Real Estate Finance: Chapter 4 Noninstitutional Lenders

California Association of Mortgage Brokers

(CAMB) Established in 1990 by mortgage professionals.

Federal Housing Administration

(FHA) Formed in 1934. FHA mortgage insurance program removed many of the risks previously involved in lending money for real estate mortgages. The FHA encouraged hesitant lenders to reenter the real estate field by advancing a system of standardized criteria to be used in estimating the value of a property and the credit ability of a borrower. To be eligible for FHA-insured mortgage loan that reduced the required down payment to a minimum amount, an applicant had to prove the ability to repay the loan and the collateral property had to meet minimum standards of acceptability. Instituted a plan for long-term payback arrangements. Rather than refinancing a mortgage loan every five years, a 25-year payback system was instituted whereby the borrower was allowed to make regular monthly payments over a long period of time. Each payment included a portion for repayment of the amount borrowed as well as interest on the amount owed. This strengthened the qualities of a mortgage and, when coupled with the federal government's guarantee to back up the value of the loan, created an investment market for individual mortgages. These mortgages could now be created by local financial lenders, then bought and resold in a national market by individuals and businesses seeking such financial investments. Only approved mortgage lenders could service the new FHA-insured loans and the mortgage bankers were ready, willing and able to conform to the new FHA standards for loan originators. Investors were reluctant until the system proved itself successful, which it did by encouraging many people to purchase more and better housing by providing them with the opportunity to pay for this housing with affordable monthly payments. Now the mortgage banking industry flourishes to this day and has remained a major source of real estate financing.

Limited Liability Company

(LLC) A form of business organization with limited liability. It avoids the restriction of limited partnership and is taxed like a partnership.

Mortgage Bankers

(Mortgage Companies according to California Bureau of Real Estate) (Correspondents) They manage real estate loans. Financial intermediary who originates new mortgage loans, collects payments, inspects the collateral, and forecloses, if necessary. Mortgage lenders seek the services of local mortgage bankers because it is desirable to observe carefully the physical condition of the collateral, as well as to be available in the event of loan collection difficulties.

Real Estate Investment Trust

(REIT) Real Estate investment trust; an unincorporated trust, set up to invest in real estate, that must have at least 100 investors; management, control, and title to the property are in the hands of trustees. Designed to deal in equities, REITs are owners of improved income properties, including apartments, office buildings, shopping centers, and industrial parks. As an equity trust, the REIT can offer small investors an opportunity to pool their monies to participate as owners of larger and more efficient and profitable real estate investments. The REIT's income is derive from the rents secured from specific properties owned by it and the capital gains made when these properties are sold. The REITs are subject to income tax only at the participant's level.

Real Estate Mortgage Trust

(REMT) A trust dealing in financing investments rather than in owning them. Real estate mortgage trust; similar to REIT, but investment is made in mortgage securities rather than in real estate. More significant to real estate finance are the REMTs. Attracting millions of dollars through the sale of beneficial shares, REMTs expand their financial bases with strong credit at their commercial banks and make mortgage loans on commerical income properties. Many of these are properties constructed for the investment portfolios of the REITs. Many REMTs are owned by either a parent company REIT or a commercial bank. The REMT's main source of income are mortgage interest, loan origination fees, and profits earned from buying and selling mortgages. Although these trusts participate in on-term permanent financing, they are more inclined to invest a short-term senior and junior loans, when higher potential profits prevail. Balanced trusts combine the REIT with the REMT, thus earning profits from rental income and increased property values as well as mortgage interest and placement fees.

Truth in Lending

(Regulation Z) Truth-in-lending provision that requires lenders to reveal the actual costs of borrowing.

Debentures

(Unsecured bonds) Bonds issued without any specific collateral pledge but secured by the general assets of the issuer.

Zero Coupon Bonds

(Zero treasuries) A single-payment bond that grows to its face value over a prescribed time period at a specified interst rate. All interim compound interest is tax-deferred until the bond is cashed. Represent an old approach to bond buying that has been reintroduced into the money market. Patterned after WW2 savings bonds, which were sold for $18.75 and redeemed after 10 years for $25, tax-deferred zero bonds are designed to postpone the interest income tax liability until the bonds are redeemed. A buyer writes a check for a bond at a discounted price and hold this bond until maturity or until sold. Interest compounds regularly, and the buyer pay tax on the earnings after cashing in the bond. Taxable bonds require the holder to report the interest income as it accrues each year.

Industrial Development Bonds

A bond that allows private investors to finance apartment and commercial developments by using tax-exempt, inexpensive funds. TRA'86 imposed severe restrictions on this financing technique. Unlike industrial revenue bonds, which are issued by a municipality for public improvements, industrial development bonds are designed to allow private investor an opportunity to finance apartment and commercial developments by using tax-exempt relatively inexpensive funds. The developer prepares and application for approval by a local city or county Industrial Development Authority (IDA). This application includes the plans for the apartment or commercial development and a statement describing the need for these units as an enhancement of the communities welfare. The bond attorney for the IDA reviews the application and makes a recommendation to an all-volunteer board. If approval is secured, the developer hires bond broker who floats a new issue. The interest rate is determined by the broker a function of the market with the earnings exempted from federal and state income taxes.

Municipal Bonds & Private Bonds

A more popular use for real estate bonds is to finance municipal improvement projects. By issuing general obligation bonds guaranteed by the taxing power and full faith and credit of the community, governments can raise funds for financing schools, street improvements, sewer installations, park development, and other civic improvement projects. Municipal bond owners enjoyed a special tax privilege under a federal government statute exempting the interest income earned on state and local securities from federal income tax. Buyers of municipal bonds don't have to declare their interest earnings as taxable income. This acts to reduce the cost of improvements to state and local governments and is an added incentive for purchasers. On April 20, 1988 the U.S. Supreme Court ruled that the federal government may tax the interest earned on state and local bonds. This decision has had no impact on the marketing of tax-free bonds, but the possibility exists that future legislation would seek to tax such interest income to increase federal tax revenues. A variation on this theme is the issuance of revenue bonds to fund a specific community improvement project. The bonds are repaid from the revenues generated by the improvement. A toll bridge could be constructed using the money raised from the sale of revenue bonds and the repayment of the bonds would be designed to match the revenue secured from tolls collected. A dramatic illustration of the role of such revenue bonds in real estate finance is their possible using developing employment centers for a community. A city could float revenue bonds to develop an industrial park or to construct buildings that might be leased to commercial tenants. These bonds are known as industrial revenue bonds. The rental income from the buildings would be adequate to repay the bonds over a long period of time. By this process, new jobs are created, new taxes are generated and an impetus of growth occurs in the community. Revenue bonds and other incentives can then be used by these growth-oriented communities to attract more businesses to industrial parks.

Correspondents

A mortgage banker. Not only originate new loans, but also collect payments, periodically inspect the collateral and supervise a foreclosure, if necessary.

Balanced Trust

A trust that participates in real estate investments as both financier and investor.

Combination Trust

A trust that participates in real estate investments as both financier and investor.

Mortgage Revenue Bonds

A type of industrial development bond that is offered by state and local governments through their housing financing agencies and is tax-exempt. A form of industrial development bond. The bond issue is tax-exempt because it is offered by state and local governments through their housing financing agencies. The government agency transfers the proceeds of the bond sale to the lender, who then makes a mortgage loan to the developer of the project. Because of the tax exemption on income derived by the bondholders, interest to the borrower is lower than market rates, and rents can be lowered accordingly. 1/5 of the units must be allocated for low-income renters for 10 years or half the life of the loan, whichever is longer.

Cosigners

Additional signers to a financial agreement adding their guarantees to that of the borrowers.

Mortgage Brokers

Agent who joins borrower and lender for a real estate loan, thereby earning a placement fee. A borrower seeks the services of a mortgage broker to help secure the appropriate financing for a specific realty property. Scrappy entrepreneurs and sales representatives who match up borrowers and lenders on roughly seven out of every ten new mortgages. They will collect some $33 billion from their share of a projected $2.8 trillion in new home mortgages. The Decline of the savings and loan companies and by the growth of Fannie Mae and Freddie Mac enabled a rise of mortgage brokers as retail arm of the mortgage industry. Seldom invest capital in a loan and most do not service a loan beyond its placement. After a loan "marriage" is completed, specific arrangements are designated for the collection of the required payments. These payments are made directly to the lender, but often they are collected by a local collection service. Most obligations are fulfilled when the loan is completed. The very business of mortgage brokers relies on qualifying borrowers and investigating the soundness of an investment. A broker's success is really a function of two things: 1. Accessibility to the offices of the major real estate lenders. 2. Ability to "sell" the loan to these lenders. If the intermediary receives a fee for mortgage placement services, he/she is acting as a mortgage broker. The mortgage business has expanded to serve the increasing need for financing and refinancing. Mortgage brokers are consumer advocates in the mortgage selection process, helping borrowers to prequalify, select a mortgage loan, and complete escrow. Mortgage brokers offers consumers access to a wide range of choices as they select the right mortgage for their needs.

Rescission

Agreement to cancel the contract, enforceable only if both parties have some performance remaining (otherwise no consideration)

Refinancing Process

Allows the lender an opportunity to take another look at the borrower's financial position, reinspect the physical conditions of the collateral property, adjust the interest to current market rates, and charge a new loan placement fee.

Line of Credit

An amount stipulated by a commercial bank to an active customer on an annual basis. Must be brought to zero on an agreed upon regular date.

Syndicate

An organization of investors who pool their capital to make a real estate investment.

National Association of Mortgage Brokers

Based in Washington DC. The trade organization for mortgage brokers. Emphasizing adherence to a strict code of ethics, this association promulgates a full range of educational programs for its members. It promotes the licensing in all states of mortgage brokers and bankers.

*Real Estate Bonds

Bonds can be used to secure funds for financing real estate projects in two distinct ways. 1. The issuance and sale of mortgage bonds by business firms, usually corporations, as means of raising capital. 2. The issuance and sale of municipal, county, or state bonds for purposes of financing community improvements, such as schools, parks, paving, sewers, and renewal projects. Bonds in the latter group are collectively termed municipal bonds. The administration of funds raised y a bond sale is left in the hands of a trustee, who acts as an intermediary between the borrower (issuer) and the bond owners (purchaser-lenders). The trustee supervises the collection of payments from the borrower and make disbursements to the appropriate bondholders. If the borrower defaults on a real estate bond, the trustee files a notice with the borrower that the entire balance and the interest to date are immediately due in full. At the same time, upon declaration that the borrower cannot or will not satisfy the debt, the trustee may enter the property, dispossess the borrower, and manage or sell it. All income or sales proceeds will inure to the benefit of the bond owners.

Industrial Revenue Bonds

Bonds issued for developing an industrial park or for constructing a building for lease to commercial tenants.

Municipal Bonds

Bonds issued for purposes of financing public improvements, such as schools, parks, and renewal projects.

Revenue Bonds

Bonds that pay interest from specified revenue sources (e.g., airports, school districts, counties, toll-road authorities, and governmental bodies)

Mortgage Companies

Businesses designed to lend money on real or personal property.

California Bonds

Community Redevelopment Agencies (CRAs) are authorized under the Community Redevelopment Law (Health and Safety Code, Section 33,000) to carry out redevelopment programs at the local level. CRAs can finance projects by issuing general obligation bonds. CRAs can finance residential and limited commercial developments by issuing tax-exempt mortgage revenue bonds. The bond proceeds may be used to make below-market interest rate loans to qualified developers of low-income and medium-income residential projects. California law also permits savings associations an opportunity to issue mortgage-backed bonds. The association pledges a mortgage pool as collateral to the trustee to back up the sale of these bonds to investors. The monies from the sale are used to create more mortgages, creating an almost perpetual supply of funds for real estate finance.

Nature of Bonds

Corporate bonds are credit instruments used to raise long-term funds. When these bonds are backed by a mortgage on specifically described real property, they are call secured bonds. When a company issues bonds that are a claim against its general assets, they are called unsecured bonds or debentures. Corporate bonds are also classified according to their method of payment. Coupon bonds have interest coupons attached, which are removed as they become due and are cashed by the bearer. Interest is paid to the person possessing the coupon, so these bonds are also called bearer bonds. Registered bonds are issued to a specific owner and cannot be transferred without the owner's endorsement. Under this form of bond, interest is paid to the last registered owner. Registered coupon bonds have only the face amount of the bonds, the principal amount, registered. Bonds can be further classified as to the nature of the issuer--railroad bond, industrial bonds, or corporate bonds. Described by the nature of their security, such as mortgage bonds, income bonds, or guaranteed bonds, or by their maturity date, as in long-term, short-term, or perpetual bonds. Bonds may be classified by their type of termination--convertible, redeemable, serial, or sinking fund bonds. May be classified by their purpose--refunding, construction, equipment, or improvement bonds. Issuance of corporate bonds as a means of raising funds for capital improvements to real estate, such as plant expansion or new equipment acquisition, is a relatively costly approach when compared to the use of mortgages. To float a new bond issue, a corporation must secure the services of an investment banker or broker, print bonds (usually in $1,000 denominations), and pay fees in advance to the appropriate regulating agencies as well as to the issuing brokerage house. The success of a new bond issue is usually underwritten by the investment company because it promises to buy all the bonds not sold. The effectiveness of a bond sale depends upon the yields designated to be paid to the purchasers as well as the available supply of investment money. Underlying the entire process are the financial credibility of the issuing company and the value of the collateral property involved. A large company could easily gloat a debenture or unsecured bond issue, while smaller companies would have difficulty even in issuing secured bonds. The investment broker is responsible for advising which bonds to market, what interest rates to pay, and what price the bonds should be, according to specific money market conditions. After the bonds are sold, their values fluctuate with the money market. If market interest rates rise, the value of the bonds issued at a lower interest rate decreases accordingly. In order to compete with higher market interest rates, the face value of these bonds would be discounted if the bond owner wished to sell them. The reverse is also true. When market interest rates drop below those being paid on existing bonds, their value increases above their face amount. Bonds may be worth 95% of their face value at one time and 105% at another, depending upon market conditions. This effectively changes the yield on bonds that are sold before maturity to more or less than the stated rate of interest depending upon the bond's sales price. Bonds are rated according to the financial security of their issuers. Investment rating services constantly watch the major companies and report their financial conditions as the reflect upon the companies' ability to pay their debts when due. Bonds with the highest ratings are considered by buyers to be safe investments and are not discounted to any major degree. Bond with lower ratings are usually traded at greater discounts to reflect their higher risks.

Bearer Bonds

Coupon bonds have interest coupons attached, which are removed as they become due and are cashed by the bearer. Interest is paid to the person possessing the coupon.

Uses for Bond Issues

Designed to attract small investors into large investment pools, bonds were issued to finance office buildings, apartment projects, and commercial developments. The bonds were repaid from the flow of rents coming from these income properties and were a popular form of investment. They generated relatively safe and high yields for their owners. The depression of the 1930s changed the reality of many bondholders. The total amount of the bond issued exceeded reasonable estimates of the value of the collateral. When property values declined the bondholders were wiped out. The use of bonds as a device to finance corporate capital projects faded and has never recaptured is former popularity. Mortgages are used today as one method of raising corporate funds, but many companies continue to use debenture bonds as a source for raising long-term funds. Because the debenture bond is a unsecured general lien against all of a company's assets, financial managers can effectively balance their company's overall debt by establishing the proper mix of short-term notes, long-term individual property mortgages, long-term debenture bonds, and equity participation through preferred and common stock sales.

*Real Estate Trusts

Designed to provide vehicles by which real estate investors can enjoy the special income tax benefits granted to mutual funds and other regulated investment companies. Unlike regular corporations, whose earning are taxed at the corporate level and again at the individual level when distributed as dividends to stockholders, the real estate trusts act as investment conduits, with only a single tax being imposed at the beneficiary level. There are 3 types of real estate trusts: 1. Real estate investment trust (REIT), also known as an equity trust 2. Real estate mortgage trust (REMT) 3. Combination trust, which is called a balanced trust in California To qualify, a trust must meet the following basic requirements: 1. The trust must not hold property primarily for sale to customers in the ordinary course of business. 2. The trust must be owned beneficially by at least 100 investors. 3. The trust must not have fewer than five persons who ow more than 50% of the beneficial interest. 4. The trust's beneficial interests must be evidenced by transferable shares or certificates of interest. 5. 95% of the trust's gross income must be derived from its investments 6. 75% of the trust's gross income must be derived from real estate investments. 7. No more than 30% of the trust's gross income may result from saes of stocks and securities held for less than 12 months or from the sale of real estate held for less than 4 years. 8. 95% of the trust's gross income must be distributed in the year it is earned. 9. All trust income must be considered passive by the IRS. In California, each share or certificate of interest must carry with it an equivalent vote in determining trust policy. This condition is one that many believe restricts theis state's development of trusts. Real estate trusts' investment decisions are generally entrepreneurial in design. As with a mutual fund in the stock market where the value of the stock is primarily a reflection of the success of the fund's managerial decisions, so also is the value of a beneficial interest in an investment trust the profitability function of that enterprise. If the investment trust is a successful entity, the beneficiaries profit accordingly. If the investment trust fails, as many have over time, the beneficiaries' investments are lost.

*Endowment Funds

Endow means to provide with a permanent fund of source of income. A myriad of educational institutions and research foundation enjoy the earnings from endowment funds established by generous donors. The basic quality of an endowment is its permanence, with a specific requirement being the preservation of the value of the invested capital while the recipient benefits from its income. Managers of endowment funds are charged with maximizing earnings as well as protecting the integrity of the principal. Donations to educational institutions and nonprofit research foundations are tax-deductible, and donors usually place few restrictions upon the investment of endowment funds. The permanent quality of these funds complements the acquisition of long-term investment portfolios, but investment decisions are complicated by the need to preserve the basic values of the funds. Many endowment funds are not large enough to support a full-time investment staff; the management is usually assigned to an investment counselor, to a trust company, or to members of the institution's or foundation's board of trustees. These managers must select investments that will safely generate relatively high levels of income for long periods of time. It would seem that sound real estate mortgages fit this description, endowment funds managers have not as yet pursued these investment alternatives to any significant extent. A new entity resulting for TRA '86 is the Real Estate Mortgage Investment Conduit (REMIC) that bay be the vehicle for motivating these endowment managers to pursue real estate loans aggressively as an investment alternative.

Families as Lenders

Family members also participate as lenders on real estate. Frequently, they provide the cash necessary for the down payment and closing costs toward the purchase of a residence or investment property. Sometimes, to allow the buyer to secure the loan, family members are required to cosign the loan documents to include their financial resources as additional collateral. Based on the 2002 tax law, which now allows anyone to make an annual tax-free gift of $13,000, some parents can aid their children in purchasing a home. A married couple could accept up to $52,000 in tax-free gifts; $13,000 from each parent to each of the children.

*Mortgage Brokers and Bankers

Financial intermediaries sometimes lack the capacity to expand beyond their local markets. However, various commercial and savings banks do accumulate assets that exceed local needs. When this occurs, these institutions look to the regional and national mortgage markets provided by Fannie Mae, Freddie Mac, and Ginnie Mae for expanded investment opportunities. These institutions will also use the services of mortgage brokers and mortgage bankers. Life insurance companies and pension fund managers enlist the aid of mortgage bankers to originate and service some of their real estate loans on a local level, rather than maintain an expensive network of branch offices. Investment trusts, endowment fund managers, and individuals make mortgage loans with the aid and services of these local mortgage brokers and bankers. The SAFE Act requires all mortgage loan originators (MLOs) to be licensed under the Nationwide Mortgage Licensing System (NMLS). California MLOs also require an endorsement from the Bureau of Real Estate.

Warehousing

Guaranteeing for a specified time and fee, that funds will be available under certain terms and conditions; assembling into one package a number of mortgage loans, which the correspondent has originated, in anticipation of sale in the secondary market.

General Partner

In a limited partnership, the individual or company acquiring, organizing, and managing the investment.

Limited Partner

In a syndicate or regular partnership, the owners other than the general partners. Liability in limited to the amount of their investment.

Mortgage Lenders

Investors.

Registered Bonds

Issued to a specific owner and cannot be transferred without the owner's endorsement. Under this form of bond, interest is paid to the last registered owner.

Mortgage Bankers: Activities

Mortgage bankers maintain a high community profile, taking active roles in social, political, and humanitarian efforts within their geographic regions. They cultivate friendships with local land developers, builders, and real estate brokers in order to establish reciprocally beneficial associations. At the same time, they associate with mortgage loan investment companies, which they represent in a specific locale. The mortgage banker assumes the role of the intermediary-- searching out and developing new mortgage business, originating loans, selling the loans to investors, and the collecting the payments on the loans for the benefit of the investors. Some also write life insurance and act as real estate brokers, appraisers, and investment counselors. The mortgage banking industry is regulated under specific state laws, it's less regulated than banks because mortgage bankers are not lending depositors' monies. Mortgage bankers lend their own monies from borrowed funds to place new loans, which are then grouped into homogeneous "packages" that satisfy the requirements of specific loan investors as to loan amounts and property locations. Such packages are then sold to these investors, which the mortgage bankers retains the servicing contract. Mortgage bankers are involved with every type of real estate loan and they can finance every stage of the real estate development--from providing funds to a developer to purchase, improve, subdivide the land, and construct buildings thereon, to providing the final, permanent, long-term mortgages for individuals to buy these homes. A mortgage banker provide the expertise, money, and commitments necessary for the success of many real estate projects, both residential and commercial. Some of their business comes from the origination of conventional, FHA-insured, and DVA-guaranteed, owner-occupied, single-family home loans. Mortgage bankers financial participation is based largely upon the investors' commitments as to the quantity and required yields of mortgages to be placed in a particular community. Mortgage bankers generally lack the financial capacity to directly loan the monies necessary to develop a "package" for their final investors. They will usually seek the aid of a commercial banker who will establish a line of credit. These short-term loans fit perfectly into the commercial bank's requirements and these banks become warehousers for mortgage money. Now the mortgage banker can draw down on the committed warehouse of funds until the final funding from the investor satisfies the total commitment. The financial participants complement each other's activities. Substantial and constant competitions is ever present in the mortgage lending business. Depending to a great degree up the status of the money markets, the mortgage bankers compete with local thrifts, commercial banks, real estate investment trusts, and other mortgage bankers for a share of the market.

Mortgage Bankers: Operation

Mortgage banking is not traditional banking. There are no tellers, cashiers, checking accounts, savings accounts, safe deposit boxes, or depositors. Mortgage bankers are real estate loan administrators. Some banks and bank holding companies own subsidiary mortgage banking companies to expand their latitude in creating and servicing their loans, most mortgage banking companies are privately owned. As private entrepreneurs, they derive income from fees received for originating and servicing real estate loans. The more loans they place in their books, the greater their income. The mortgage banker is under continual pressure to secure new business with which to earn substantial origination fees and to increase service collection accounts.

Mortgage Bankers: Development

Mortgage banking was born when an individuals, maybe a lawyer, or perhaps, a real estate broker, arranged to lend money to a client to enable a real estate transaction to be closed. This loan originator then sold the mortgage to another client who desired such an investment. Repeating the process frequently over time, the loan originator became known in the community as a source of money for real estate loans. In the 1900's, mortgage banking grew rapidly but somewhat haphazardly, developing mainly short-term mortgages at relatively high rates of interest. Small farm and home loans were issued at about 50% of the property's value for 3-year to 5-year terms and were designed so only the interest would be paid, on either a monthly or annual basis, with the entire amount of principal due in full as a balloon payment at the end of the period. Refinancing enabled the payoff obligation with a new mortgage loan under similar terms. Appraisers became optimistic about the continuing increase in property values. Overestimating property made loans on unrealistically high appraised values. During the Great Depression borrowers could not find the funds required to satisfy their short-term mortgage loans as they became due. Many borrowers had difficulty making the interim interest payments on mortgage amounts based on highly inflated prices. Results were numerous foreclosures and a rapid decline in the acceptability of real estate as an investment or as security for a mortgage loan. Finally the federal government stepped in to turn the tide of the depression. The Federal Housing Administration (FHA) was formed.

Mortgage Bankers: Servicing a Loan

Once a loan is closed, arrangements must be made to service it. Principal and interest payments need to be collected in a timely manner and accurate records must be kept. Some loan payments include amounts for property taxes and insurance. The servicing agent must not only place these funds in a proper escrow account but must also take responsibility for their payment, promptly and in the proper amounts. These activities are repetitious and continuing, usually on a monthly basis for many years. Servicing duties are usually accepted by mortgage bankers and other lenders as an opportunity to earn money. Most payment collectors charge their lenders a fee for these services. A few weeks after closing the loan, the borrower will receive information in the mail as to how and where to make their payments.

*Private Loan Companies

Privately owned loan companies are found throughout the U.S. Ranging from large national companies with branches in almost every city to individual entrepreneurs who may personally buy and sell loans, these private lenders deal primarily in junior financing arrangements, such as second deeds of trust that utilize a borrower's equity in real property as collateral. This type of financing is often used to raise funds for consumer purchases, such as cars, furniture, and other "big ticket" consumer items. The consumer goods financing companies technically can participate in real estate finance, their activities are too peripheral and sporadic to make them important in the field. There are numerous other private loan companies designed to deal exclusively in real estate finance. These companies make loans from their own funds or monies borrowed from their commercial banks, act as mortgage brokers in arranging loans between other lenders and borrowers, and buy and sell junior financing instruments. In this latter capacity, these private real estate loan companies help create a market for investment in junior loans. TRA'86 disallowed interest deductions on consumer loans but permitted deductions for interest paid on home loans, making investment in junior loans more prevalent. Private real estate loan companies usually charge more than other lenders. They attempt to offset the risks inherent in their junior lien position by charging the maximum interest rates allowable by law and by imposing high loan placement fees. California has laws regulating the activities of private lenders. The state requires loan companies to obtain licenses and performance bonds. Limits are imposed on the fees these lenders can charge for their services. Regulation Z of the Truth in Lending portion of the 1968 Consumer Protection Act requires lenders to reveal what the final effects of the various charges will be on the overall cost of a loan. This revelation doesn't prohibit a borrower from completing a loan transaction. It only reveals the total costs involved and allows a borrower up to three business days to cancel the loan arrangement. Known as rescission, this right applies only to loans for refinancing.

General Obligation Bonds

Public improvement bonds to be paid from property taxes.

Investment Conduits

Real Estate investment trust; an unincorporated trust, set up to invest in real estate, that must have at least 100 investors; management, control, and title to the property are in the hands of trustees.

Registered Coupon Bonds

Registered coupon bonds have only the face amount of the bonds, the principal amount, registered.

Blue-Sky Provision

Requiring full disclosure of all risks in a limited partnership solicitation under the Uniform Partnership Act.

Sellers as Lenders

Sellers participate in the finance market by financing a portion of the sales price with carryback loans. Using junior loans, land contracts, wrap-arounds, and other creative financing devices, sellers frequently agree to help finance some of the property's sales price rather than lose the deal. There has been a significant increase in the variety of loan products available to qualified borrowers. Lenders are offering senior loans at up to 100% of appraised value coupled with appropriate junior loans, lessening the need for seller financing. Ex. A property sells for $750,000 with a 5% cash down payment ($37,500), a 15% junior loan ($112,500), and a new senior loan for 80% ($600,000). Ex. A home sells for %550,000 with an existing loan balance of $350,000. The buyer make a 20% cash down payment (($110,000) and the seller agrees to carry back a second deed of trust for $55,000. The buyer then obtains a new senior loan for $385,000 to pay off the existing loan.

Mortgage Loan Bonds

Some states issue income-tax-free bonds to secure funds for relatively low-cost mortgage loans. These loans are available to eligible persons to help them acquire homes and condominium apartments. The interest income from these bonds is tax-exempt at both the federal and state levels, so their purchasers can buy them at lower rates than would be required on other taxable investments. These savings are passed along to the borrowers, who will pay slightly higher interest rates on their loans that are paid to the bondholders to cover operational costs. The entire program is designed to be self-supporting, it does pass the subsidizing effect over the entire country and the state involved through the loss of income tax revenue. California issues Cal-Vet Bonds to finance eligible veterans' homes.

*California Syndication

Syndicates can take the form of a corporation, a full partnership, or, the most popular, a limited partnership. A typical syndicate combines the money of the individual investors with the management expertise of a sponsor, known as the general partner, and follows a 3-step-cycle: 1. Acquisition 2. Operation 3. Disposition Syndicates are considered to be investment conduits that pass profits and losses to investors in proportion to their ownership shares. Any tax liabilities are imposed at the investors' level. Intrinsic in the design is the investors' liability for debts of the partnership, which are usually limited to their investment. The income from these syndicates, or limited partnerships, is considered passive by the IRS. In reaction to past misrepresentation and fraudulent profits claimed by some syndicate promoters, when a syndicate is marked nationally, the Securities and Exchange Commission (SEC) requires full disclosure of all the risks involved in the investment, the blue-sky provision. In California, the Department of Corporations regulates control of syndicates. Under the Corporations Code, Section 25,000, real estate brokers may engage in the sale of real estate syndicate security interests without obtaining a special broker-dealer license. All such sales must be made under strict adherence to the full disclosure provisions of the California Uniform Partnership Act. The California Corporations Code, Section 15507, states that a limited partner may become liable for the total debts of the partnership if the limited partner takes an active role in management. Unlike the C corporation, which charges taxes at both the company and shareholder levels, the popular limited liability company (LLC), combines the single-level tax benefit of a partnership with the organizational structure and limited liability of limited partnerships and corporations. Members of an LLC can participate in running the organization without becoming personally ilable for business obligations. In California, an "articles of organization" form must be filed with the Secretary of State to establish the LLC. The LLC format may incur higher fees and taxes than general or limited partnerships.

Balloon Payment

The final payment of a partially amortized loan that is considerably larger than the required periodic payments.

Nonistitutional Lenders

The second source of fund for real estate finance. This heterogeneous group is composed of real estate mortgage brokers and bankers, real estate mortgage and investment trusts, real estate bond dealers, endowment fund managers, private loan companies, and individuals. Some arrange mortgages between the institutional lenders and borrowers, while others make direct loans using their own funds. Unlike banks, thrifts, life insurance companies, pension funds, and credit unions, which are directly responsible to their depositors and premium payers, the noninstitutional lenders are removed from a first-person fiduciary relationship. Although they are expected to invest entrusted funds with sound judgement, no guarantee is given that the money will be returned dollar for dollar, as is the case with the primary lenders. This distinction allows the noninstitutional lenders to make more risks than the primary lenders.

Mortgage Bankers: Assignment of Loan

The servicing of real estate loans by financial institutions was the task of the lenders themselves because they maintained ownership of the securities. This relationship has changed as the originators of loans have found it more expedient to sell these securities in the secondary market. When these loans are sold (assigned), the originators often retain the servicing responsibility under a contract with the new owners. Using this technique, loan originators can build a substantial loan collection business. These loan servicing companies collect the payments and keep records for borrowers and lenders. They provide a property tax service, checking the records of the county for the amounts due and paying the taxes on time. They are also billed directly by insurance companies for premiums due on the various hazard policies placed on the collateral properties. Most importantly, they maintain a watchful eye one the timely receipt of loan payments. When a payment is late, the collection manager is alerted to watch for a check. If it's not forthcoming, a letter is sent to the borrowers that notifies them of the consequences of a default. If no payments are received, the manager notifies the lender and follows instructions to foreclose on the property. Under the loan servicing transfer provisions included in the October 1990 Federal Housing Law: 1. Lenders must give 15-day advance notice that a loan is changing hands; 2. Both the old and the new owners of the loan must give toll-free numbers and the names of persons empowered to handle borrower inquiries; 3. Waivers of up to 60 days after the loan has been assigned must be given for late fees in the event that the borrowers sent in a payment on time but to the wrong lender.

*California Real Property Loan Law

Under Article 7, Chapter 3 of the California Real Estate Law, a real estate broker or mortgage broker is limited in the amount of commission and fees that can be charged for making or arranging a hard money loan. A hard money loan s an equity loan and not a purchase loan. Commission and cost limitations are: * First trust deed loans of LESS than $30,000 -5% of principal if term of loan is less than 3-years -10% if term of loan is 3-years or more *Junior trust deed loans of LESS than $20,000 -5% of principal if term is less than 2-years -10% of principal if term is at least 2-years but less than 3-years -15% of principal if term is 3-years or more *Expenses of making the loan include appraisal fees, notary fees, escrow fees, credit report fees, and others. They are not to exceed the following: -Loans from$0-$7,800: actual costs or $390, whichever is less -Loans from $7,801-$14,000: actual costs or 5% of the loan amount, whichever is less -Loans over $14,000: actual costs but not more than $700 Ex. The cost for borrowing $19,500 on a junior trust deed equity loan for 3-years is $3,625. $19,500 x 15% = 2,925 Broker's Commission + 700 Maximum Closing Expenses =$3,625 Balloon payments are not allowed on hard money loans of less than 3-years, nor on a hard money loan of 6-years or less for owner-occupied dwellings. If the borrower doesn't disclose to the broker any and all liens against the property being offered as security for the loan, the borrower may be liable for payment of all costs and one-half of the broker's commission if the new loan can't be completed. The borrower can't be required to purchase credit life or disability insurance as a condition of the loan. A mortgage loan disclosure statement must be given a copy kept for 4-years. Any late charges are limited to 10% (with a $5 minimum) of a principal and interest part of the installment. No late charge can be assessed for a payment received within 10 days of the due date. Any listing agreement between the borrower and the broker authorizing a broker to find a loan of $2,000 or less can't be for more than 45 days. Interest can't begin until the funds have been made available to the borrower. Concerning a loan on an owner-occupied dwelling, the following applies: -Upto 20% of the principal can be paid off during any 12-month period without penalty. -The maximum allowable prepayment penalty is 6 months' interest on the balance after 20% payment. -No prepayment penalty can be imposed after 7-years form the date of the loan. If a real estate broker expects to deal with 20 or more loans or negotiates loans worth more than $2 million in any one year period, the broker must notify the Bureau of Real Estate within 30 days and will be obligated to comply with additional requirements. Exempt from the California Real Property Loan Law are institutional lenders, such as banks, credit unions, savings associations, and finance companies. Also exempt are first trust deed loans of $30,000 or more, junior trust deeds loan of $20,000 or more, and seller carryback purchase money transactions.

Other Lenders

Various foreign sources of funds for real estate financing activities in our country have not yet been clearly identified. The oil-producing countries of the Middle East and North Africa have billions of dollars on deposit in U.S. banks. These monies substantially increase the capacity of these banks to enlarge their loan portfolios, the quality of these funds is still unknown. If they turn out to be relatively short-term funds, they will have little impact on the real estate financial market. But if these funds are left on deposit for longer periods of time, they may have a profound effect upon the monies available for real estate finance. Foreign investors participate in about 7% of the U.S. equity market. A decline in the Euro causes many European investors to sell rather than buy U.S. real estate. Dutch investors usually buy REITs while Australians prefer their U.S. holdings in New York City, San Francisco, Boston, and Washington D.C.

Secured Bonds

When these bonds are backed by a mortgage on specifically described real property.