Chapter 15: Real Estate Financing: Principles

Mortgage basics

A voluntary lien on real estate. Person who borrows gives lender the right to take property if loan is not repayed. Debit is created through a promissory note, which is negotiable instrument and evidence of mortgage. Promises to pay.

mortgagor is borrower, mortgagee borrows

Mortgage

A voluntary lien on real estate. Money borrowed to pay for home

Mortgagor

The person who gives, who pledges land to lender

Mortgagee

The lender, takes land as security for debt

Security and Debt

Basic principle of property law is that no one can convey more than what is owned. Applies to mortgages. Fee simple estate can mortgage full interest, etc

Mortgage Loans

creates relationship between a debtor and a creditor. C loans D money for some purpose, D promises to pay back at some rate and schedule.

Mortgage loans are secure loans, debt and security

Hypothecation

Borrower is required to pledge specific and real property as security/collateral. Debtor retains right of possession while creditor receives underlying equitable title based on nonpayment

Promissory Notes

AKA Financing instrument is the promise of the borrower to repay a debt according to terms agreed on. Note exposes borrowers assets. When signed by borrowers, note becomes legally enforceable promise of payment. Cannot be tied to mortgage or deed, must be used as instrument of negotiation.

Unsecured note

A promissory note that is not secured or related to any collateral

Negotiable instruments

like a check or bank draft that makes one side of a transaction hold negotiating power. Lender who holds note is called the payee

Interest

A charge for the use of money. May be due at beginning of each payment as payment in advance of at the end as payment in arrears.

Usury

Charging interest in excess of the max rate allowed by law. Laws enacted in many states limit interest rates banks can charge. Lenders are penalized for making usurious loans.

In IL, there is no max rate. Subject to max fed rates

Loan origination fee

Processing of a mortgage application is loan origination. When mortgage is originated, this fee is charged by lenders to covers expenses involved with generating loan funds. IRS allowed deduction, but it is included in the annual percentage rate

Discount Points

A lender may sell a mortgage to investors. But the interest rate the lender charges may be less than yield they demand. To make up the difference, a lender charges discount points. Number of points depends on difference between interest rate and required investor yield. For borrowers, one point = one percent of the loan. Paid in cash at closing option

(.03 × 100) = 3%

Prepayment

Most mortgage loans are paid installments over a long period. Total interest paid by borrower adds to more than principal amount. Some mortgage notes include clauses to protect foreseen interest

Prepayment Penalty

Some mortgage clauses contain prepayment clauses that require the borrow to pay a prepayment penalty against the unearned portion of interest for payments made ahead of schedule

PROHITIBED ON FIXED RATE IN ILLINOIS

Deed of trust

a three party instrument that conveys a naked title or bare legal title, without right of possession. Deed is given as security for loan to a third party

Beneficiary

The person who is benefiting from or receiving the trust

Duties of Mortgagor or Trustor

Payment of debt in accordance with terms of note

Payment of all real estate taxes

Maintenance of adequate insurance to protect lender

Maintenance of property

Receipt of lender authorization

Failure to meet these requirements can result in a borrowers default. Lender should be given right to foreclose on mortgage or deed and collect

Mortgage clauses and Provisions

Acceleration clause

Alienation clause

Acceleration Clause

Assists lender in foreclosure. If borrower defaults, lender has right to accelerate maturity of debt. This means it may become payable along with any interest immediately

Satisfaction of mortgage

Required to be executed by lender by provisions of defiance clause when note has been fully paid and all parties satisfied

Release deed

Conveys the same rights and powers that the trustee was given under the deed of trust. Should be acknowledged by public record

Alienation Clause

Provides that when a property is sold, the lender may declare entire debt to be paid immediately or permit buyer to take loan at current market rate. Prevents future purchasers from taking low rates

Assignment of the mortgage

Assignee takes on the loan, when a note is sold to a thrift party, then required to execute the satisfaction release

Tax and insurance reserves

Taxes and insurance costs can be reserved ahead of time and borrowers have the right to place future fee amounts into interest bearing account.

Flood insurance is also a reserve, meaning that there are regulations and regulatory agencies for these 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 escrow account

Escrow account

Many lenders require that borrowers provide a reserve fund to meet future real estate taxes and property insurance premiums. This fund is called an escrow account

Flood insurance reserves

Flood insurance reform act of 1994 Imposes mandatory obligations on lenders to set aside escrow funds for flood insurance on new loans. Borrower must be notified if home is in flood hazard area and now has 45 days to purchase insurance. Cost may be charged to borrower

Assignments of rents

If the property involved includes rental units, the borrower may provide for rents to be assigned to the lender in the event of the borrowers default. Assignment may be included in mortgage or deed of trust. Should clearly indicate will to assign rent

Buying property subject to or assuming existing financing

Property may be purchased in subject to the mortgage of it or the mortgage may be assumed by buyer.

When property is sold in subject to, buyer is not personally required to pay debt in full. Buyer takes title to real estate knowing he must make payments on loan. Upon defaulting, property is sold to pay off loan. Any extra is required to be paid by seller

When mortgage is assumed, sellers debt becomes personal obligation of buyer for entire debt, seller still liable until released by mortgagee

Novation

The switching of an original contact for a new one

Recording a mortgage or a deed of trust

Must be recorded in county of property. Establishes priority

Priority of a mortgage or deed of trust

Determined by order recorded. May be changed by subordination agreement

Provisions of land contracts and other owner financing

Buyer agrees to make a down payment and monthly loan payment that includes monthly interest and principal directly to seller. Seller retains legal title, and buyer gets equitable title and possession.

Predatory lending and mortgage fraud

Any lending practice that imposes unfair or abusive loan terms on a borrower. Also any practice that deceives or forces a borrower to accept terms

Mortgage law (or theories)

Mortgages are contractual between mortgagor and mortgagee, but there are doctrines or theories that spell out interests of each party:

Title theory

Lien theory

Intermediate mortgage theory

Title theory

Mortgagor actually gives legal title to mortgagee and retains equitable title, legal title returned to mortgagor after loan paid off

Lien theory

Intermediate mortgage theory

Defeasance clause

Foreclosure

Methods of foreclosures

Nonjudicial foreclosure

Judicial foreclosures

Strict foreclosure

Deed in lieu of foreclosure

Redemption

Equitable right of redemption

Sheriffs deed

Statutory right of reinstatement

Sheriffs sale

Certificate of sale

Deficiency judgment

Short sales

Bankruptcy and foreclosure