Chapter 23 Unit 2 Notes

"hypothecate" or "pledge"

"hypothecate" or "pledge" their property as a condition of a loan

Which statements are TRUE? Select all correct responses. Choose all that apply. A borrower in a lien theory state holds legal title. A promissory note is an example of a financing instrument. A straight note is calculated to pay off the entire balance by the end of loan term. The UCC sets out certain requirements for negotiable instruments.

A borrower in a lien theory state holds legal title. A promissory note is an example of a financing instrument. The UCC sets out certain requirements for negotiable instruments.

condemnation clause

A condemnation clause ensures if a property is condemned, or some or all of the property is taken through a governmental eminent domain action or is otherwise destroyed, the lender has the right to take all or part of the proceeds to satisfy the loan. This clause acknowledges that the lender's collateral was reduced by the condemnation.

Covenants

A covenant is a promise made by the borrower to the lender.

defeasance clause

A defeasance clause provides that, in the event a stated condition has been fulfilled, the document becomes null and void. With a mortgage, for example, once the borrower has repaid the debt, the mortgage is cancelled and the mortgagee has no further claims on the property. At that point, the mortgagee would prepare a satisfaction of mortgage document that is placed in the public record.

There are two types of real estate finance documents:

A financing instrument, typically a promissory note An accompanying security instrument, such as a mortgage or deed of trust The financing instrument and the security instrument are two separate contracts between the borrower and the lender work in conjunction with one another.

Land Contracts

A land contract is another security instrument used to finance the purchase of real estate. It is a real estate agreement whereby the buyer makes payments to the seller in exchange for the right to occupy and use the property, but no deed or title is transferred until all, or a specified portion, of the payments have been made. Land contracts—also called contracts for deeds, installment sales contracts, among other names—are much different from mortgages or trust deeds where the debtor takes possession of the property while the creditor holds a mortgage or trust deed as security against the property.

Which statements about the mortgage are TRUE? Select all correct responses. Choose all that apply. The borrower in a financing transaction is called the mortgagee. A mortgage creates a voluntary lien. Once a borrower repays the amount on the note, the mortgage is worthless. The purpose of the mortgage is to indicate the amount of money owed and when it is due.

A mortgage creates a voluntary lien. Once a borrower repays the amount on the note, the mortgage is worthless.

mortgage

A mortgage is the conveyance of an interest in real property to a lender as security for the payment of a promissory note. A mortgage is a type of security instrument where the borrower (the mortgagor) pledges property to the lender (the mortgagee) as collateral for the debt, creating a voluntary lien on the property, but the mortgagor holds legal title to the property. Once the loan is repaid, the promissory note is cancelled. Generally speaking, mortgages are the primary security instrument used in lien theory states.

partial release, satisfaction, or conveyance clause

A partial release, satisfaction, or conveyance clause obligates the lender to release part of the property from lien and convey title to that part back to the debtor once certain provisions of the note or mortgage have been satisfied. This important clause appears in many construction mortgages so that the developer or builder can sell off completed homes with clear title before having to pay off the entire amount borrowed for an entire development project.

prepayment clause

A prepayment clause gives lenders the right to charge borrowers a penalty for paying off the loan early or making substantial principal reductions, essentially depriving the lender of further interest income. Conventional lenders used to penalize early loan repayment to discourage it, but most lenders today would rather be assured of repayment and reinvest the money. Some lenders charge a flat one-time fee as a prepayment penalty. Other lenders might charge a percentage of the balance, which could change depending on how long the borrower has held the loan. For example, if Joe repays his mortgage loan after two years, the lender might charge 3% of the balance. If he repays the loan after five years, the lender might charge 2% of the balance.

security instrument

A security instrument, the second type of real estate finance document, requires a borrower to "hypothecate" or "pledge" their property as a condition of a loan. This means that the borrower pledges their property as security or collateral for the loan, while still maintaining possession of it. The security instrument protects the lender and serves to motivate the borrower to fulfill the terms of the promissory note and repay the loan as agreed.

subordination agreement

A subordination agreement gives a mortgage recorded at a later date priority over an earlier recorded mortgage. Normally with mortgages, trust deeds, and land contracts, the first instrument to get recorded has lien priority. In some situations, however, the parties may desire that a later recorded instrument have priority over an earlier one.

Mortgage and Note Clauses Various clauses are used in financing instruments to give certain rights to the lender or borrower. Many of these clauses can be found in the promissory note or the security instrument, such as a mortgage or deed of trust, and often they appear in both. We'll look at these common clauses:

Acceleration clause Alienation clause or due on sale clause Condemnation clause Defeasance clause Occupancy clause Partial release, satisfaction, or conveyance clause Prepayment clause Subordination agreement

Types of Promissory Notes There are four basic types of promissory notes used in real estate transactions. The differences are based on the way that the repayment of the loan is structured:

Adjustable-rate note Installment Note Straight Note Fully Amortized Installment Note

acceleration clause

An acceleration clause gives the lender the right to declare the entire loan balance due immediately because of borrower default or for violation of other contract provisions. This process is sometimes referred to as "calling the note." This clause ensures that the lender does not have to initiate a separate action for each missed payment. A debtor who misses one payment may discover that they don't owe just two payments next month but rather the entire loan balance. Most lenders will wait until payments are at least 90 days delinquent before enforcing an acceleration clause. Most promissory notes, mortgages, trust deeds, and land contracts contain an acceleration clause.

Which statements are TRUE? Select all correct responses. An alienation clause requires the borrower to repay the entire loan if he sells the property. It is easier for a lender to foreclose on property in a lien theory state. Hypothecation means that once a condition has been fulfilled, the document becomes null and void. A statement that you must live in the property for at least one year is an example of a defeasance clause. A subordination clause ensures a mortgage recorded at a later date will take priority.

An alienation clause requires the borrower to repay the entire loan if he sells the property. A subordination clause ensures a mortgage recorded at a later date will take priority. In a lien theory state, the lender has only a lien against the property and would have to initiate a judicial foreclosure proceeding, which can be a long process; it's generally easier to foreclose on property in a title theory state. The concept of hypothecation means that a borrower pledges their real property as collateral for the debt while maintaining possession of it. An occupancy clause would stipulate requirements for occupancy; the defeasance clause cancels the lender's interest when the debt is repaid.

assignment of rent

An assignment of rent is generally a separate agreement that a lender may require a borrower to sign when taking out a loan to purchase investment property. In the event of loan default, such an agreement authorizes the lender to collect rent payments on the borrower's behalf until the end of the lease agreement.

occupancy clause

An occupancy clause requires the borrower to occupy the property within a certain period of time (e.g., within 60 days) and continue to occupy it for a certain period of time (i.e., one year). This clause attempts to prevent people from buying investment properties by claiming they will be owner-occupied.

Which statements about land contracts are TRUE? Select all correct responses. Choose all that apply. Arranging a land contract may require a mortgage loan originator license. A land contract is a form of seller-financing. Once a borrower repays the amount owed under a land contract, the bank must issue a discharge of mortgage. Under a land contract, the vendor holds equitable title to the property.

Arranging a land contract may require a mortgage loan originator license. A land contract is a form of seller-financing. Under a land contract, the vendor (seller) holds legal title to land as security, not just a mortgage lien against it. The vendee's (buyer's) present interest in a land contract is referred to as equitable title. The buyer of the property, known as the vendee, is paying the seller of the property, known as the vendor. A land contract, which is also known as an installment sales contract, does not involve a conventional lender such as a bank. The other statements are true.

Here are some common covenants:

Covenant to Pay Taxes. A promise to pay all property taxes and assessments. Covenant of Insurance. A promise to carry adequate hazard or property insurance on the property to protect the lender's investment. Covenant Against Removal. A promise not to remove or demolish buildings without the lender's approval. Covenant of Good Repair. A promise to keep the property in good condition and to allow the lender to inspect the property. Hazardous Substances Covenant. A promise that the borrower will not store, use, or release hazardous substances on the property.

A typical promissory note includes the following:

Date of the agreement Names of the parties to the agreement Amount of the debt, including the interest rate used to amortize the debt (note rate) How and when the money is to be paid What happens in the event of default Signature of the maker of the agreement If the interest will be paid in advance or in arrears

A borrower defaults on a mortgage. What does the acceleration clause in the mortgage allow the lender to do? Compel the borrower to sell the property and repay the debt. Demand immediate payment of the entire loan balance. Prevent the borrower from selling the property. Report the borrower to a collection agency.

Demand immediate payment of the entire loan balance

borrower

For the borrower, the advantages and disadvantages of a mortgage correspond to those of the lender, but in reverse. The lender's right of acceleration may mean that a homeowner who misses one or two payments will be faced with the prospect of having to pay off the entire debt to save the home. On the other hand, because of the time required to legally foreclose through the courts, the debtor usually has a significant period of time in which to bring the loan current.

lender

For the lender, the main advantages of mortgages in the event of default are the right to accelerate the entire debt, making it due immediately, and the authority of a court to hold a judicial foreclosure proceeding so that the lender may obtain title and possession. The main disadvantage is the time and expense involved with judicial foreclosure. The entire process can take several months, or even years, to complete, and legal fees and court costs can be extensive, which the lender may or may not recover from the sale of the property.

Land Contracts: Advantages and Disadvantages

For the vendor, the advantage of a land contract is the right to hold title as security. This lack of ownership is, conversely, the main disadvantage for a vendee. Also, a land contract provides little or no protection to the vendee in the event that the land contract or other relevant document with terms of the sale is not recorded. Another disadvantage is a risk that the vendor, who retains legal title, could transfer or encumber the property while it is under contract with the vendee. Therefore, most state laws prohibit the vendor from using the property as collateral for another loan without the vendee's consent. This protects the vendee's interest.

lien theory

In lien theory states, the security instrument creates a lien against the property that must be repaid by the debtor. The property serves as collateral, or security, for the debt. The borrower still holds legal title to the property and has possession of it. This is a concept known as hypothecation. In most lien theory states, the lender would be required to go through a judicial foreclosure proceeding to obtain title in the event of borrower default.

title theory

In title theory states, while the debt is outstanding, the lender (or the lender's trustee) holds legal title to the property. The borrower has possession of the property, but until the debt is fully paid, the borrower has only equitable title. Once the loan amount has been repaid, legal title is conveyed to the owner (borrower). Upon default, the creditor may begin a nonjudicial foreclosure procedures, which allows the property to be sold without court supervision.

In addition to the clauses we've reviewed, there are various other clauses that could be found in real estate financing documents. Here are just a few you may encounter:

Late Payment. Allows the lender to charge a penalty for payments that are not made by the agreed-upon due date. Lock-In. Ensures that the borrower may not pay the loan off early. The borrower is locked-in to the full term of the loan. Power of Sale. Allows the lender to sell the property to pay the debt that the borrower owes without going through the courts (nonjudicial foreclosure). This is most commonly found in a trust deed.

There are a number of different types of security instruments, including these:

Mortgages Deeds of trust (also called trust deeds) Land contracts (also called installment sales contracts)

Paul would like to make an offer on a house right away, but he doesn't have the cash available for an earnest money deposit yet. He is, however, expecting a large commission check from his sales job within several weeks, so he offers the seller a promissory note for $10,000 as the earnest money deposit. He will also be seeking conventional financing to pay for the rest of the home's price. Will the promissory note be tied to the buyer's mortgage? Yes, the institutional lender will require both promissory notes to be collateralized. Yes, the promissory note is not valid unless it has been collateralized. No, the promissory note is a promise to pay a debt and is a contract on its own. Not relevant, because a promissory note may never be used as earnest money.

No, the promissory note is a promise to pay a debt and is a contract on its own. It is acceptable, though not always wise, to use a promissory note in place of earnest money. A promissory note is a complete contract and never needs to be tied to a mortgage or deed of trust, although institutional loans will always be collateralized with a mortgage or deed of trust.

satisfaction of lien, a discharge of mortgage, or a mortgage certificate of release

Once a mortgage or deed of trust has been repaid, the security instrument is void and the lender no longer has any claim against the borrower or the property. The lender must issue a document—which may be referred to as a satisfaction of lien, a discharge of mortgage, or a mortgage certificate of release—which should be recorded as evidence that the obligation has been discharged. Note: Security instruments are usually recorded in the public record; financing instruments are not.

Adjustable Rate Note.

Permits the lender to periodically adjust the interest rate so the rate accurately reflects fluctuations in the cost of money; rate adjustments are tied to upward and downward movement of a selected index.

Promissory notes

Promissory notes are financing instruments that evidence a promise to pay a specific amount of money to a specific person within a specific time frame. Simply stated, a promissory note is a written promise to pay money. Before a lender will finance the purchase of a house, the borrower must promise to repay the funds.

Straight Note.

Requires payments of interest only during the term of the note with a balloon payment (lump sum) at the end of loan term to pay off the principal amount (also referred to as a term note).

Installment Note.

Requires periodic payments of the principal amount only, with a balloon payment at the end of the loan term to pay off the balance due, as well as interest and fees.

Fully Amortized Installment Note.

Requires regular payment of principal and interest calculated to pay off the entire balance by the end of the loan term. This is the most common type of conventional home loan payment structure in use today.

holder in due course

Secondary market investors will buy only a promissory note that is negotiable because they want to be a holder in due course of the note. A holder in due course is one who acquires a negotiable instrument in good faith and for consideration and has certain rights beyond those of the original payee. An example of a holder in due course would be an entity such as Fannie Mae purchasing a note from a lender as an investment at a fair price when there is no indication of irregularity in the note.

Generally speaking, mortgages are the primary security instrument used in lien theory states. TRUE or FALSE

TRUE

Uniform Commercial Code (UCC)

The Uniform Commercial Code (UCC) is a comprehensive body of statutory recommendations to govern commercial transactions, as well as contract formation and breach, within the United States and its territories (Puerto Rico, Guam, U.S. Virgin Islands). The UCC includes provisions related to negotiable instruments, as well as contract formation and breach.

Who is the maker and a payee?

The person promising to pay the money is called the maker of the note, usually the borrower. The one to whom payment is promised is called the payee, usually the lender (though it could also be the seller). Promissory notes are basic evidence of debt, showing who owes how much to whom.

Instrument

The term instrument refers to a written legal document that establishes the different rights and duties of the parties involved.

Which of the following would be MOST LIKELY to happen in a land contract? The vendor pays the property taxes, insurance, repairs, and upkeep on the property until the final payment is made. The vendor finances the property and makes installment payments. The vendor retains the title to the property until the final payment is made. The vendee receives possession, and the vendor retains equitable title.

The vendor retains the title to the property until the final payment is made.

Land contract (vendor/vendee)

Under a land contract, the seller (called the vendor) actually holds legal title to the property as security, not just a lien. The buyer/debtor (called the vendee) has the right to possess and enjoy the land, as an "owner in fact," having equitable title, but no legal title and no deed. Land contracts usually require the vendor to give the vendee a statement, at least once a year or as requested, showing the amount of payments that have been credited to principal and interest, and the balance due under the contract. Land contracts may be structured subject to an existing mortgage or structured to allow the vendee to assume the vendor's mortgage.

An alienation clause, also called a due on sale clause

gives the lender certain stated rights when there is a transfer of ownership. Alienation refers to transfer of property by any means. This is designed to limit the debtor's right to transfer the property without permission of the lender. Upon sale, or even a transfer of significant interest in the property, lenders may have the right to accelerate the debt, change the interest rate, or charge an assumption fee.

Which of these is an example of a security instrument? Select all correct responses. land contract mortgage promissory note trust deed

land contract mortgage trust deed

The borrower who pledges property to a lender as collateral is referred to as the beneficiary. mortgagee. mortgagor. trustee.

mortgagor

Which document is evidence of debt, showing who owes what to whom? deed mortgage promissory note purchase agreement

promissory note Promissory notes are written promises to pay money. They are negotiable instruments and are freely transferable so creditors can sell them for cash.

Cathy has a mortgage with an alienation clause. She deeds her property to her brother John and he assumes her mortgage. The alienation clause does NOT give the lender the right to call for the entire loan balance to be paid off at the transfer. charge an assumption fee. charge a higher rate of interest. refuse to let Cathy give away the property.

refuse to let Cathy give away the property. Upon sale of, or even a transfer of significant interest in the property, the lender has certain rights, but it cannot keep her from selling or transferring ownership.

Interest on a loan for a home purchase is which type of interest? annually paid compound complex simple

simple The interest paid on real estate loans is simple interest, which means the interest is based on the principal balance of the loan only. The interest does not compound on the unpaid interest.

With a trust deed, who is considered the beneficiary? the borrower the independent third party the lender the witness

the lender

Most conventional loans contain an alienation clause which prohibits the sale of the property. prepayment of the loan. the loan from being assumed without the lender's consent. increases or decreases in the loan's interest rate.

the sale of the property.

true or false A promissory note can stand alone as a promise to repay a any sort of debt and does not have to be tied to a mortgage or deed of trust.

true

true or false FHA-insured and VA-guaranteed loans may NOT include an alienation clause.

true

true or false An occupancy clause helps to ensure that the borrower is NOT financing the purchase of investment property.

true An occupancy clause requires the borrower to occupy the property as their principal residence for a specified period of time after receiving the loan.

When a trust deed is used as a security instrument, the borrower is referred to as the beneficiary. holder. trustee. trustor.

trustor