Unit 12

defeasance clause

A clause used in leases and mortgages that cancels a specified right upon the occurrence of a certain condition, such as cancellation of a mortgage upon repayment of the mortgage loan.

mortgage

A conditional transfer or pledge of real estate as security for the payment of a debt; also, the document creating a mortgage lien.

deed in lieu of foreclosure

A deed given by the mortgagor to the mortgagee when the mortgagor is in default under the terms of the mortgage. This is a way for the mortgagor to avoid foreclosure.

satisfaction of mortgage

A document acknowledging the payment of a mortgage debt.

promissory note

A financing instrument that confirms the debt, is signed by its maker, and is negotiable (transferable to a third party).

Fannie Mae

A government-sponsored enterprise established to purchase any kind of mortgage loans in the secondary mortgage market from the primary lenders; formerly known as the Federal National Mortgage Association (FNMA). Fannie Mae deals in conventional and Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) loans. Fannie Mae buys from a lender a block or pool of mortgages that may then be used as collateral for mortgage-backed securities that are sold on the global market.

Freddie Mac

A government-sponsored enterprise established to purchase mortgage loans in the secondary mortgage market.

straight loan

A straight loan (also known as a term loan or an interest-only loan) essentially divides the loan into two amounts to be paid off separately. 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 were once the only form of mortgage available. Today, they are generally used for home improvements and second mortgages rather than for residential first mortgage loans.

usury

Charging interest at a higher rate than the maximum rate established by state law.

Ginnie Mae

Government National Mortgage Association) has always been a governmental agency. Ginnie Mae is a division of the U.S. Department of Housing and Urban Development (HUD), organized as a corporation without capital stock. Ginnie Mae administers special-assistance programs and guarantees mortgage-backed securities using FHA and VA loans as collateral. Ginnie Mae guarantees investment securities issued by private offerors (such as banks, mortgage companies, and savings and loan associations) and backed by pools of FHA and VA mortgage loans. The Ginnie Mae pass-through certificate is a security interest in a pool of mortgages that provides for a monthly pass-through of principal and interest payments directly to the certificate holder. Such certificates are guaranteed by Ginnie Mae.

interest

Interest is the charge for the use of the money. Interest may be due either at the end or beginning of each payment period. Payments made at the end of a period are known as payments in arrears. This payment method is the general practice, and mortgages often call for end-of-period payments due on the first of the following month. Payments made at the beginning of each period are known as payment in advance. 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.

equitable right of 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 borrowers (or any other person who has an interest in the real estate, such as another creditor) pay the lender the amount in default plus costs, the debt will be reinstated. In some cases, the person who redeems may be required to repay the accelerated loan in full. In Pennsylvania A borrower may cure the default of a residential mortgage loan with an outstanding balance of $50,000 or less by merely bringing the payments up to date. If some person other than the mortgagor redeems the real estate, the borrower becomes responsible to that person for the amount of the redemption.

lien theory

Some states interpret a mortgage as being purely a lien on real property. The mortgagee thus has no right of possession but must foreclose the lien and sell the property if the mortgagor defaults. In lien theory states, the mortgagor retains both legal and equitable title. The mortgagee simply has a lien on the property as security for the mortgage debt. The mortgage, or deed of trust, 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 at public auction, and the funds from the sale are used to pay the balance of the remaining debt. In some states, a defaulting mortgagor may redeem (buy back) the property during a certain period after the sale. A borrower who fails to redeem the property during that time irrevocably loses the property.

title theory

Some states interpret a mortgage to mean that the lender is the owner of mortgaged land. Upon full payment of the mortgage debt, the borrower becomes the landowner.he mortgagor actually gives legal title to the mortgagee (or some other designated individual) and retains equitable title. Legal title is returned to the mortgagor only when the debt is paid in full (or some other obligation is performed). In theory, the lender actually owns the property until the debt is paid. The lender allows the borrower to have all the usual rights of ownership, such as possession and use. In effect, because the lender actually 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.

How many financial reserve districts has the Fed divided America into?

The Federal Reserve System divides the country into 12 federal reserve districts, each served by a federal reserve bank.

Short Sale

The best way to avoid foreclosure is to sell the property in the marketplace. This can be difficult, especially when the loan is "underwater"; that is, the debt is more than the market value. In this case, the delinquent property owner may ask the lender to accept less than what is owed; this is called a short sale. A short sale enables the property owner to get out from under an unaffordable loan and the lender to recapture capital (and write off the loss) without the cost associated with foreclosure and then having to market the property if it does not sell to another party at a sheriff's sale. Short sales are complex and time-consuming in their own right, especially because they are subject to approval by the lender and any mortgage servicer and investor who may be involved.

acceleration clause

The clause in a mortgage or trust deed that can be enforced to make the entire debt due immediately if the mortgagor defaults on an installment payment or other covenant.

Federal Reserve System (the Fed)

The country's central banking system, which is responsible for the nation's monetary policy by regulating the supply of money and interest rates. The role of the Federal Reserve System (the Fed) is to maintain sound credit conditions, help counteract inflationary and deflationary trends, and create a favorable economic climate.

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, the mortgagee may be entitled to a personal judgment against the borrower for the unpaid balance. Such a judgment is a deficiency judgment. It may also 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 mortgagor.

hypothecation

The pledge of property as security for a loan. 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.

When a property is to be mortgaged, the owner must execute (sign) two separate instruments:

The promissory note (or note) is the borrower's personal promise to repay a debt. The mortgagor executes one or more promissory notes to total the amount of the debt. The mortgage, or security instrument, is the document that creates the lien on the property. The mortgage exposes the real estate to claim by the mortgagee and is the document that gives the creditor the right to sue for foreclosure.

discount points

Units of measurement used for various loan charges; one point equals 1 percent of the amount of the loan. Discount points are used to increase the lender's yield (rate of return) on its investment. For example, the interest rate that a lender charges for a loan might be less than the yield 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 loan's stated interest rate and the yield required by the lender How long the lender expects it will take the borrower to pay off the loan

amortized loan

Unlike a straight loan payment, each payment in an amortized loan partially pays off both principal and interest. Most mortgage and deed in trust loans are amortized loans. The word amortizes literally means to kill off; they are paid off slowly, over time, in equal payments. Regular periodic payments are made over a term of years. The most common periods are 15 years or 30 years, although 20-year mortgages are also available. Each payment is applied first to the interest owed; the balance of the payment is then applied to the principal amount. At the end of the term, the full amount of the principal and all interest due is reduced to zero. Such loans are known as direct reduction loans. Most amortized mortgage and deed of trust loans are paid in monthly installments. However, some are payable quarterly (four times a year) or semiannually (twice a year). Different payment plans tend alternately to gain and lose favor with lenders and borrowers as the cost and availability of mortgage money fluctuate. The most frequently used plan is the fully amortized loan, or level-payment loan. The mortgagor pays a constant amount, usually monthly. The lender credits each payment first to the interest due, then to the principal amount of the loan. As a result, while each payment remains the same, the portion applied to repayment of the principal grows and the interest due declines as the unpaid balance of the loan is reduced. If the borrower pays additional amounts that are applied directly to the principal, the loan will amortize more quickly. This benefits the borrower who will then pay less interest if the loan is paid off before the end of its term. Of course, lenders are aware of this, too, and may guard against unprofitable loans by including penalties for early payment. If you know what the monthly payment and interest rates are, you can determine the amount of the constant payment of an amortized loan from a prepared mortgage payment book or a mortgage factor chart (see the figure that follows).The mortgage factor chart indicates the amount of monthly payment per $1,000 of loan, depending on the term and interest rate. This factor is multiplied by the number of thousands (and fractions of thousands) of the amount borrowed. In Practice Financial calculators can accurately perform most standard mortgage lending calculations, and most commercial lenders provide mortgage calculators on their Web sites.

A legal procedure whereby property used as security for a debt is sold to satisfy the debt in the event of default in payment of the mortgage note or default of other terms in the mortgage document. The foreclosure procedure brings the rights of all parties to a conclusion and passes the title in the mortgaged property to either the holder of the mortgage or a third party who may purchase the realty at the foreclosure sale, free of all encumbrances affecting the property subsequent to the mortgage.

foreclosure

alienation clause

he clause in a mortgage that states that the balance of the secured debt becomes immediately due and payable at the mortgagee's option if the mortgagor sells the property. In effect, this clause prevents the mortgagor from assigning the debt without the mortgagee's approval. (also known as a resale clause or due-on-sale clause)

A charge imposed on a borrower who pays off the loan principal early. This penalty compensates the lender for interest and other charges that would otherwise be lost.

prepayment penalty

The mortgage market in which loans are originated and which consists of lenders such as commercial banks, savings and loan associations, and mutual savings banks.

primary mortgage market

A market for the purchase and sale of existing mortgages designed to provide greater liquidity for mortgages; also called the secondary money market. Mortgages are first originated in the primary mortgage market. The secondary mortgage market helps lenders raise capital to continue making mortgage loans. Furthermore, the secondary market is especially useful when money is in short supply; it stimulates both the housing construction market and the mortgage market by expanding the types of loans available. In the secondary mortgage market, loans are bought and sold only after they have been funded. Lenders routinely sell loans to avoid interest rate risks and to realize profits on the sales. This secondary market activity helps lenders raise capital to continue making mortgage loans. Secondary market activity is especially desirable when money is in short supply; it stimulates both the housing construction market and the mortgage market by expanding the types of loans available. Growth in the use of secondary markets has greatly increased the standardization of loans. When a loan is sold, the original lender may continue to collect the payments from the borrower. The lender then passes the payments along to the investor who purchased the loan. The investor is charged a fee for servicing of the loan. In the secondary market, various agencies purchase a number of mortgage loans and assemble them into packages (called pools). These agencies purchase the mortgages from banks and savings associations

secondary mortgage market

In Pennsylvania Some relief is available to qualifying Pennsylvanians from the Homeowner Emergency Assistance Program (HEMAP). The HEMAP program provides counseling and loans to help people pay delinquent mortgage loans. Qualifying families may be required to pay up to 40 percent of their net monthly income toward their total housing expense. Several types of relief are available, including bringing delinquent payments current and assistance for on-going loans. The program is funded by repayment of existing HEMAP loans and state appropriations.

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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 all the remaining principal balance, along with all overdue monthly payments and interest, penalties, and administrative costs. The lender's attorney can then file a suit to foreclose the lien. After presentation of the facts in court, the property is ordered to be sold. A public sale is advertised and held, and the real estate is sold to the highest bidder. This is the prevalent type of mortgage foreclosure in Pennsylvania.

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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. In states where deed of trust loans are used, the trustee is generally given the power of sale. Some states allow a similar power of sale to be used with a mortgage loan. To institute a nonjudicial foreclosure, the mortgagee may be required to file a notice of default in the county recorder's office. The default must be recorded within a designated time to give adequate notice to the public of the intended auction. This official notice is generally accompanied by advertisements published in local newspapers that state the total amount due and the date of the public sale. After selling the property, the trustee or mortgagee may be required to file a copy of a notice of sale or an affidavit of foreclosure.

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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. 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. In Pennsylvania If the foreclosure is caused by default on a mortgage loan, the borrower first receives an Act 91 notice. This is notice of payments being in arrears; it also advises the borrower to file an application for the state's HEMAP assistance. Completion and acceptance of that application can provide a 120-day stay of foreclosure. The borrower then receives an Act 6 notice, otherwise known as a notice of intention to foreclose. At this point, the borrower has 30 days to contact the lender and set up a schedule of payments. If the borrower takes no action, the lender or its service company issues a complaint, which is the beginning of a lawsuit to foreclose. The borrower has 30 days to respond to that complaint. If the borrower fails to answer, the lender may obtain a judgment against the borrower, followed by a writ of execution, which permits the property to be sold at sheriff sale. If the owner fails to pay taxes or other specific lien charges, the homeowner receives an Act 1 "demand" letter. This demand gives the owner 15 days' notice to pay the amount owed; it also states that attorney's fees involved during collection can be charged. If the owner fails to make payment, the next step is that the owner receives a complaint and has 30 days to file an affidavit of defense. If the owner fails to file a defense, the municipality or its service company may obtain a judgment against the owner, followed by a writ of execution permitting the property to be sold at sheriff sale.■

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The mortgage document 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.

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A basic principle of property law is that individuals cannot convey more than what they actually own. 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. Even the owner of a cooperative interest may be able to offer that personal property interest as collateral for a loan. 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 execute (sign) two separate instruments—a promissory note stating the amount owed and a security document, either a mortgage or deed of trust, specifying the collateral used to secure the loan.

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A promissory note executed by a borrower (known as the maker or payor) is a contract complete in itself. 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 called the payee and may transfer the right to receive payment to a third party in one of two ways: By signing the instrument over (that is, by assigning it) to the third party By delivering the instrument to the third party

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For 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 percent, or 0.03). If a house sells for $100,000 and the borrower seeks an $80,000 loan, each point would be $800, not $1,000. In some cases, however, 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) rather than financed as part of the total loan amount. To calculate 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 points

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In Pennsylvania The Mortgage Bankers and Brokers and Consumer Equity Protection Act is administered by the Pennsylvania Department of Banking. A mortgage broker is defined as any person or company, who for a fee, arranges or negotiates a first mortgage loan. Failure to obtain a license is a felony offense of the third degree. Requirements to obtain a mortgage broker license include taking at least 20 hours of approved education, passing the test, undergoing a criminal background history check, and posting a surety bond between $50,000 and $150,000. The mortgage broker who intends to collect fees in advance must post a penal bond for $100,000. Annual continuing education is required to maintain the license

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In Pennsylvania The law does not permit prepayment penalties on residential mortgage loans when the principal amount is $50,000 or less

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In addition to the income directly related to loans, some lenders derive income from servicing loans for other mortgage lenders or investors who have purchased the loans. Servicing involves collecting payments (including insurance and taxes), accounting, bookkeeping, preparing insurance and tax records, processing payments of taxes and insurance, and following up on loan payment and delinquency.

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In parts of the country, but not Pennsylvania, lenders may prefer to use a three-party instrument known as a deed of trust. A trust deed 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 bare 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 figure that follows for a comparison of mortgages and deeds of trust. In states where deeds of trust are generally preferred, foreclosure procedures for default are usually simpler and faster than for mortgage loans.

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Income on the loan is realized from two sources: Finance charges collected at closing, such as loan origination fees and discount points Recurring income, the interest collected during the term of the loan

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Many lenders require borrowers to provide a reserve fund for future real estate taxes and insurance premiums. This fund is called an impound, trust, or escrow account. When the mortgage 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 annual insurance premium. The borrower's monthly payments will include principal, interest, taxes, and insurance reserves (PITI—principal, interest, taxes, and insurance), and perhaps other costs, such as flood insurance or homeowners' association dues. Federal regulations limit the amount of tax and insurance reserves that a lender may require.

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Many lenders use the standardized forms and follow the guidelines issued by Fannie Mae and Freddie Mac. In fact, the use of such forms is mandatory for lenders that wish to sell mortgages in the agencies' secondary mortgage market. The standardized documents include loan applications, credit reports, and appraisal forms.

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Some major lenders in the primary market include the following: Thrifts, savings institutions, and commercial banks. These institutions are known as fiduciary lenders because of their fiduciary obligations to protect and preserve their depositors' funds. Thrifts is a generic term for the savings associations. Mortgage loans are perceived as secure investments for generating income and enable these institutions to pay interest to their depositors. Fiduciary lenders are subject to standards and regulations established by governmental agencies such as the Federal Deposit Insurance Corporation (FDIC). The various governmental regulations (which include reserve fund, reporting, and insurance requirements) are intended to protect depositors against the reckless lending that characterized the savings and loan industry in the 1980s. Insurance companies. Insurance companies accumulate large sums of money from the premiums paid by their policyholders. While part of this money is held in reserve to satisfy claims and cover operating expenses, much of it is free to be invested in profit-earning enterprises, such as long-term real estate loans. Credit unions. Credit unions are cooperative organizations whose members place money in savings accounts. In the past, credit unions made only short-term consumer and home improvement loans. Now, they routinely originate longer-term first and second mortgage and deed of trust loans. Pension funds. Pension funds usually have large amounts of money available for investment. Because of the comparatively high yields and low risks offered by mortgages, pension funds have begun to participate actively in financing real estate projects. Most real estate activity for pension funds is handled through mortgage bankers and mortgage brokers. Endowment funds. Many commercial banks and mortgage bankers handle investments for endowment funds. The endowments of hospitals, universities, colleges, charitable foundations, and other institutions provide a good source of financing for low-risk commercial and industrial properties. Investment group financing. Large real estate projects, such as highrise apartment buildings, office complexes, and shopping centers, are often financed as joint ventures through group financing arrangements like syndicates, limited partnerships, and real estate investment trusts. Mortgage banking companies. Mortgage banking companies originate mortgage loans with money belonging to insurance companies, pension funds, and individuals, and with funds of their own. They make real estate loans with the intention of selling them to investors and receiving a fee for servicing the loans. Mortgage banking companies are generally organized as stock companies. As a source of real estate financing, they are subject to fewer lending restrictions than are commercial banks or savings associations. They are not mortgage brokers. Mortgage brokers. Mortgage brokers are not lenders. They are intermediaries who bring borrowers and lenders together. Mortgage brokers locate potential borrowers, process preliminary loan applications, and submit the applications to lenders for final approval. They do not service loans once the loans are made. Mortgage brokers also may be real estate brokers who offer these financing services in addition to their regular real estate brokerage activities. Many state governments are establishing separate licensure requirements for mortgage brokers to regulate their activities.

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Some states, including Pennsylvania, have adopted an intermediary theory. Historically, Pennsylvania has been a title theory state. But as an intermediary theory state, the property owner does not automatically forfeit the real estate on default of the debt. The borrower must first be given a notice of intention to foreclose before the lender can file suit and proceed with foreclosure. The notice forewarns the borrower and provides an opportunity to resolve the matter before the lender takes legal action

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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 for property in flood-prone areas. 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 the insurance, the lender must purchase the insurance on the borrower's behalf. The cost of the insurance may be charged back to the borrower.

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The borrower is required to fulfill certain obligations. 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 Receipt of lender authorization before making any major alterations to 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 the mortgage and collect on the note.

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The borrower, or mortgagor, receives a loan and in return gives a note and mortgage to the lender, called the mortgagee. When the loan is paid in full, the mortgagee issues a satisfaction of mortgage. The mortgage is a voluntary, specific lien. If the debtor defaults, the lender can sue on the note and foreclose on the mortgage.

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The real estate financing market has the following three basic components: Governmental influences, primarily the Federal Reserve System The primary mortgage market The secondary mortgage market

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Under the umbrella of the financial policies set by the Federal Reserve System, the primary mortgage market originates loans that are bought, sold, and traded in the secondary mortgage market.

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