to pledge a property as collateral for the money borrowed on the property.

Loan Servicing:

is the collecting of the mortgage payment by the lender or by a group he selects to collect it. Usually a loan servicing company is paid a percent of the lender's proceeds to service the loan.

Default

is the failure to complete the contract as specified. The most common default is the nonpayment of the mortgage loan by the buyer. Most deeds of trust and mortgages call for notice to be given to the purchaser of his default and that after the appropriate time period, the property may be sold on the courthouse steps. In 2014, a Consumer Financial Protection Bureau Rule was adopted that requires loan holders and servicers to wait until a borrower is at least 120 days delinquent on payments prior to beginning the foreclosure process.

Interest:

is the fee or amount the borrower pays to use someone else's money. For example, a mortgagor borrows 100,000 for a loan at a rate of 7% interest for 30 years. This means the borrower will pay 7% each year on the unpaid balance of the loan. The higher the interest payment, the higher the mortgage payment will be. Interest on housing is currently deductible on Federal Income Tax.

A deed of reconveyance

issued upon full payment of the loan to return title to the trustor.

The parties to a mortgage are:

mortgagor (borrower) who gives a mortgage to the mortgagee (the lender).

A promissory note would usually contain each EXCEPT the interest rate charged. the total amount owed. the terms of payment. physical description of the collateral.

physical description of the collateral.

When the buyer's mortgage is more than the market value of a home and the buyer MUST sell the home, a/an ___________ might be negotiated with the bank. foreclosure trade equity loan short sale

short sale

lien theory state

the borrower keeps legal title to the property during the period of the loan and the lender places a lien against the property. Florida is a lien theory state.

If the amount realized at the foreclosure sale is more than the indebtedness, the excess belongs to the sheriff's office. the mortgagee. the mortgagor. the grantor.

the mortgagor.

PITI payment

this stands for principal, interest, taxes and insurance. The borrower pays a certain amount of payment each month consisting of these elements. This is also called a budget mortgage payment.

Clauses in a mortgage or Deed of Trust:

1) Acceleration Clause: If a borrower defaults on the loan (does not make payments, etc.) the lender can call the entire balance due and payable immediately. Without this clause in the mortgage or deed of trust, the lender would not have the power or right to foreclosure without suing each month for the monthly payment. 2) Alienation Clause: (also called the "due on sale" clause). The mortgagee or beneficiary declares the entire balance of the loan due and payable when any interest in the property is transferred without the written consent of the lender. When this clause is present, the loan cannot be assumed by new purchaser. The reasoning for this is that the lender wishes to know who owns the property, that the purchaser is qualified, and that the property is held intact and unencumbered for the duration of the loan. 3) Prepayment and Prepayment Penalty Clause: This is a clause which allows the borrower or mortgagor to pay the loan earlier than the schedule called for in the mortgage contract. Occasionally, the lender may charge extra interest or an additional fee if the loan is paid off before the normal completion date (for example, if a loan is paid off in 10 years rather than 30 years.) If a prepayment penalty is present, the mortgage document will state the penalty for paying off the loan early, usually six months interest or a flat fee. Many newer mortgages and deeds of trust do not have a prepayment penalty. However, most subprime loans do contain a prepayment penalty. 4) Defeasance Clause: This is the clause that provides for a satisfaction piece to be issued when the mortgage (deed of trust) has been paid in full.

Clauses that MAY BE in the mortgage clause

1) Borrower's Right to Reinstate after Acceleration: If the buyer is in default (has not made his payments), the buyer is entitled to the opportunity to reinstate his loan after the bank has issued notice to him of his default. Generally, five days before the sale of the property on the courthouse steps the buyer has the opportunity to make up all past due payments, along with any penalty fees to bring the loan current. The loan will then proceed normally. 2) Due on sale clause - states that the full balance of the loan may be called due (repaid in full) upon sale or transfer of ownership of the property used to secure the note. This prevents the seller from allowing a purchaser to assume the loan for a specific property. 3) Hazardous Substances: This clause forbids the presence, use, disposal, storage and release of any hazardous substances that is a violation of the Environmental Law or creates an environmental condition which would adversely affect the value of the property. Hazardous substances are defined as toxic or hazardous such as gasoline, kerosene, other flammable or toxic petroleum products, toxic pesticides and herbicides, volatile solvents, materials containing asbestos or formaldehyde and radioactive materials.

Judicial and Nonjudicial Foreclosures:

A judicial foreclosure requires the court to foreclose the property. In every state, there is a legally required time period of notice to the borrower regarding the equitable right of redemption. This is the legal period of time prior to the sale for the owner to recover the property by paying all required charges and fees. The lienor determines the loan is in default and proper notice is published in the legal newspaper of the county. Further notice is given to the borrower at his or her last known address. The borrower has a time period to make up any deficiencies prior to the time that the sale is finalized by the court. Florida permits only judicial foreclosure. If the lienee does not make up for the deficiencies filed, the court will order the property sold to the highest bidder on the court house steps. The loan will be paid in its order of priority.

Mortgage features

Down Payment Loan-To Value Ratio (LTV) Equity Interest Loan Servicing Escrow (impound) account PITI payment Principal Discount points Loan Origination fee Yield Take Out Commitment Estoppel certificate

Novation

For a true assumption of the loan by a second borrower, the lender must agree to hybrid of assumption and assignment of the mortgage by the first borrower to a second borrower. Along with this transfer of the loan, liability is also transferred to the second buyer by the lender in a novation. The novation is a new contract substituted for a first contract (in this case a substitution of names and liability) with all other terms remaining the same. Novation is a rare occurrence in today's mortgage market.

Effects of Foreclosure on a property

For the lender, foreclosures are time consuming and expensive, due to legal fees. Once the foreclosure is completed, and the time periods for equitable and statutory redemption are completed, the title is cleared and the property becomes whole again.

Contract For Deed

Known by three different names, the contract for deed is also called installment contract or land contract. It is a major difference from a regular sales contract and the real estate professional should know and understand the legal difference and be prepared to disclose the proper information. In a contract for deed, the seller does not give the buyer the legal title to the property until the final payment is made. This means if there is a contract for five years, during which time the buyer pays the seller a set amount of money and interest, the buyer only has equitable title in the property until the end of the five-year period and the final payment is made. The seller retains the legal title during that time period. If the buyer defaults, the seller keeps what the buyer has already paid plus the property itself. The advantage to the seller in this type of sale is that the payment for the total purchase price is spread over a five-year period (or whatever the time frame is). The seller will only pay income tax on the amount received in that year, rather than the total amount. The disadvantage to the buyer is that the seller can encumber the property at any time since the seller has the legal title. The property is subject to encumbrance by another lien, an easement or mechanic's lien. When the buyer has only equitable title, he could lose some interest in the property if the seller encumbers the property during the loan period. Most attorneys advise the buyer to have the title of the property put into escrow by the seller so that neither buyer nor seller has access to the title during the holding of the contract for deed period. This will ensure some safety on the part of the buyer. The seller should take great care that the contract is properly written to prohibit the buyer from assigning the contract without the seller's written permission. Also, as a result of the Dodd-Frank Act of 2013, a seller who finances more than one loan in a two-year period may need to register as a Mortgage Loan Originator in the State of Florida.

Loan Origination fee:

Lenders charge a fee to originate (prepare the paperwork) necessary for the loan. One point equals one percent of the loan value. The cost of originating a $500,000 loan would be $5,000. These fees help the lender increase the profit margin and cover expenses.

Assumption of a mortgage

Most non-governmental loans are not assumable. They contain the alienation clause (due on sale clause) which prohibits the transfer of interest from one party to another without the written authorization of the lender. Some VA and FHA loans are assumable by the purchaser. A real estate professional must take great care to help disclose who will have the liability (buyer or seller) for the loan if it is assumed.

Subordination Agreements

Occasionally, a lender may be willing to take a secondary position in the line of foreclosure. For example, if the first mortgage has a balance of $20,000 and a new second has a balance of $50,000, the second may wish to become the first and the first become the second in the line of priority. If both lenders are agreeable, they sign a subordination agreement which changes the priority for foreclosure.

If the total amount of interest paid is $6,000 per year and the loan amount if $50,000, what is the interest rate?

Placing the numbers into the formula will look like this: 6000 ÷ $50,000 = .12 or 12% is the answer. Be sure to change a decimal to a percent since interest rate is always a percent. Remember also that interest is annualized or per annum. 12% in twelve months would be 1% per month.

These are the duties of the borrower in a mortgage or deed of trust:

Promise to Pay - Means payment of the debt in accordance with the terms of the note Taxes and Insurance - Borrower assures payment of all real estate taxes on the property given as security, and to maintain adequate insurance to protect the property Covenant of good repair - Borrower will assure maintenance of the property in good repair at all times Further, the mortgage may have a requirement for lender authorization prior to making any major alterations to the property.

the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2014

Requires the lender to disclose if they will service the loan or sell the loan to another finance company. (The primary and secondary markets will be discussed later.) The note can be included in the financing process as either a separate document or included in the mortgage or deed of trust. The note makes the borrower personally liable for the loan. Also, as a result of the Dodd-Frank Act of 2013, a seller who finances more than one loan in a two-year period may need to register as a Mortgage Loan Originator in the State of Florida.

Assumption or Subject to Mortgage:

The phrase "subject to" is included in most assumptions. It means that the original borrower maintains the liability for paying off the loan even if he has sold the property to someone else. The lender is saying to the borrower, "You may sell your property to anyone you choose, but you will retain the liability for the loan, even if you no longer own the property." If the second borrower defaults, he can simply walk away and the first borrower will be charged with the costs of foreclosure and bad credit reports.

Yield

The return on an investment or the amount of profit, stated as a percentage of the amount invested; the rate of return. In real estate, yield refers to the effective annual amount of income that is being accrued on an investment. The yield, or profit, to a lender is the spread or differential between the cost of acquiring the funds lent and the interest rate charged.

Estoppel certificate

This is a letter that shows the current balance of the loan and is used by lenders when selling the note from one lender to another. The estoppel certificate states the amount that is currently due and it "stops" the new lender from charging any more than that amount. In essence, it is a "pay-off letter" from one lender to another. Estoppel certificates are further used when closing the sale of a home to show the total payoff amount for the loan.

Loan-To Value Ratio (LTV):

This is a phrase most often used by lenders. The ratio represents the amount of the loan in relation to the sales price or appraised value. If the loan is $80,000 and the value is $100,000, the LTV is 80%; meaning 80% of the value is being borrowed. The ratio also shows that the buyer will be required to pay a $20,000 cash down payment.

Bridge loan:

This is a short term loan for the buyer, usually six months to one year in duration. It is used to get into a new house to complete the sale by providing money borrowed on the old house. This is a second mortgage on the old house and the buyer will end up paying payments on two houses simultaneously until the old house is sold and closed. The terms for each bridge loan are set by the lender; some bridge loans require monthly principal and interest payments, others charge a large interest payment at the end of the loan period.

Wrap around mortgages

This mortgage is also rarely used except in a time of high interest rates. A wrap-around mortgage requires additional financing from a second lender; one payment for two loans. The new lender pays the first loan but charges a higher interest rate for a second deed of trust (second mortgage). The original loan must be assumable with no alienation clause and must be the type of loan where the original first mortgage is not disturbed. Example: A buyer wants to purchase a property but interest rates are high and the buyer cannot obtain a complete new loan at the high rate. The purchaser discovers that the seller has an FHA or VA loan. The buyer assumes the first and "wraps the second around the first" to make one loan payment. The advantage to this type of payment is that the buyer has a lower total interest rate. The disadvantage is that if the second lender does not make the payment to the first on the time schedule set by the first, late fees can be charged.

Results of Foreclosure

When the foreclosure is complete, the sale of the property will result in the bills being paid. The priority of liens in foreclosure is important: it indicates who gets paid first. Cost of the sale (paid to the county for advertising, legal fees etc.) This is normally paid with the price of the purchase. Property taxes (These do not have to be recorded.) Ad Valorem Taxes, Special Assessment Taxes, and any Community Development District Taxes First mortgage or Deed of Trust or the first lienor All other mortgages and other types of liens recorded by date of recording including mechanic and materialman's liens. If there is excess money left from the sale, the mortgagor (the borrower) will receive the money. If there is not enough money for all the liens to be paid, the court may issue a deficiency judgment against the borrower. The total assets of the borrower are then available for collection by the debt holder. Everything is available to the debt holder including cars, boats, campers, airplanes etc. If the borrower does not want to go through foreclosure, he may choose to use a deed in lieu of foreclosure instead, if the lender is willing. In this deed, the borrower gives all rights and claims to the property to the lender in settlement of the debt. However, this procedure has a high cost. If a deed in lieu of foreclosure is given, a borrower may not be able to get a new loan on a different property for 7 years or more. A deed in lieu of foreclosure is considered by lenders a significantly bad credit risk just as bankruptcy is.

Promissory note

is the promise to repay the debt. This is similar to an I.O.U. and it is the primary evidence that there is a loan between the lender and the borrower. The promissory note defines the payment terms including the interest rate, the date of repayment, prepayment penalties if any, purchase price and penalty if there is a default. The promissory note is the lender's personal property and it is a readily negotiable item. The note can be sold to another financing company either on the primary or secondary market. The Promissory Note or Note is the promise to repay the mortgage by the mortgagor. It is evidence of the debt owed by the borrower. When a lender decides to sue to collect money owed on a mortgage, they sue on the note.

Take Out Commitment:

is the second phase of lending on commercial development. An interim lender will want the permanent lender to give a letter of commitment before beginning a commercial development. It is never used in residential lending.

A mortgage which is subordinate to another mortgage is called a first mortgage. purchase money mortgage. package mortgage. junior mortgage.

junior mortgage.

There are two theories used when pledging property for a mortgage. These theories determine how the mortgage company holds interest in the property. Each of these affect how a foreclosure would take place if it became necessary for non-payment of the loan.

lien theory state, title theory.

The Promissory Note essential elements:

the amount of the loan, the date by which it is to be paid back, the interest rate, and a record of any collateral that is being used to secure the loan. Other interest-rate options, like discounting or compensating balance requirements, can also be included. Default terms (what happens if a payment is missed or the loan is not paid off by its due date) should also be spelled out in the promissory note. When signing a promissory note, both the lender and the person receiving the loan should be fully aware of the note's language. This is important if the seller is financing the property. One obvious way to do this is to read the promissory note carefully and in its entirety before committing a signature to it. If there are any questions or confusion regarding the contents of the promissory note, a certified public accountant (CPA) or attorney should be called on to make sure everything is understandable. When a casual promissory note is drawn up between two individuals, the IRS has a required interest rate. A CPA can help determine if the interest rate stated in the promissory note is too low and if it will result in penalties or automatically be raised. If the loan is interest free, the IRS may consider it a gift and require that a gift tax be paid on it.