UNIT 15

Discount points

A lender may sell a mortgage to investors, which we will cover shortly. However, the interest rate that a lender charges the borrower for a loan might be less than the yield (true rate of return) an investor demands. To make up the difference, the lender charges the borrower discount points. The number of points charged depends on two factors: The difference between the interest rate and the required investor yield How long the lender expects it will take the borrower to pay off the loan For the borrowers, one discount point equals 1 percent of the loan amount and is charged as prepaid interest at the closing. For instance, three discount points charged on a $100,000 loan would be $3,000 ($100,000 × 3%, or .03). If a house sells for $100,000 and the borrower seeks an $80,000 loan, each point would be $800. In some cases, however, the points in a new acquisition may be paid in cash at closing rather than being financed as part of the total loan amount. For Example: To determine how many points are charged on a loan, divide the total dollar amount of the points by the amount of the loan. For example, if the loan amount is $350,000 and the charge for points is $9,275, how many points are being charged? $9,275 ÷ $350,000 = 0.0265 or 2.65% or 2.65 point

REAL ESTATE FINANCING

A mortgage is a voluntary lien on real estate. The person who borrows money to buy a piece of property voluntarily gives the lender the right to take that property if the borrower fails to repay the loan. The borrower, or mortgagor, pledges the land to the lender, or mortgagee, as security for the debt. In title-theory states, the mortgagor actually gives legal title to the mortgagee (or some other designated individual) and retains equitable title. Legal title is returned to the mortgagor when the debt is paid in full. In theory, the lender actually owns the property until the debt is paid. The lender allows the borrower all the usual rights of ownership, such as possession and use. Because the lender holds legal title, the lender has the right to immediate possession of the real estate and rents from the mortgaged property if the mortgagor defaults. In lien-theory states, the mortgagor/borrower holds both legal and equitable title. The mortgagee/lender simply has a lien on the property as security for the mortgage debt. The mortgage is nothing more than collateral for the loan. If the mortgagor defaults, the mortgagee must go through a formal foreclosure proceeding to obtain legal title. The property is offered for sale, and sale proceeds are used to pay all or part of the remaining debt. In some states, a defaulting mortgagor may redeem the property during a certain period after the sale. A borrower who fails to redeem the property during that time loses the property irrevocably. A number of states have adopted an intermediate mortgage theory based on the principles of title-theory states but still requiring the mortgagee to formally foreclose to obtain legal title. Illinois does not adhere strictly to either the title or lien theory. As a result, Illinois often is referred to as an intermediate mortgage theory state. Mortgages and deeds of trust in Illinois convey only qualified title to the lender as security for the loan during the existence of the debt. The mortgagor/borrower remains the owner of the mortgaged property for all beneficial purposes, subject to the lien created by the mortgage or deed of trust. The qualified title held by the lender is subject to the defeasance clause, which stipulates that such title must be fully re-conveyed, or released back, to the mortgagor at the time the debt is repaid in full. In reality, the differences between the parties' rights in a lien-theory state and those in a title-theory state are more technical than actual. A typical procedure before any foreclosure is to accelerate the loan based on the original agreement made with the borrower. Acceleration means asking for the loan to be paid in full based on the borrower's having broken the original promise to repay with regular payments. A basic principle of property law is that no one can convey more than he actually owns. This principle also applies to mortgages. The owner of a fee simple estate can mortgage the fee. The owner of a leasehold or subleasehold can mortgage that leasehold interest. The owner of a condominium unit can mortgage the fee interest in the condominium. The owner of a cooperative interest may be able to offer that personal property interest as collateral for a loan.

Mortgage Loans

A mortgage loan, like all loans, creates a relationship between a debtor and a creditor. In the relationship, the creditor loans the debtor money for some purpose, and the debtor agrees to pay or pledges to pay the principal and interest according to an agreed schedule. The debtor agrees to offer some property or collateral to the creditor if the loan is not repaid. Mortgage loans are secured loans. Mortgage loans have two parts: the debt itself and the security for the debt. When a property is mortgaged, the owner must sign two separate instruments—a note stating the debtor will repay the lender, and a security document, which is typically the mortgage. In mortgage lending practice, a borrower is required to pledge specific real property as security (collateral) for the loan. The debtor retains the right of possession and control, while the creditor receives an underlying equitable right in the pledged property. This type of pledging is termed hypothecation. The right to foreclose on the pledged property in the event a borrower defaults is contained in a security agreement, such as a mortgage or a deed of trust.

Short Sales

A short sale is the process by which a lender accepts less than the amount owed on the property as satisfaction for the loan. For example, if a borrower owes $200,000 on their house that is worth $175,000, the lender may accept the proceeds from the sales price of $175,000 to payoff this loan. Although not always the case, a short sale request most often occurs when the owner/borrower is unable to make the mortgage payments and cannot sell the house for what is owed on the property. The lender agrees to accept less because the lender may lose more money by acquiring the property through a foreclosure process and then holding the property until the lender can find another buyer. Lenders are leery of short sales due to the potential for several different types of fraud. The first type is when the buyers are not actually buying for themselves. The buyers might actually be friends or relatives of the delinquent borrower who are helping the borrower gain back the house for a lower amount. In other situations, the buyers are investors using "straw buyers" to buy the house for a low amount expecting to quickly sell it at a profit shortly thereafter. Still another variation of a fraudulent short sale is when payments are made to someone (e.g., seller, other mortgage holders) in order to get them to agree to the sale. For example, when the holder of a second (junior) mortgage is unwilling to accept the amount that the senior lien holder (the one agreeing to the sale) an arrangement is privately agreed to for additional payments that are not shown on the HUD-1 closing statement and remain unknown to the senior lien holder. This is a violation of RESPA. For these reasons, fewer delinquent borrowers have been able to benefit from a short sale. Still another issue arises when lenders typically reserve the right to file suit to acquire the missing amount, called a deficiency. Although few lenders actually file suit to recover the missing amount, they can. Because the borrower has received the money and has not repaid it, the borrower generally owes income tax on the deficient amount (i.e., the amount forgiven in the short sale and then receiving an IRS Form 1099). Under the Mortgage Debt Relief Act of 2007, however, taxpayers are permitted to exclude from taxable income the amount of debt reduced through mortgage restructuring as well as mortgage debt forgiven through foreclosure. The act applies to debt forgiven in the years 2007 through 2012. For specific details, be sure to consult a competent accountant. Lenders take their time agreeing to a short sale. Licensees working in this field should expect the process to be long and tedious and likely to fail before closing or a foreclosure takes place.

Strict foreclosure

Although judicial foreclosure is the prevalent practice, it is still possible in some states for a lender to acquire mortgaged property through a strict foreclosure process. First, appropriate notice must be given to the delinquent borrower. Second, once the proper papers have been prepared and recorded, the court establishes a deadline by which time the balance of the defaulted debt must be paid in full. If the borrower does not pay off the loan by that date, the court simply awards full legal title to the lender. No sale takes place.

Deed in Lieu of Foreclosure

As an alternative to foreclosure, a lender may accept a deed in lieu of foreclosure from the borrower. This is sometimes known as a friendly foreclosure because it is carried out by mutual agreement rather than by lawsuit. The major disadvantage of the "deed in lieu" is that the mortgagee takes the real estate subject to all junior liens. In a foreclosure action, all junior liens are eliminated. Also, by accepting a deed in lieu of foreclosure, the lender usually loses any rights pertaining to FHA or private mortgage insurance or VA guarantees. Finally, a deed in lieu of foreclosure is still considered an adverse element in the borrower's credit history. Today, many property owners are unable to meet their mortgage payments, in part because they may have lost their jobs and/or their adjustable rate mortgage (ARM) payments became more than they could afford. When these owners put their home on the market, they find that values have declined that they now owe more money than they can realize from the sale of their home.

Usury

Charging interest in excess of the maximum rate allowed by law is called usury. To protect consumers from unscrupulous lenders, many states have enacted laws limiting the interest rate that may be charged on loans. In some states, the legal maximum rate is a fixed amount. In others, it is a floating interest rate that is adjusted up or down at specific intervals based on a certain economic standard such as the prime lending rate or the rate of return on government bonds. Whichever approach is taken, lenders are penalized for making usurious loans. In some states, a lender that makes a usurious loan is permitted to collect the borrowed money but only at the legal rate of interest. In others, a usurious lender may lose the right to collect any interest or may lose the entire amount of the loan in addition to the interest. Technically, there is no legal limit specifically imposed by Illinois on the rate of interest that a lender may charge a borrower when the loan is secured by real estate so there is considered to be no usury limit in Illinois. There is, however, exemption from these state laws. Residential first mortgage loans made by federally chartered institutions, or loans made by lenders insured or guaranteed by federal agencies, are exempt from state interest regulations, and consequently are subject to federal limits. Included in the federal law's definition of "residential loans" are loans for purchasing houses, condominiums, manufactured housing, and loans to buy stock in a cooperative. The overall effect in Illinois is to apply federal usury limits to many if not most residential loans, thereby protecting the consumer

Foreclosure

If borrowers default on mortgage payments, lender could be forced to exercise their rights to foreclose against properties used as security for their loans. Foreclosure is a legal procedure in which property pledged as security is sold to satisfy the debt. The foreclosure procedure brings the rights of the parties and all junior lienholders to a conclusion. It passes title either to the person holding the mortgage document or deed of trust or to a third party who purchases the realty at a foreclosure sale. The purchaser could be the mortgagee. At the foreclosure sale, the property is sold free of the foreclosing mortgage and all junior liens

Mortgage Documents

In some situations, lenders may prefer to use a three-party instrument known as a deed of trust, or trust deed, rather than a mortgage. A deed of trust conveys naked title or bare legal title—that is, title without the right of possession. The deed is given as security for the loan to a third party, called the trustee. The trustee holds title on behalf of the lender, who is known as the beneficiary. The beneficiary is the holder of the note. The conveyance establishes the actions that the trustee may take if the borrower (the trustor) defaults under any of the deed of trust terms (see the two figures below for a comparison of mortgages and deeds of trust). In states where a deed of trust is generally preferred, foreclosure procedures for default are usually simpler and faster than for mortgage loans. In Illinois, a deed of trust is treated like a mortgage and is subject to the same rules including foreclosure. In Illinois, the trustor (borrower) in a deed of trust holds the title to the real estate. The borrower is required to fulfill certain obligations created by the mortgage or deed of trust. These usually include the following: 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 other hazard Maintenance of the property in good repair at all times Receipt of lender authorization before making any major alterations on the property Failure to meet any of these obligations can result in a borrower's default. The loan documents may, however, provide for a grace period (such as 30 days) during which the borrower can meet the obligation and cure the default. If the borrower does not do so, the lender has the right to foreclose on the mortgage or deed of trust and collect on the note. The mortgage or deed of trust typically includes an acceleration clause to assist the lender in foreclosure. If a borrower defaults, the lender has the right to "accelerate the maturity of the debt." This means the lender may declare the entire debt due and payable immediately. Without an acceleration clause, the lender would have to sue the borrower every time a payment was overdue. Other clauses in a mortgage or deed of trust enable the lender to take care of the property in the event of the borrower's negligence or default. If the borrower does not pay taxes or insurance premiums or fails to make necessary repairs on the property, the lender may step in and do so. The lender has the power to protect the security (the real estate). Any money advanced by the lender to cure a default may be either added to the unpaid debt or declared immediately due from the borrower. Without changing the provisions of a contract, a note may be sold to a third party, such as an investor or another mortgage company. The original mortgagee endorses the note to the third party and executes an assignment of mortgage. The assignee becomes the new owner of the debt and security instrument. When the debt is paid in full (or satisfied), the assignee is required to execute the satisfaction (or release) of the security instrument.

Interest

Interest is a charge for the use of money. Interest may be due at either the end or the beginning of each payment period. Payment made at the beginning of each period is payment in advance. When payments are made at the end of a period, it is known as payment in arrears. Whether interest is charged in arrears or in advance is specified in the note. This distinction is important if the property is sold before the debt is repaid in full. Most mortgages have interest in arrears.

Judicial foreclosure

Judicial foreclosure allows the property to be sold by court order after the mortgagee has given sufficient public notice. When a borrower defaults, the lender may accelerate the due date of the remaining principal balance, along with all overdue interest, penalties, and administrative costs. The lender's attorney then can file a suit to foreclose the lien. After presentation of the facts in court, the property is ordered sold. A public sale is advertised and held, and the real estate is sold to the highest bidder. By statute, mortgage foreclosures may be brought about only through a court proceeding. As a result, Illinois is classified as a judicial foreclosure state. Under the Illinois 1987 Mortgage Foreclosure Law, the term mortgage includes deeds of trust, installment contracts payable over a period in excess of five years (when the unpaid balance is less than 80 percent of the purchase price), certain collateral assignments of the beneficial interest in land trusts used as security for lenders, and traditional mortgage instruments

Tax and Insurance Reserves

Many lenders require that borrowers provide a reserve fund to meet future real estate taxes and property insurance premiums. This fund is called an impound account, a trust account, or an escrow account. When the mortgage or deed of trust loan is made, the borrower starts the reserve by depositing funds to cover the amount of unpaid real estate taxes. If a new insurance policy has just been purchased, the insurance premium reserve will be started with the deposit of one-twelfth of the insurance premium liability. The borrower's monthly loan payments will include PITI: principal, interest, tax, and insurance. Other costs such as private mortgage insurance premiums (PMI), flood insurance, or homeowners' association dues may also be included. Illinois law prescribes additional guidelines that must be followed by lenders who require escrow accounts for mortgage loans on single-family, owner-occupied residential properties. The Illinois Mortgage Tax Escrow Account Act at 765 ILCS 915/ provides that except during the first year of the loan, a lender may not require an escrow accumulation of more than 150 percent of the previous year's real estate taxes. Lenders must give borrowers written notice of the act's provisions at closing. The Illinois Mortgage Escrow Account Act at 765 ILCS 910/ states that when the principal loan balance has been reduced to 65 percent of its original amount, the borrower may terminate his escrow account. The latter does not apply to loans insured, guaranteed, supplemented, or assisted by the state of Illinois or agencies of the federal government such as FHA and VA. Also, borrowers have the right to pledge an interest-bearing deposit in an amount sufficient to cover the entire amount of anticipated future tax bills and insurance premiums instead of establishing an escrow account

Prepayment

Most mortgage loans are paid in installments over a long period of time. As a result, the total interest paid by the borrower may add up to more than the principal amount of the loan. That does not come as a surprise to the lender; the total amount of accrued interest is carefully calculated during the origination phase to determine the profitability of each loan. If the borrower repays the loan before the end of the term, the lender collects less than the anticipated interest. For this reason, some mortgage notes contain a prepayment clause. This clause requires that the borrower pay a prepayment penalty against the unearned portion of the interest for any payments made ahead of schedule. The penalty may be as little as 1 percent of the balance due at the time of prepayment or as much as all the interest due for the first ten years of the loan. Some lenders allow the borrower to pay off a certain percentage of the original loan without paying a penalty. However, if the loan is paid off in full, the borrower may be charged a percentage of the principal paid in excess of that allowance. Note: Lenders may not charge prepayment penalties on mortgage loans insured or guaranteed by the federal government or on those loans that have been sold to Fannie Mae or Freddie Mac. Lenders in Illinois are prohibited from charging a borrower a prepayment penalty on a fixed rate loan secured by residential real estate when the loan's interest rate is greater than 8 percent per year. However, they can charge a prepayment penalty on an adjustable rate loan

Redemption

Most states give defaulting borrowers a chance to redeem their property through the equitable right of redemption. If, after default but before the foreclosure sale, the borrower (or any other person who has an interest in the real estate, such as another creditor) pays the lender the amount in default, plus costs, the debt will be reinstated and regular payments may be resumed. In some cases, the person who redeems may be required to repay the accelerated loan in full. If some person other than the mortgagor or trustor redeems the real estate, the borrower becomes responsible to that person for the amount of the redemption. Some states also allow defaulted borrowers a period in which to redeem their real estate after the sale. During this period (which may be as long as one year), the borrower has a statutory right of redemption. The mortgagor who can raise the necessary funds to redeem the property within the statutory period pays the redemption money to the court. Because the debt was paid from the proceeds of the sale, the borrower can take possession free and clear of the former defaulted loan. The court may appoint a receiver to take charge of the property, collect rents, and pay operating expenses during the redemption period. There is no statutory right of redemption in Illinois. In Illinois, a mortgagor in default who wishes to exercise the equitable right of redemption to avoid loss of the mortgaged real estate may do so for a period of seven months after the date of service on the mortgagor or after first publication date, whichever is later. This time period can currently be shortened to as little as 30 days after a judgment is entered if the property has been abandoned or is vacant. When a property is redeemed in this way, the foreclosure sale does not occur. Otherwise, the foreclosure sale is held as soon as possible after the equitable right of redemption expires. The mortgagor generally has a right to remain in possession of the property from the time of service of summons until the entry of a judgment of foreclosure. After judgment and through the 30th day after confirmation of the sale, the mortgagor can still retain possession, but he may be required to pay rent to the holder of the certificate of sale. Thirty-one days after judgment, the mortgagor must have vacated the property or be subject to eviction. The owner of the certificate of sale receives a sheriff's deed and gains the right to possession. While Illinois does not have statutory right of redemption, it does offer a statutory right of reinstatement. This option is applicable when the defaulting mortgagor wishes to cure the default and reinstate the loan as if no acceleration had occurred. The mortgagor has the right to exercise this statutory right for a period of 90 days after service of summons or publication date. At the lender's discretion, expressed through an attorney, the right of reinstatement may be extended to run as long as the equitable right of redemption. The reinstatement right usually may be exercised only once every five years. After reinstatement occurs, the suit must be dismissed by the lender, and the mortgage loan remains in effect just as before. When a default is not cured by redemption or reinstatement, the entry of a decree of foreclosure will lead to a judicial sale of the property, usually called a sheriff's sale. Each defendant to the suit must be given written personal notice of the sale, and public notice of the sale must be published in a newspaper of general circulation. The successful bidder at the sale receives a certificate of sale, not a deed. Only after the sale is confirmed by the court will the certificate holder receive a sheriff's deed.

Priority of a Mortgage or Deed of Trust

Priority of mortgages and other liens normally is determined by the order in which they were recorded. A mortgage or deed of trust on land that has no prior mortgage lien is a first mortgage or deed of trust. If the owner later executes another loan for additional funds, the new loan becomes a second mortgage or deed of trust (or a junior lien) when it is recorded. The second lien is subject to the first lien; the first has prior claim to the value of the land pledged as security. Because second loans represent greater risk to the lender, they are usually issued at higher interest rates. The priority of mortgage or deed of trust liens may be changed by a subordination agreement, in which the first lender subordinates its lien to that of the second lender. To be valid, such an agreement must be signed by both lenders. Real estate can be purchased under a land contract, also known as a contract for deed or an installment contract (see Unit 11). Real estate is usually sold on contract for specific financial reasons. For instance, mortgage financing may be unavailable to a borrower for some reason. High interest rates may make borrowing too expensive, or the purchaser may not have a sufficient down payment to cover the difference between a mortgage loan and the selling price. Under a land contract, the buyer (called the vendee) agrees to make a down payment and a monthly loan payment that includes interest and principal directly to the seller. The payment also may include real estate tax and insurance reserves. The seller (called the vendor) retains legal title to the property during the contract term, and the buyer is granted equitable title and possession. At the end of the loan term, the seller delivers clear title. In the event the seller fails to deliver clear title, the buyer (vendee) would file a vendee's lien. The contract usually permits the seller to evict the buyer in the event of default. In that case, the seller may keep any money the buyer has already paid. If, however, the buyer has 20 percent equity in the property and a contract in excess of five years, judicial foreclosure would be necessary. While land contracts or owner financing can occur with residential or commercial properties, they are more common with unimproved acreage and farmland sales. Sometimes the seller is the primary lender, and at other times, the seller may be in a secondary position. In either case, the sellers would want to secure their interest either by the use of a deed, note and mortgage, deed of trust, or perhaps the use of a contract for deed instrument

Nonjudicial foreclosure

Some states allow nonjudicial foreclosure procedures to be used when the security instrument contains a power-of-sale clause. In nonjudicial foreclosure, no court action is required

Government Programs

The "Making Home Affordable" programs (2009), part of President Obama's approach to help the housing market, are available to assist delinquent borrowers and consist of several components: the Home Affordable Modification Program (HAMP), the Home Affordable Refinance Program (HARP), and the Home Affordable Foreclosure Alternatives Program (HAFA). All programs are voluntary, and not all lenders participate

HAFA

The HAFA program provides alternatives to foreclosures by encouraging lenders and delinquent borrowers to enter into a short sale or a deed-in-lieu of foreclosure.

HARP

The HARP program is designed to help property owners refinance their properties who are not yet delinquent or more than 30 days overdue in the past 12 months. Lenders will scrutinize all financial information from a HARP applicant, requiring previous income taxes statements and more

Flood insurance reserves

The National Flood Insurance Reform Act of 1994 imposes certain mandatory obligations on lenders and loan servicers to set aside (escrow) funds for flood insurance on new loans. The act also applies to any loan still outstanding on September 23, 1994. This means that if a lender or servicer discovers that a secured property is in a flood hazard area, it must notify the borrower. The borrower then has 45 days to purchase flood insurance. If the borrower fails to procure flood insurance, the lender must purchase the insurance on the borrower's behalf. The cost of the insurance may be charged to the borrower. If the property involved includes rental units, the borrower may provide for rents to be assigned to the lender in the event of the borrower's default. The assignment may be included in the mortgage or deed of trust, or it may be a separate document. In either case, the assignment should clearly indicate that the borrower intends to assign the rents, not merely pledge them as security for the loan. In title-theory states, lenders are automatically entitled to any rents if the borrower defaults.

Deficiency Judgment

The foreclosure sale may not produce enough cash to pay the loan balance in full after deducting expenses and accrued unpaid interest. In this case, where permitted by law, the mortgagee may be entitled to a personal judgment against the borrower for the unpaid balance. Such a judgment is a deficiency judgment. It also may be obtained against any endorsers or guarantors of the note and against any owners of the mortgaged property who assumed the debt by written agreement. However, if any money remains from the foreclosure sale after paying the debt and any other liens (such as a second mortgage or mechanic's lien), expenses, and interest, these proceeds are paid to the borrower. Strict foreclosure does not always provide for a deficiency judgment

HAMP

The goal of HAMP is to help delinquent borrowers modify the terms of their home mortgage loan to an affordable level (i.e., no more than 31 percent of the borrower's pretax monthly income using a combination of three factors: reduce the interest rate, increase the term up to 40 years, and reduce the principal on which interest is charged until the loan is repaid). Modifications are only available to owner occupants of one- to four-family dwellings with loan amounts not exceeding $729,750 for a single-family dwelling (amounts increase for 2, 3, or 4 units).

Alienation clause

The lender may want to prevent a future purchaser of the property from being able to assume the loan, particularly if the original interest rate is low. For this reason, some lenders include an alienation clause, also known as a resale clause, due-on-sale clause, or call clause, in the note. An alienation clause provides that when the property is sold, the lender may either declare the entire debt due immediately or permit the buyer to assume the loan at the current market interest rate. The mortgage document or deed of trust must be recorded in the recorder's office of the county in which the real estate is located. Recording gives constructive notice to the world of the borrower's obligations. Recording also establishes the lien's priority

Loan origination fee

The processing of a mortgage application is known as loan origination. When a mortgage loan is originated, a loan origination fee is charged by most lenders to cover the expenses involved in generating the loan. These include the loan officer's salary, paperwork, and the lender's other costs of doing business. A loan origination fee is not prepaid interest; rather, it is a charge that must be paid to the lender. While a loan origination fee serves a different purpose from discount points, both increase the lender's yield. Therefore, the federal government treats the fee like discount points. It is included in the annual percentage rate of Regulation Z, and the IRS lets a buyer deduct the loan origination fee as interest paid up front

Promissory Notes

The promissory note, referred to as the note or financing instrument, is the borrower's personal promise to repay a debt according to agreed terms. The note exposes all the borrower's assets to claims by secured creditors. The mortgagor executes one or more promissory notes to total the amount of the debt. A promissory note executed by a borrower (known as the maker or payor) is a contract between the borrower and the lender. It generally states the amount of the debt, the time and method of payment, and the rate of interest. When signed by the borrowers and other necessary parties, the note becomes a legally enforceable and fully negotiable instrument of debt. When the terms of the note are satisfied, the debt is discharged. If the terms of the note are not met, the lender may choose to sue to collect on the note or to foreclose. A note need not be tied to a mortgage or a deed of trust. A note used as a debt instrument without any related collateral is called an unsecured note. Unsecured notes are used by banks and other lenders to extend short-term personal loans. A note is a negotiable instrument like a check or bank draft. The lender who holds the note is referred to as the payee and may transfer the right to receive payment to a third party in one of two ways:

Methods of Foreclosure

There are three general types of foreclosure proceedings—nonjudicial, judicial, and strict foreclosure. One, two, or all three may be available. The specific provisions and procedures for each vary from state to state.

Buying Property "Subject to" or "Assuming" Existing Financing

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. The property may be purchased subject to the mortgage or the buyer may assume the mortgage or deed of trust and agree to pay the debt. This technical distinction becomes important if the buyer defaults and the mortgage or deed of trust is foreclosed. When the property is sold subject to the mortgage, the buyer is not personally obligated to pay the debt in full. The buyer takes title to the real estate knowing that he must make payments on the existing loan. Upon default, the lender forecloses and the property is sold by court order to pay the debt. If the sale does not pay off the entire debt, the purchaser is not liable for the difference. In some circumstances, however, the original seller might continue to be liable. In contrast, a buyer who purchases the property and assumes the seller's debt becomes personally obligated for the payment of the entire debt, and the seller (original mortgagor) is still liable until the mortgagee releases the seller. This release generally occurs when the buyer establishes a seasoned payment history (a stable and consistent history of payments under the terms of the loan). If the mortgage is foreclosed and the court sale does not bring enough money to pay the debt in full, a deficiency judgment against the assumer and the original borrower may be obtained for the unpaid balance of the note. If the lender has released the original borrower, only the assumer is liable. If a seller wants to be completely free of the original mortgage loan, the seller(s), buyer(s), and lender must execute a novation agreement in writing. The novation makes the buyer solely responsible for any default on the loan. The original borrower (seller) is freed of any liability for the loan. The existence of a lien does not prevent the transfer of property; however, when a secured loan is assumed, the mortgagee or beneficiary must approve the assumption and any release of liability of the original mortgagor or trustor. Because a loan may not be assumed without lender approval, the lending institution would require the assumer to qualify financially, and many lending institutions charge a transfer fee to cover the costs of changing the records. This charge can be paid by either the buyer or the seller

Release of the Mortgage Lien

When all mortgage loan payments have been made and the note has been paid in full, the borrower will want the public record to show that the debt has been satisfied and that the lender is divested of all rights conveyed under the mortgage. By the provisions of the defeasance clause in most mortgage documents, the lender is required to execute a satisfaction of mortgage (also known as a release of mortgage or mortgage discharge) when the note has been fully paid. This document returns to the borrower all interest in the real estate originally conveyed to the lender. Entering this release in the public record shows that the mortgage lien has been removed from the property. If a mortgage has been assigned by a recorded assignment, the release must be executed by the assignee or mortgagee. When a real estate loan secured by a deed of trust has been completely repaid, the beneficiary must make a written request that the trustee convey the property back to the grantor. The trustee executes and delivers a release deed, sometimes called a deed of reconveyance, to the trustor. The release deed conveys the same rights and powers that the trustee was given under the deed of trust. The release deed should be acknowledged and recorded in the public records of the county in which the property is located. In Illinois, any mortgagee, or his assigns or agents, who fails to deliver a release to the mortgagor or the grantor of a deed of trust within one month after full payment and satisfaction will be liable to pay the mortgagor or grantor a $200 penalty. The release also must state the following on its face in bold letters: FOR THE PROTECTION OF THE OWNER, THIS RELEASE SHALL BE FILED WITH THE RECORDER OR THE REGISTRAR OF TITLES IN WHOSE OFFICE THE MORTGAGE OR DEED OF TRUST WAS FILED. It is then the mortgagor's responsibility to record the release