Chapter 12 (Residential Mortgages) Flashcards
Mortgage Law
- Lien Theory
Legal concept that regards a mortgage as a just claim on specific property pledged as security for a mortgage debt.
Today, most states, including Florida, are lien theory states. The borrower retains title to the property. The lender is protected with a lien on the real property to secure the payment of the mortgage debt.
If the borrower defaults on the mortgage debt, the lender will foreclose to recover the money owed.
- Title Theory
In some states, title to the mortgaged property is conveyed to the lender through a mortgage deed, or to a trustee through a deed of trust.
This mortgage theory is called Title Theory.
If the borrower defaults, the lender may take possession of the property. The borrower retains equitable title to the property. Once the debt is paid in full, the lender conveys legal title to the borrower.
Loan Instruments
- Promissory Note
Legal evidence of a debt that must accompany a mortgage in Florida; a legally executed pledge to pay a stipulated sum of money.
A promissory note (or mortgage note, or sometimes a bond) must accompany all mortgages in Florida.
The note is the legal instrument that represents the evidence of a debt. A note is a promise to repay that makes the borrower personally liable for the obligation.
It represents the borrower’s promise to pay the lender according to the agreed-upon terms of the loan.
The note is usually a separate legal instrument and must be signed by the borrower. The note states the amount of indebtedness, interest rate, repayment method, and term or time period to repay.
- Mortgage
The mortgage note lists the penalties that will be assessed if the borrower doesn’t make the monthly mortgage payments.
It also warns the borrower that the lender can call the loan (demand repayment of the entire loan before the end of the term) if the borrower violates the terms of the mortgage. The note is usually not recorded.
Mortgages
A mortgage is an instrument that pledges the property as security (collateral) for a debt.
It is the legal document that represents the lien on the real estate that secures the debt. For the lender, the property becomes security, legally sufficient to ensure recovery of the loan.
Hypothecation refers to the pledging of property as security for payment of a loan without surrendering possession of the property.
Mortgages identify the property being used to secure a loan and contain the borrower’s promises to fulfill certain other obligations to the lender.
A mortgage instrument must be in writing to be enforceable. The mortgage is recorded to establish constructive notice of the lien and to establish priority ahead of subsequent liens.
Parties to a Mortgage
- Mortgagor
A borrower who gives a mortgage on the borrower’s property in order to obtain a loan from a lender.
- Mortgagee
A lender who holds a mortgage on specific property as security for the money loaned to the borrower.
There are two parties to a mortgage: (1) the mortgagor, or borrower (debtor), and (2) the mortgagee, or lender (creditor). The mortgagor owns the property, and the mortgagee owns the mortgage.
A mortgage is regarded as an investment or chattel (personal property) by the mortgagee and, like other such investments, may be sold to another investor if desired.
Satisfaction of Mortgage
A certificate issued by the lender when the debt obligation is paid in full.
Chapter 701, F.S., requires that lenders provide the mortgagor with payoff information. The mortgagee must provide an estoppel certificate stating the unpaid principal balance, interest due, and the per diem rate.
On that joyous occasion when the mortgagor pays the debt in full, the mortgagee executes a satisfaction of mortgage (or a release of mortgage).
Florida statute requires that the mortgagee cancel the mortgage and send the recorded satisfaction to the mortgagor within 60 days.
This document returns to the mortgagor all interest in the real property that had been conveyed to the mortgagee.
Recording the satisfaction of mortgage in the public records shows that the mortgage lien has been removed.
Mortgage Lien Priority
When a mortgage loan is recorded in the public records, it becomes a lien on the real property.
The mortgage lien is a voluntary lien created by the property owner.
Priority of mortgage liens is normally determined by the order in which the liens are recorded.
The First Mortgage (A mortgage on property that is superior in right to any other mortgage) loan to be executed and recorded is the first mortgage. If the property owner later executes another mortgage loan for additional funds, the new loan becomes a second mortgage.
A second mortgage is also called a junior mortgage.
Whether a recorded mortgage lien is a first mortgage, second mortgage, or third mortgage, and so on, it has priority over all subsequently recorded mortgages, unless it is subordinated to subsequent liens.
The holder of the first mortgage can voluntarily take a lower priority through a Subordination Agreement;
(A written agreement between holders of liens on a property that changes the priority of mortgage, judgment, or other liens under certain circumstances.).
A subordination agreement alters the normal rule of giving priority to the first recorded mortgage loan. As a result, a junior mortgage that was recorded at a later date, takes priority over the mortgage that was recorded at the earlier date.
For example, a lender who holds a first lien on a vacant parcel may subordinate the first mortgage lien to a lender who is providing construction financing.
Borrower’s Covenants and Agreements
A mortgage is a contract between mortgagor and mortgagee and, therefore, must contain the essential elements of a contract to be valid.
Mortgage lenders in Florida commonly use the Fannie Mae-Freddie Mac Single Family Uniform Mortgage Instrument.
This standard mortgage instrument contains certain uniform covenants (warranties). An explanation of the most important clauses in the uniform mortgage instrument follows.
- Promise to Repay
The borrower (mortgagor) promises to pay principal and interest according to the terms of the note. The mortgagor also agrees to pay escrowed items, prepayment charges, and late fees, if applicable.
- Taxes and Liens
The borrower agrees to pay all taxes, assessments, and fines that could create a lien with superior priority over the mortgage (security) instrument. This clause also stipulates that the mortgagor will pay community association dues, if applicable.
- Property Insurance
The mortgagor promises to keep the property insured against loss by fire and hazards included in an extended coverage policy. The lender may require the mortgagor to pay a one-time charge for flood zone determination and, if applicable, flood insurance coverage. If the borrower fails to maintain hazard insurance, the lender may obtain insurance coverage, at the lender’s option, and charge the borrower for the expense.
- Occupancy
The borrowers agree to use the property as their principal residence for at least one year, unless the lender otherwise agrees in writing.
- Maintenance and Covenant of Good Repair
The mortgagor promises to keep the property in good condition, maintain the property, and prevent waste. The lender is authorized to make reasonable inspections of the property.
- Covenant Against Removal
The mortgagor promises not to remove the building or any part of the improvements that are pledged as security for the debt.
Mortgage Provisions
- Prepayment Clause
A prepayment clause allows the borrower to pay off part or all of the debt, without penalty or other fees, before maturity.
In Florida, a borrower has the right to prepay a mortgage loan unless the mortgage instrument states otherwise.
A prepayment clause is normally included in FHA and VA mortgages on real property. A prepayment clause typically stipulates conditions and terms under which the mortgage loan may be prepaid.
- Prepayment Penalty Clause
The lender may choose to charge a Prepayment Penalty (The amount set by the creditor that the debtor is charged for retiring the debt early) for early payment, if provided for in the mortgage instrument.
- Acceleration Clause
The acceleration clause authorizes the mortgagee to accelerate or advance the due date of the entire unpaid balance if the mortgagor fails to fulfill any promises stated in the mortgage instrument.
The acceleration clause gives the lender the power to declare the entire unpaid mortgage loan due and payable and to foreclose on the property if the mortgagor does not remedy the default. The foreclosure process cannot begin unless the entire debt is delinquent.
Without the acceleration clause, the mortgagee could sue a delinquent mortgagor for only the monthly payments that are in arrears. The borrower is given 30 days from the date of the notice of acceleration to pay all sums secured by the mortgage instrument.
If the borrower fails to pay the debt within the specified time period, the borrower is considered to be in default.
The Fannie Mae-Freddie Mac Uniform Single Family Mortgage Instrument includes in the acceleration clause the remedies for curing defaults.
- Right to Reinstate
This clause provides for the mortgagor’s right to reinstate the original repayment terms in the note after the mortgagee has initiated the acceleration clause.
It gives the mortgagor the right to have foreclosure proceedings stopped before the foreclosure sale, provided that the mortgagor pays all sums that would be due if no acceleration had occurred plus all expenses incurred by the mortgagee in enforcing the mortgage.
- Due-on-Sale Clause
(A provision in a conventional mortgage that entitles the lender to require the entire loan balance to be paid in full if the property is sold.)
If all or any part of the property or any interest in the property is sold or transferred without the lender’s prior written consent, the lender may require immediate payment in full.
The due-on-sale clause allows the mortgagee to call due the outstanding loan balance plus accrued interest. In effect, this clause prevents another party from assuming the mortgage and requires that the mortgage debt be paid in full when the property is sold.
- Defeasance Clause
(A provision in a mortgage that specifies the terms and conditions to be met in order to avoid default and thereby defeat the mortgage.)
The defeasance clause is so named because it “defeats” the prior action when the borrower-mortgagor has made the final payment on the loan.
Recall that in title theory states, the mortgaged property is conveyed to the lender through a mortgage deed. Therefore, in title theory states, the defeasance clause defeats the conveyance of legal title and returns the legal title to the borrower-mortgagor.
In lien theory states, the lender is protected with a lien on the property that pledges the property as collateral until the debt is paid in full.
Once the debt is repaid, the defeasance clause defeats the mortgage lien and the property is no longer pledged as collateral. Constructive notice that the mortgage is defeated is accomplished when the lender-mortgagee executes and records a satisfaction of mortgage.
Common Mortgage Features
- Down Payment
The amount of cash a purchaser will pay at the time of purchase. Any earnest money that was pledged when the original offer to purchase was made, is applied toward the total amount of cash down payment due at closing.
- Loan-to-Value Ratio (LTV)
The loan-to-value ratio (LTV) is the relationship between the amount borrowed and the appraised value (or purchase price) of a property.
Lenders use this ratio as the measure of financial risk associated with lending and borrowing money. The higher the LTV, the lower the lender’s safety cushion, should the borrower default. Although the LTV typically falls between 60% and 90%, it can fall outside this range.
Loan-to-Value Ratio Formula:
loan amount ÷ price (or value) = loan-to-value ratio (LTV)
EXAMPLE: A home was purchased with a down payment of $36,000 and a loan of $200,000 at 6.5% for 30 years. Monthly payments are $1,264.14. What is the LTV?
$200,000 loan ÷ $236,000 purchase price
= .84745 or 85% LTV
- Equity
(The market value of a property less any debt against it; in a business entity, assets minus liabilities equals capital (owner’s equity); a system of legal rules administered by a court of chancery.)
An owner’s equity in property is the monetary interest the owner has in property over and above the mortgage indebtedness. When purchasing a property, the owner’s initial equity is the down payment. The greater an owner’s equity, the less risk for the mortgagee.
Equity Formula:
Current market value – mortgage debt = equity
EXAMPLE: The current market value of a home is $350,000. The owners have a mortgage loan with a principal balance of $280,900. How much equity do the homeowners have in their home?
$350,000 market value – $280,900 loan = $69,100 equity
- Interest
(The price paid for the use of borrowed money; estate.)
Interest is the cost for the use of borrowed funds. A lender charges interest on the remaining principal balance (amount borrowed) over the life of the loan.
Interest may be due at either the end of the payment period or at the beginning of each payment period.
Payments made at the end of a payment period are called 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 may also be made at the beginning of each period and are called payments in advance.
- Loan Servicing
(An additional source of income for lenders. Servicing fees typically range from 3/8 to of 1% of the unpaid balance of loans serviced.)
Some lenders handle the loan payment collection and recordkeeping for the mortgages they originate.
Loan servicing is an additional source of income for lenders. Servicing fees typically range from 3/8 to ¾ of 1% of the unpaid balance of loans serviced.
Lenders are generally willing to retain servicing of any loans sold to institutional investors.
- Escrow (Impound) Account
(An impound account required by most lenders that require borrowers to pay in advance monthly installments for property taxes and hazard insurance. The monthly escrow payment is one-twelfth of the estimated annual expense for property taxes and the hazard insurance premium.)
Most lenders require borrowers to pay in advance monthly installments for property taxes and hazard insurance. The monthly escrow payment is one-twelfth of the estimated annual expense for property taxes and the hazard insurance premium. These payments are held in an escrow (impound) account for the borrower. When the taxes and insurance premiums become due, the lender pays the expenses out of the escrow account. Federal regulations limit the total amount of reserves that lenders may require.
Holding funds in an escrow account to cover ongoing expenses associated with the property protect lenders from defaults, tax liens, and catastrophe.
The monthly mortgage payment paid by the borrower consists of principal and interest on the loan, and the monthly reserve for property taxes and hazard insurance. The monthly principal, interest, taxes, and insurance payment is called PITI (Principal, interest, taxes, and insurance payment on a mortgage loan).
- Discount Points
Discount points are an added loan fee often charged by lenders to increase the yield on a lower-than-market-interest loan and to make the loan more competitive with higher-interest loans. Borrowers often pay discount points upfront in order to gain a long-term, lower interest rate. This extra, up-front fee increases the real yield, or annual percentage rate (APR), to the lender (also see “Mortgage Discounting” later in this unit).
- Loan Origination Fee
In addition to discount points, lenders typically charge the borrower a loan origination fee. Amounts vary, but the fee is typically 1% or 2% of the loan amount.
The lender also charges the borrower all expenses encountered in obtaining credit reports, preparing loan documents, and processing a mortgage loan application.
EXAMPLE: The lender is charging an origination fee of 1.5% on a new mortgage loan of $250,000. What is the cost of the fee?
$250,000 × .015 (1.5%) = $3,750 cost of loan origination fee
- Takeout Commitment
(A written commitment from a financial institution certifying that permanent financing will be provided when the project is completed.)
Another source of income to lenders takes the form of commitment fees.
The developer of a subdivision, a shopping center, or an apartment complex often needs to obtain a written commitment from a financial institution certifying that permanent financing will be provided when the project is completed.
The point here is that the financial institution is willing to become the permanent lender in the future, but first the developer must find a lender of construction money. With the written commitment of the future permanent lender, called a takeout commitment, it is much easier to find a construction money lender.
When the project is built, the permanent lender advances the amount committed, and the developer repays the construction lender. Most lenders that issue a takeout commitment charge a nonrefundable fee for making the commitment. The borrower, in this case the developer, is required to pay the fee at the time the commitment is made.
Mortgage Discounting
Discount Points
(A method for increasing a lender’s yield)
Discount points are based on the loan amount, not on the selling price. When calculating the actual borrower’s cost in dollars added by the discount points, each point is equal to 1% of the loan amount (1 point equals 1%).
EXAMPLE: On a $40,000 loan for which the lender is charging 6 points, find the dollar cost of the points. Take 6% of $40,000.
$40,000 × .06 = $2,400
When the lender receives the $2,400, only $37,600 is needed from the lender’s funds to make up the total $40,000 that is loaned to the borrower. However, the lender will receive interest based on the entire $40,000 during the full term of the loan. The real yield to a lender includes not only this interest but also the $2,400 paid as a mortgage discount.
Lenders use computers or prepared tables to determine the number of discount points that must be paid. However, as a general rule of thumb, each discount point paid to the lender will increase the lender’s yield (return) by approximately 1/8 of 1% (.00125). When using the rule of thumb, for each discount point charged by a lender, add 1/8% to the stated (contract) mortgage interest rate to estimate the lender’s yield (and cost to the borrower) from the loan.
EXAMPLE: A buyer wants to obtain a mortgage of $180,000, and a lender agrees to make the loan at 5.5% interest plus 6 points up front. What will the approximate yield be to the lender?
To the quoted interest rate of 5.5%, add ⅛ of 1% for each point, or 6⁄8, which reduces to ¾:
⅛ × 6 = 6⁄8 = ¾
Add the ¾ to the mortgage interest rate of 5.5%, and the lender’s real yield is approximately 6.25% on the money actually loaned:
¾% + 5.5% = 6.25% approximate yield
Frequently, a lender will state that mortgages are “going at” 96 or 94, for example. This is a different way of quoting discount points. It means that the lender is willing to lend only 96% or 94% of the face value of a mortgage loan. If the seller, the buyer, or a third party is willing to come up with the remaining 4% or 6%, then the lender will make the loan. It means exactly the same thing as quoting 4 points or 6 points. Regardless of the method used, the real interest rate earned for the lender will be increased approximately 1/8 of 1% for each point charged up front.
Discounting interacts with the previously discussed FRS control of the money supply. Suppose the national economy is booming and inflation threatens to get out of hand. The Fed decides to decrease the amount of money in circulation as an inflation control effort. Securities are sold to absorb part of the money in circulation, and the discount rate at which banks are permitted to borrow is raised. The money supply drops and interest rates rise. Mortgage rates go to 6.5%, but some lenders raise their interest rates to only 5.5%. To offset the apparent 1% loss in yield, most lenders would make their mortgage loans at 5.5% plus an 8-point discount. This means the lender actually would be lending only 92% of the amount needed; the additional 8% of the loan would come from the person(s) attempting to obtain the loan.
Assignment of Mortgage
A legal instrument stating that the mortgagee assigns (transfers) the mortgage and promissory note to the purchaser.
estoppel certificate aka estoppel letter
A written statement that bars the signer from making a claim inconsistent with the instrument (commonly used with a mortgage assumption).
The individual or company purchasing the mortgage will receive an estoppel certificate (estoppel letter) verifying the amount of the unpaid balance, the rate of interest, and the date to which interest has been paid prior to the assignment.
The purpose of an estoppel certificate is to stop a claim that the amount owed is different from the actual unpaid balance, or that the interest rate is an amount other than the contracted rate. If requested, the mortgagee must provide an estoppel letter to the mortgagor.
Methods of Purchasing Property Encumbered By an Existing Mortgage
When a buyer purchases property that is encumbered by an outstanding mortgage loan, the buyer may choose to purchase the property in one of two ways.
Subject to the mortgage.
(A buyer makes regular periodic payments on the mortgage but does not assume responsibility for the mortgage)
When a 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 property knowing that the seller is still legally responsible for the debt although the buyer will be making the mortgage payments.
In the event of the buyer’s 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.
*Assumption of an existing mortgage.
(The buyer of real property that is already mortgaged assumes liability for the mortgage payments of the original loan that remains on the property)
Assumption of the mortgage obligates the buyer to assume liability for the debt. Both the buyer and the seller are equally liable in the event of default.
- If a seller wants to be completely free of the original mortgage loan obligation, the seller, buyer, and lender must execute a written novation agreement.
- The novation makes the buyer solely responsible for any default on the mortgage loan. The original mortgagor (seller) is freed of liability associated with the mortgage loan.
Lenders may want to prevent buyers from purchasing property subject to the mortgage or from assuming an existing mortgage.
Most lenders today include a due-on-sale clause (A provision in a conventional mortgage that entitles the lender to require the entire loan balance to be paid in full if the property is sold) in mortgage loans.
If the property or any interest in the property is sold or transferred without the lender’s prior written consent, the lender may require immediate payment in full.
The due-on-sale clause allows the mortgagee to call due the outstanding loan balance plus accrued interest.
Contract for Deed (Land Contract)
A financing technique wherein the seller agrees to deliver the deed at some future date and the buyer takes possession while paying the agreed amount. Also called a land contract, installment sale contract, or agreement for deed.
A contract for deed (land contract) is a financing device that is used when a buyer does not have sufficient cash to make a down payment that is acceptable to the seller.
The buyer (vendee) makes a small down payment and the seller (vendor) finances the rest of the purchase price. The buyer makes monthly installment payments of principal and interest to the seller and the buyer is also responsible for real estate taxes, insurance, and upkeep.
Unlike other types of financing, the vendor retains legal title until the loan is repaid. The vendee is granted equitable title and takes possession of the property. Contract for deeds can be used to finance residential and commercial property. However, more often, contract for deeds are used to finance unimproved property; hence the term “land contract.”
Only an attorney should prepare a contract for deed. In case of buyer default, regular foreclosure proceedings are required, just as though it were a seller-held mortgage.
Foreclosure
- Foreclosure:
A legal procedure whereby property used as security for a debt is sold to satisfy the debt owing to default in payment of the mortgage note or default of other terms in the mortgage document.
- Default:
Failure to comply with the terms of an agreement or to meet an obligation when due.
The borrower is required to fulfill certain obligations agreed to in the promissory note. These obligations include repayment of the debt, payment of property taxes, maintenance and upkeep, and keeping the property insured. Failure to meet any of these obligations can result in a borrower’s default.
When default occurs, the lender has the right under the mortgage contract to pursue legal action against the borrower for payment of the debt.
In Florida, foreclosure is a judicial process that requires the mortgagee to file a foreclosure suit in court. Foreclosure is enforcement of the mortgage lien.
If default on the mortgage occurs, the mortgagee has two remedies:
- Initiate a suit on the promissory note.
The mortgagee may choose to sue on the note, obtain a judgment, then execute the judgment against any real or personal property of the mortgagor. This judgment may be levied against any of the mortgagor’s property except property that is specifically exempted (such as homestead property, unless it is the property on which the default is based).
- Initiate a foreclosure proceeding.
The mortgagee may foreclose on the property that is subject to the mortgage lien.
The foreclosure process begins with the mortgagee accelerating the due date of all remaining payments and then filing a lawsuit to foreclose.
On receiving final judgment, the sale is advertised (public notice of the sale), and the property is sold at public auction to the highest bidder.
On confirmation of the sale, the clerk files a certificate of title and title passes to the purchaser.
The clerk then disburses the sale proceeds in accordance with the final decree.
The difference between what is owed the mortgagee at foreclosure sale and the successful bid is called surplus funds. Any excess proceeds are paid to the mortgagor.
If, however, the proceeds are not sufficient to satisfy the outstanding debt, the mortgagee may request that the court issue a deficiency judgment against the person(s) who signed the note.
When granted, a deficiency decree can extend to include all real and personal property belonging to the maker of the note, except a homestead.
The doctrine of caveat emptor applies in foreclosure sales; that is, the purchaser is presumed to know that the purchase is subject to any prior liens of record or interests for which there is constructive notice.
Equity of redemption allows the mortgagor to prevent foreclosure from occurring by paying the mortgagee the principal and interest due plus any expenses the mortgagee has incurred in attempting to collect the debt and initiating foreclosure proceedings.
In Florida, the right of equity of redemption ends once the property has been sold at foreclosure sale.
