Unit 12 Highlights
Buying "subject to " or assuming a seller's mortgage or deed of trust 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 they must make payments on the existing loan. In some circumstance, the original seller might continue to be liable.
A buyer who purchases a property and assumes the seller's debt becomes personally obligated for the payment of the entire debt. If a seller wants to be completely free of the original loan, the seller, buyer, and lender must execute a novation agreement in writing. The novation makes the buyer solely responsible for any default on the loan. With the existence of a lien and a secured loan is assumed, the mortgagee or beneficiary must approve the assumption and any release of liability of the original mortgagor or trustor. Many lending institutions charge a transfer fee to cover the costs of changing the records.
Short sale A prospective property seller may still be faced with a proposed sale price that is less than the amount outstanding on the seller's mortgage debt. In this situation, the lender my permit a short sale where the sales price is lower than the remaining balance. Contact the lender before marketing the property to determine whether or not the short sale would be accepted and, if so, how low a sales price the lender would be willing to approve. Short sales should always be disclosed. Lender approvals will add several months or longer to the closing of the transaction
A lender's willingness to approve a short sale may result in forgiveness of part of the borrower's debt. The forgiveness of part of the seller's mortgage debt has been considered to the IRS to be income to the seller/borrower and thus subject to income tax. The widespread dismay at this outcome resulted in the passage by Congress of the Mortgage Forgiveness Debt Relief Act of 2007 which allows a taxpayer to exclude from income the forgiveness of part of the mortgage debt. Subsequent legislation extended this provision through January 1, 2017
Straight loan With a straight loan (or term loan, interest-only loan) the borrower makes periodic payments of interest only, followed by the payment of the principal in full at the end of the term. Straight loans are now generally used for home improvements and second mortgages. A loan may provide for interest-only payments in the beginning years.
Amortized loan Each payment in an amortized loan partially pays interest as well as a portion of the principal owed. The word amortize literally means to kill off. Loans known as direct reduction loans mean the full amount of the principal and all interest due is reduced to zero after a period usually of 10-30 years. With a fully amortized loan, or level-payment loan, the lender credits each payment first to the interest due, then to the principal amount of the loan.
Provisions for default The mortgage or deed of trust typically includes an acceleration clause to assist the lender in foreclosure. If the borrower defaults, the lender has the right to accelerate the maturity of the debt meaning the lender may declare the entire principal balance due and payable immediately. 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.
Assignment of the mortgage Without changing the provisions of the contract, the promissory note may be sold to a third party. The original mortgagee (assignor) endorses the note to the third party (assignee) and executes an assignment of the mortgage. The assignee becomes the new owner of the debt and security instrument.
Growing-equity mortgage A growing-equity mortgage is also called a rapid-payoff mortgage and uses a fixed interest rate, but payments of principal are increased according to an index schedule. The total payment thus increases, and the loan is paid off more quickly. It is most frequently used when the borrower's income is expected to keep pace with the increasing loan payment.
Balloon payment loan When the periodic payments on a loan are not enough to fully pay off the principal of the loan by the time the final payment is due, the final payment will be larger than the others. Typically a balloon payment is a final payment that is at least twice the amount of any other payment. It is considered a partially amortized loan because some of the principal has been paid, with some still owed at the end of the term.
Homeowners insurance A home is usually the biggest purchase many people ever make. A lender will require that a homeowner obtain insurance when the loan is secured by the property.
Coverage and claims Special apartment and condominium policies generally provide fire and windstorm, theft, and public liability coverage for injuries or losses sustained within the unit. *Most homeowners insurance policies contain a coinsurance clause. This provision usually require that the owner maintain insurance equal to a specified percentage (usually 80%) of the replacement cost of the dwelling (not including land price).
Deed to purchaser at sale If redemption is not made, or if state law does not provide for a redemption period, the successful bidder at the foreclosure sale receives a deed to the real estate. Officials execute this deed to the purchaser to convey whatever title the borrower had
Deficiency judgement The foreclosure sale may not produce enough cash to pay the loan balance in full. In that care, the mortgagee may be entitled to a personal judgement against the borrower of the unpaid balance. Such a judgement is a deficiency judgement. If any money remains from the foreclosure sale after paying the debt and any other liens, expenses, and interest, those proceeds are paid to the borrower. Some states prohibit a deficiency judgement. A lender could decide not to pursue a deficiency judgement.
The trustee is authorized to sell the secured property, providing the proceeds to the beneficiary. The lender chooses the trustee and reserves the right to substitute trustee in the event of death or dismissal. A mortgage or deed of trust must clearly establish that the property is security for a debt, identify the lender and the borrower, and include an accurate legal description of the property.
Duties of the borrower include -Payment of the debt in accordance with the terms -Payment of all real estate taxes on the property -Maintenance of adequate insurance to protect the lender -Maintenance of the property in good repair -Receipt of lender authorization before making property alterations
In flood-prone areas identified as special flood hazard areas (SFHAs), flood insurance is required on all types of buildings--residential, commercial, industrial, and agricultural. *A borrower who can produce a survey showing that the lowest part of the building is located above the 100-year flood mark may be exempted from the flood insurance requirement, even if the property is in a flood-prone area. Flood insurance should be considered for all properties in coastal states subject to hurricanes and in any state through which major rivers run.
Flood insurance: what is/isn't covered FEMA defines a flood as "a general and temporary condition of partial or complete inundation of two or more acres of normally dry land or two or more properties from -An overflow of inland or tidal waves -Unusual, rapid accumulation of runoff -Mudslides on normally dry land -Collapse of land along the shore of a body of water The physical damage to a building or personal property "directly" cause by a flood is covered by flood insurance policies. Two types: Replace Cost Value (RCV) or Actual Cost Value (ACV).
Reverse mortgage A reverse mortgage allows a homeowner aged 62 or older to borrow money against the equity built up in the home. The money may be used for any purpose and borrower decides if the funds will be paid out in a lump sum, fixed monthly payments, an open line of credit, or other option. The lender does not need to be repaid until the property is sold or the borrower defaults, moves, or dies. The usual property tax, insurance, maintenance, and utility costs must still be paid by the homeowner and equity in the home is reduced.
Foreclosure is a legal procedure in which property pledged as security for a debt is sold to satisfy the debt when a borrower defaults. Any unpaid lienholder, can initiate foreclosure proceedings; however, foreclosure of a junior lien means that the liens with higher priority remain in place and the buyer takes title subject to those liens. The foreclosure of a lien with highest priority brings the rights of the parties and all junior lienholders to a conclusion. The property is sold free of the foreclosing mortgage and all junior liens. The property then becomes part of the lender's REO (real estate owned) portfolio. The lender is then responsible for maintaining the property and paying the expenses of ownership including taxes.
Real estate financing Most homes are bought with borrowed money.
Housing affordability Congress, state legislatures, and local governments work diligently to increase the affordability of housing. Home ownership involves substantial commitment and responsibility. Recent history has shown some will commit mortgage fraud in applying for a home loan by exaggerating income or assets, minimizing or concealing debt obligations, or providing a false employment history. Loan applicants have also been victims of predatory lending practices that result in too-high loan fees and abusive interest rates.
Security instrument Mortgage loans are secured loans. Mortgage loans have two parts: the debt itself and the security of the debt. When the property is mortgaged, the owner must execute (sign) two separate instruments—the financing instrument and security instrument. The financing instrument is the promissory note. The security instrument will take the form of either a mortgage or a deed of trust. A mortgage creates a lien on the property; the deed of trust actually transfers legal title from the borrower to a third party to hold on behalf of the lender while the borrower's debt is still outstanding.
Hypothecation A borrower is required to make specific real property security (collateral) for the loan. The process hypothecation, the debtor retains the right of possession and control of the secured property, while the creditor receives an equitable right in the property.
Monthly payments on all debts—normally including long-term debt such as car payments, student loans, or other mortgages—would be expected to not exceed 36% of gross monthly income. The formula can vary, depending on the type of loan program and the borrower's credit score now plays a key role in the lending decision, though the debt-to-income ratio is still important.
If actual monthly non-housing debts exceed 8% of gross income (36-28%), and the borrower is unable to reduce that amount, the monthly payment must be lowered proportionately. The lender will also consider the loan-to-value ratio (LTV), which is the amount of the loan as a percentage of the purchase price of the property.
Deed of trust In some states, lenders prefer to use a three-party security instrument know as a deed of trust. A trust deed conveys bare legal title (naked title)—that is, title without the right of possession—from the borrower to a third party, called the trustee. The trustee holds legal title on behalf of the lender, the holder of the promissory note, who is known as the beneficiary. On full payment, the lender/beneficiary notifies the trustee, who returns legal title to the trustor.
In a deed of trust or title theory state, the trustor who conveys legal title to the trustee but retains equitable title and the right of possession. Legal title is returned to the borrower/trustor only when the debt is paid in full. Foreclosure procedures for default, which must comply with state law, are usually simpler and faster than for mortgage loans.
Mortgage A mortgage is a lien on the real property of the debtor. The borrower is the mortgagor, receives a loan and in return gives a promissory note and mortgage to the lender, or mortgagee. When the loan is paid in full, the mortgagee issues a document called a satisfaction of mortgage.
In a mortgage or lien theory state, the mortgagor retains both legal and equitable title to property. The mortgagee has a lien on the property. The mortgagee must go through a formal foreclosure proceeding in court to obtain legal title. A defaulting mortgagor may redeem (buy back) the property during a certain period after the sale, the statutory right of redemption.
The payee who holds the note may transfer the right to receive payment to a third party one of two ways: -By signing the instrument over to the third party -By delivering the instrument to the third party Interest
Interest is a charge for the use of money, expressed as a percentage. A lender charges interest on the principal (amount borrowed that has not yet been repaid) over the term of the loan. Payments made at the end of a period are known as payments in arrears. Payments may also be made at the beginning of each period and are known as payments in advance.
Methods of foreclosure There are three general types of foreclosure proceedings -Judicial -Nonjudicial -Strict
Judicial foreclosure Allows the property to be sold by court order after the mortgagee has given sufficient public notice. When the borrower defaults, the lender may accelerate the due date of the remaining principal. The lender's attorney can file a suit to foreclose the lien. After presentation of the facts in court, if the court grants the request, the property is ordered sold.
Lenders use a computerized underwriting system that considers various factors, including the loan applicant's credit report and credit score. (Equifax, Experian, transunion) The credit score is prepared by a credit reporting company and is based on a consumer's past history of credit use, including income, outstanding loans, number of credit accounts open, outstanding credit lines, number of accounts opened and closed, payment history, and credit inquiries. The Fair Isaac and Company (FICO) score can range from a low of 300 to a high of 850, the best score. Lenders will require a minimum credit score for a loan.
Lenders generally look at a loan applicant's percentage of debt to income (DTI). A homebuyer who is able to provide at least 10% of the purchase price as a down payment, for instance, could be expected to incur a monthly PITI payment of no more than 28% of the borrower's gross (pretax) monthly income.
Usury Charging interest in excess of the maximum rate allowed by law is called usury. *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. As of March 31, 1980, federal law exempts federally related residential first mortgage loans made after the date from state usury laws. Federal law means most home loans are not subject to state usury protections. Private lenders are still subject to state usury laws.
Loan origination fee The processing of a mortgage application is known as loan origination. The loan origination fee includes the loan officer's salary and the lender's other costs of doing business. The loan origination fee will vary, depending on how competitive a lender chooses to be, but typically is about 1% of the loan amount.
Comprehensive loss underwriting exchange (CLUE) Is a database of consumer claims history that enables insurance companies to access prior claims information in the underwriting and rating process. The database contains up to five years of personal property claims history.
National Flood Insurance Program The National Flood Insurance Act of 1968 was enacted by Congress. The Federal Emergency Management Agency (FEMA) administer the National Flood Insurance Program (NFIP). The Army Corps of Engineers has prepared maps that identify specific flood-prone areas throughout the country.
Mortgage terms Mortgage terms and payment plans are two of the biggest factors when deciding whether to own or rent a home. The Federal housing Administration (FHA) and the US department of Veterans Affairs (VA), have programs with low down payments and lower credit score requirements, but also have tightened lending standards.
Ownership expenses and ability to pay Home ownership expenses include utility costs, routine maintenance, and repairs. They must also pay real estate taxes, buy property insurance, and repay (with interest) the mortgage loan used. Lenders refer to it as PITI (principal, interest, taxes, and insurance).
Discount points Discount points are used to increase the lender's yield (rate of return) on its investment. The number of points charged depends on two factors: -The difference between the loan's stated interest rate -How long the lender expects it will take the borrower to pay it off One discount point equals 1% of the loan amount (not purchase price) and is charged as prepaid interest at the closing. The points in a new acquisition may be paid in cash at closing by the buyer (or, of course, by the seller on the buyer's behalf, as negotiated by the parties).
Prepayment penalty The total interest paid by the borrower may add up to more than the principal amount of the 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 the borrower pay a prepayment penalty against the unearned portion of the interest for any payments made ahead of schedule. Lenders may not charge prepayment penalties on mortgage loans insured or guaranteed by the federal government.
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. Most lenders include an alienation clause (or resale clause, due-on-sale clause, call clause) in the note.
Recording a mortgage or deed of trust 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.
Deed in lieu of foreclosure As an alternative to foreclosure, a lender may be willing to accept a deed in lieu of foreclosure. This is sometimes known as a friendly foreclosure because it is carried out by mutual agreement rather than by lawsuit. The disadvantage of the deed in in lieu to the lender is that it does not eliminate junior liens. Finally, a deed in lieu is still considered an adverse element in the borrower's credit history.
Redemption Most states give defaulting borrowers a chance to redeem their property through the equitable right of redemption. If, after default, but before foreclosure, the borrower pays the lender the amount in default, plus costs, the debt will be reinstated.
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. To institute foreclosure, the mortgagee will send a notice of default to the borrower indicating the amount that must be paid to make the debt current. If the borrower fails to cure the default within the specified time, a notice of foreclosure will be sent to the borrower. The notice of foreclosure will be recorded within a designated period to give notice to the public of the intended auction.
Strict foreclosure First, appropriate notice must be given to the delinquent borrower. Once the proper documents have been prepared and recorded, the court establishes a deadline for the balance of the default debt to 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. Strict foreclosure is more common when personal property is used to secure a debt.
Release of the mortgage lien or deed of trust When all loan payments have been made and the promissory note has been paid in full, the borrower will want the public record to show the debt has been satisfied. By the provisions of the defeasance clause in the financing instrument, the lender is required to execute a satisfaction of mortgage (release or discharge) The trustee executes and delivers a deed of reconveyance (release of deed) to the trustor. If the mortgage or deed of trust has been assigned, the satisfaction of mortgage or reconveyance deed must be executed and recorded by the assignee or mortgagee.
Tax and insurance reserves A reserve fund to meet future real estate taxes and property insurance premiums is called an impound or escrow account. Flood insurance reserves The national Flood Insurance Reform Act of 1994 imposes certain mandatory obligations on lenders and loan servicers to set aside (escrow). If the 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.
Consumer protections As directed by the Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank), the Consumer Financial Protection Bureau (CFPB) issued new mortgage disclosure rules that took effect January 10, 2014. A consumer information pamphlet explains information that the mortgage lender must provide to the borrower.
The lender must: -Provide billing info in writing -Give the borrower 2 months' warning if an adjustable-rate mortgage will have a rate change -Promptly credit the borrower's payment -Respond quickly when a borrower asks about paying off the loan -Not charge for insurance the borrower doesn't need -Quickly resolve complaints -Have/follow good customer service policies -Contact and help the borrower if they have trouble making payments -Work with the borrower before foreclosure -Allow borrower to seek review of decision about the loan request
Adjustable-rate mortgage (ARM) begins at one rate of interest, then fluctuates up or down during the loan term, based on a specified economic indicator. Loan payments change as interest rates change. Common components of this type of loan are: -The index is used to adjust the interest rate. The adjustment period establishes how often the rate may change -Usually, the interest rate is the index rate plus a premium, called the margin. -Rate cap limits the amount the interest rate may change. A periodic rate cap limits the amount the rate may increase over a stated term.
The mortgagor can be protected from unaffordable individual payments by a payment cap which sets the maximum amount for payments, but the difference between the payment made and the full payment amount will be added to the remaining mortgage balance. The amount of the loan actually increases in the process called negative amortization and can result in the borrower owing more than the property is worth--the unhappy situation of being under water. The lender may offer a conversion option that permits the mortgagor to convert from an adjustable-rate to a fixed=rate loan at certain intervals during the life of the mortgage.
Promissory note In exchange for a lender providing the needed funds, the borrower promises to repay the debt with interest. The promissory note, called the note or financing instrument, is a borrower's personal promise to repay a debt according to the agreed terms. A promissory note executed by a borrower (the maker or payor) is the contract with the lender (the payee).
The note generally states the amount of the debt, the time and method of payment, and the rate of interest. When the terms of the note are satisfied, the debt is discharged. When a note is unsecured (there is no collateral provided for the debt), the lender can sue to collect on a note. A note is a negotiable instrument, similar to a check or bank draft.
Priority of a mortgage or deed of trust Is normally determined by the order in which they were recorded. Second loans represent greater risk to the lender, and they usually have a higher interest rate. In the event the second lien is higher than the first, the lender may require a subordination agreement.
Types of loans Real estate can be financed in a variety of ways. Most provide for some form of amortization, with each payment including part of the loan principal. Straight loan Amortized Loan Adjustable-rate mortgage (ARM) Growing-equity mortgage Balloon payment loan Reverse mortgage
