Lender Financing - Part 2 - Chapters 58-60

Question 1

Determine which lending arrangements are subject to or exempt from usury restrictions on interest rates

Answer 1

When a mortgage is made, the lender charges the borrower interest for use of the money during the period the money is lent.

However, the amount of Interest a private, non-exempt lender can charge is regulated by Statue and the California Constitution. Collectively, these are referred to as Usury laws.

Today, the remaining goal of usury laws is the prevention of loan-sharking by private lenders. Loan-sharking involves charging interest at a higher rate than the ceiling rate established by the usury laws. These mortgages are categorized as usurious.

Adopted in 1918 as a consumer protection referendum, the first California usury laws set the maximum interest rate at 12% for all lenders - no exceptions. However, during the Great Depression California legislation Exempted certain types of lenders from usury restrictions. These exemptions were implemented with the intent to open up the mortgage Market. These exemptions to usury laws remain in place today and more have been added.

For example in 1979, mortgages made or arranged in California by real estate BROKERS were exempt from usury restrictions. Further sales transactions involving the extension of credit by sellers are not subject to usury laws.

Other types of lenders exempt from usury law restrictions include:

• Savings and Loan associations
• State and National Banks
• industrial mortgage companies
• credit unions in pawn brokers
• agricultural cooperatives
• corporate insurance companies
• personal property brokers

Exemptions successfully opened the market by increasing the availability of funds. In turn, interest rates were soon driven lower to increase competitions.

Two basic classifications of private mortgage transactions exist relating to interest rates private lenders May charge on real estate mortgages:

• Usury EXEMPT BROKERED real estate mortgages
• Usury NON-EXEMPT RESTRICTED or NON-BROKERED real estate mortgages

BROKERED REAL ESTATE MORTGAGES ARE EXEMPT from usury restrictions in fall into one of two categories:

• mortgages made by a licensed real estate broker Acting As A Principal for their own account as a private lender who funds the mortgage
• mortgages arranged with a private lender by a licensed real estate broker acting as an agent in the mortgage transaction for compensation

RESTRICTED REAL ESTATE MORTGAGES ARE NON-EXEMPT mortgages made by PRIVATE PARTY LENDERS and are NOT made nor arranged by a broker. Private lenders include corporations, limited liability companies, partnerships and individuals. These entities are NOT exempt from usury limitations (unless operating under an exempt classification such as a personal property broker or real estate broker.)

Question 2

Identify extensions of credit on property sales as excluded from usury restrictions

Answer 2

Sales transactions involving the extension of credit by seller are not subject to usury laws. SELLER CARRY BACK NOTES ARE NOT SUBJECT TO USURY LAWS.

Private party transactions involving the creation of a debt which avoid usury law restrictions break down into two categories:

• EXEMPT DEBTS, being debts which involved a mortgage or a forbearance on a mortgage and are BROKER OR AGENT arranged
• EXCLUDED debts, being debts which do not involve a mortgage, SELLER CARRYBACK

The most familiar of the excluded non-mortgage type debts is seller carry-back financing.

Carry-back notes executed by the buyer in favor of the seller are not loans of money. They are CREDIT SALES, also called installment sales. A seller may carry back a note at an interest rate in excess of the unsury threshold rate. The rate exceeding the unsury law threshold is enforceable since the debt is not a mortgage.

CARRYBACK SALE = CREDIT SALE = INSTALLMENT SALE

Question 3

Discern when the usury threshold rate applies

Answer 3

If the use of the proceeds of a mortgage is earmarked primarily for personal, family, or household use by the borrower, the maximum annual interest rate is 10% per annum.

Non-exempt mortgages made to fund the improvement, construction, a purchase of real estate are subject to a different usury threshold interest rate restriction of:
* 10% annually or
* the current discount rate of the Federal Reserve Bank of San Francisco + 5%
whichever is greater.

Question 4

Explain the penalties imposed on a non-exempt private lender on violations of usury law

Answer 4

The most common penalty imposed on a non-exempt private lender in violation of usury law is the forfeiture of all interest on the mortgage. Thus, the lender is only entitled to a return of the principal advanced on the mortgage. All payments made by the borrower are applied entirely to principal reduction, with nothing applied to interest.

Lenders who are found to have taken grossly unfair advantage can also be penalized with treble damages.

Treble damages are computed at 3x the total interest paid by the borrower during the one-year period immediately preceding their filing of a suit and during the period of litigation until the judgment is awarded.

Question 5

exempt debt

Answer 5

PRIVATE PARTY TRANSACTIONS involving the creation of a debt which ARE EXEMPT from usury law restrictions break down into two categories:

• EXEMPT debts, being debts which involved a mortgage or a forbearance on a mortgage and are broker made or arranged
• EXCLUDED debts, being debts which do not involve a mortgage, these are carryback sellers

Question 6

excluded debt

Answer 6

Private party transactions involving the creation of a debt which avoid usury law restrictions break down into two categories:

• EXEMPT debts, being debts which involved a mortgage or a forbearance on a mortgage and our broker made or arranged
• EXCLUDED debts, being debts which do not involve a mortgage - SELLER CARRYBACK

Excluded Debts are extensions of credit by sellers of real estate creating a debt obligation in sales transactions which avoid usury laws.

Question 7

restricted real estate loans

Answer 7

RESTRICTED or NON-BROKERED REAL ESTATE MORTGAGES are all mortgages made by private party lenders which are neither made nor arranged by a broker (which makes them NON EXEMPT from usury laws. Private lenders include corporations, limited liability companies, partnerships and individuals. These entities are NOT EXEMPT from usury limitations (unless operating under an exempt classification such as a personal property broker or real estate broker.)

Question 8

treble damages

Answer 8

Lenders who are found to have taken grossly unfair advantage can also be penalized with treble damages.

Treble damages are computed at 3x the total interest paid by the borrower during the one-year period immediately preceding their filing of a suit and during the period of litigation until the judgment is awarded.

Question 9

usury

Answer 9

When a mortgage is made, the lender charges the borrower interest for the use of their money during the period the money is lent.

However, the amount of interest of private, non-exempt lender can charge is regulated by the statute of the California Constitution. Collectively, these are referred to as USURY LAWS. USURY means a limit on the lenders interest rate yield on non-exempt real estate mortgages.

Today, the remaining goal of usury laws is the prevention of loan-sharking by private lenders. Loan-sharking involves charging interest at a higher rate and the ceiling rate established by the usury laws. These mortgages are categorized as usurious..

Question 10

Identify the unenforceability of a lender’s oral or unsigned mortgage commitment

Answer 10

A lender’s oral or unsigned mortgage commitment is unenforceable by a buyer. A mortgage commitment is only enforceable when it is placed in writing and signed by the lender, unconditionally committing the lender to the specific terms of a mortgage for consideration.

Lenders customarily process applications and prepare mortgage documents. However, these documents are signed only by the buyer and not the lender.

The first and only act committing the lender is its actual funding of the mortgage which occurs at the time of closing. Thus, until the lender delivers funds and a closing has occurred, the lender can back out of its oral or unsigned written commitment at any time without liability.

Question 11

Better your buyer’s chance of closing with the best rates and terms possible by submitting mortgage applications to at lease two lenders.

Answer 11

To better your buyers chance of closing with the best rates and terms possible counsel them to submit applications for a mortgage to at least TWO institutional lenders. A second application with another institution gives the buyer additional leverage in mortgage negotiations needed at closing. Multiple competitive applications keep lenders vying for your buyers business up to the very last minute – the ultimate moment of funding, when commitments truly are commitments.

Question 12

mortgage commitment

Answer 12

A mortgage commitment is a lender’s commitment to make a mortgage, enforceable only when written, unconditional and signed by the lender for consideration.

Question 13

Advise your buyers who have a down payment less than 20% about the availability of private mortgage insurance (PMI) on conventional mortgages with loan to value (LTVs) exceeding 80%

Answer 13

PRIVATE MORTGAGE INSURANCE (PMI) indemnifies a lender for loss on a mortgage secured by an interest in real estate when a borrower whose down payment is less than 20% default.

Question 14

Review the qualification and approval process for obtaining PMI with buyers

Answer 14

To qualify for PMI, the buyer need to be a natural person and take title as the vested owner of the property.

The lender making a conventional mortgage to fund the purchase of a principal residence when the mortgage will exceed 80% of the property value requires the buyer to meet the qualifications for PMI coverage, not just a lender’s qualifications.

The PMI investigation in documentation takes place after submission of a mortgage application. It is generally limited to verification of all the buyers representations on the application. The availability of PMI coverage for different types of California real estate is limited.

Only properties classified as single-family residences may receive PMI.

The buyer’s credit rating and disposable income need to clearly support their ability to make the monthly payments on the low down payment mortgage (PMI).

Question 15

lender-paid mortgage insurance (LPMI)

Answer 15

The buyer usually pays the PMI premiums, not the lender (although the lender is the insured and the holder of the policy). However, some lenders and PMI insurers offer a LENDER PAID MORTGAGE INSURANCE (LPMI) program. If issued by the PMI insurer, the lender pays the mortgage insurance premium and charges the borrower a higher interest rate on their principal payments.

A LENDER PAID MORTGAGE INSURANCE is default mortgage insurance provided by private insurers in which the lender pays the mortgage insurance premium and recovers the cost through a higher interest rate paid by the borrower.

Question 16

loan-to-value ration (LTV)

Answer 16

PMI insures the lender for losses incurred up to a percentage of the mortgage amount. In turn, the mortgage amount represents a percentage of the property’s value, called the LOAN-TO-VALUE RATIO. Typically mortgages insured by PMI are covered for losses on amounts exceeding 67% of the property’s value at the time the mortgage is originated.

Question 17

private mortgage insurance (PMI)

Answer 17

Private Mortgage Insurance (PMI) is default mortgage insurance coverage provided by private insurers for conventional loans with low loan-to-value ratios higher than 80%.

PMI insurers are unrelated to government-created insurance agencies, such as the FHA and the Veterans Administration (VA) which also insure or guarantee mortgages made to qualified Borrowers.

Question 18

Understand a signed promissory note is evidence of the existence of an underlying debt, not the debt itself

Answer 18

The promise to pay is set out in a written document called a promissory note. A promissory note represents an underlying debt owed by one person to another. The sign promissory note is not the debt itself, but the evidence that exists.

The buyer, called the debtor or payer, signs the note and delivers it to the lender or carry-back seller, called the creditor.

The note can either be secured or unsecured. If the note is secured by real estate, the security device use is a trust deed. When secured, the debt becomes a voluntary lien on the real estate described in the trust deed.

Question 19

Recognize the linkage between a promissory note and trust deed

Answer 19

A trust deed alone, without a monetary obligation for it to attach to the described property, is a worthless trust deed for there is nothing to be secured.

A promissory note may be secured or unsecured. If the note is secured by real estate the security device used is a trust deed, commonly called a mortgage. When secured, the debt evidence by the note becomes a voluntary lien on the real estate described in the trust deed that references the note. Even though they are separate documents the note and Trust deed are for the same transaction in are considered one contract to be read together.

Question 20

Identify the different types of promissory notes and debt repayment arrangements they are used to evidence

Answer 20

Promissory notes are categorized by the method for repayment of the debt as either:

• installment notes
• straight notes

INSTALLMENT NOTES are used for debt obligations with constant periodic repayments in any amount and frequency negotiated. Variations of the installment note include:

• interest-included - same payment each month
• interest-extra - payment declines each month

Finally, notes are further distinguish based on interest rate calculation, such as:

• fixed rate notes commonly called fixed-rate mortgages
• variable interest rate notes commonly called adjustable rate mortgages

A STRAIGHT NOTE calls for the entire amount of its principal to be paid in a single lump sum due at the end of a period of time, when the principal is due. Thus this form of real estate financing is sometimes referred to as a sleeper trust deed. Straight note is typically used by Bankers for short-term mortgages since a banker’s short-term note is not usually secured by real estate. In real estate transactions, the note evidences what is generally called a bridge loan, a short-term obligation.

STRAIGHT NOTE = SLEEPER TRUST DEED = BRIDGE LOAN

Question 21

adjustable rate mortgage (ARM)

Answer 21

An adjustable rate mortgage (arm) is a variable interest rate note, often starting out with an introductory teaser rate, only to reset at a much higher rate in a few months or years based on a particular index.

Question 22

all-inclusive trust deed (AITD)

Answer 22

The All-Inclusive Trust Deed (AITD) is a note used more often in carryback transactions. It is a note entered into by the buyer in favor of the seller to evidence the amount remaining due on the purchase price after deducting the down payment, and amount inclusive of any specified mortgage debts remaining of record with the seller retaining responsibility for their payment. Also referred to as a wrap around mortgage or overriding mortgage where it calls for the buyer to pay the carryback seller constant monthly installments of principal and interest. The carryback seller then pays the installments due on the underlying (senior) trust deed note from the payments received on the AITD note.

ALL INCLUSIVE TRUST DEED =
WRAP AROUND MORTGAGE =
OVERRIDING MORTGAGE

The AITDs become popular in times of recession, increasing long-term rates and tight credit.

Question 23

Shared Appreciated Mortgage (SAM) and Applicable Federal Rate (AFR) and

Answer 23

An Applicable Federal Rate (AFR) is a rate set by the IRS for carry-back sellers to impute and report income at the minimum interest when the note rate on the carryback debt is a lesser rate.

The Shared Appreciation Mortgage (SAM) repayment schedule variation is designed to help sellers attract buyers during times of tightening mortgage money. Usually, the real estate sales volume is in a general decline, followed in a year by a drop in prices. This is the case with a Shared Appreciation Mortgage (Sam), aka a split-rate note.

Under a SAM note, the buyer pays an initial fixed interest rate, called the floor or minimum rate. The floor rate charge is typically 2/3 to 3/4 of the prevailing market rate, but not less than the applicable federal rate (AFR) for reporting an imputed interest.

A shared appreciation mortgage, or SAM, is a home loan in which the lender offers a below-market interest rate in exchange for a share of the profit when the house is sold. In return for this additional compensation, the lender agrees to charge an interest rate which is below the prevailing market interest rate.

In return, the carryback seller receives part of the property’s appreciated value as additional interest, called CONTINGENT INTEREST, when the property is sold or the carryback SAM is due.

Question 24

balloon payment

Answer 24

A balloon payment is any final payment on a note which is greater than twice the amount of any one of the six regularly scheduled payments immediately preceding the date of the final balloon payment. It is under the Installment Note “Interest-included” category.

Question 25

graduated payment mortgage

Answer 25

A Graduated Payment Mortgage (GPM) is a mortgage providing for installment payments to be periodically increased by predetermined amount to accelerate the payoff of the principal. Any accrued monthly interest remaining unpaid each month is added to the principal balance resulting in negative amortization. The negative amortization causes the unpaid interest to bear interest as though it were principal, called compounding.

A graduated payment mortgage (GPM) is a type of fixed-rate mortgage in which the payments increase gradually from an initial low base level to a higher final level. Typically, the payments will grow between 7-12 percent annually from their initial base payment amount until the full monthly payment amount is reached.

A graduated payment mortgage (GPM) is a form of home loan that is often favored by prospective home buyers with lower incomes, or who may lack significant savings with which to purchase a property. Under the terms of a GPM, initial mortgage payments start out small, then increase over time.

Question 26

installment note

• interest-included - same payment each month
• interest-extra - payment declines each month

Answer 26

Promissory notes are categorized by the method for repayment of the debt as either:

• installment notes
• straight notes

An installment note is a note calling for periodic payments of principal and interest or interest only, until the principal is paid in full by amortization or a final balloon payment.

INSTALLMENT NOTES are used for debts paid periodically in negotiated amounts and at negotiated frequencies.
Variations of the installment note include:
* interest-included - same payment each month
* interest-extra - payment declines each month

INTEREST-INCLUDED installment notes may either:

• be fully amortized through constant periodic payments, meaning the mortgage is fully paid at the end of the term
• include a final / balloon payment after a period of installment payments, called a due date

INTEREST EXTRA installment notes call for a constant periodic payment of principal on debt. IN addition to the payment of principal, accrued interest is paid separately, typically concurrent with a payment of the principal installment. Thus, unlike an interest-included note, the amount of each scheduled payment of principal and interest on an INTEREST-EXTRA note is a DECLINING amount from payment to payment.

Question 27

promissory note

Answer 27

The promise to pay is set out in a written document called a promissory note. A promissory note represents an underlying debt owed by one person to another. The sign promissory note is not the debt itself, but the evidence that exists.

Question 28

reconveyance

Answer 28

The promissory note, once signed by the borrower and delivered to the lender, represent the existence of a debt. When a secured debt has been fully paid, the trust deed securing the debt is removed from title to the secured property, a process called reconveyance. Reconveyance is a document executed by a trustee named in a trust deed to release the trust deed lien from title to real estate, used when the secured debt is fully paid.

Question 29

straight note

Answer 29

Promissory notes are categorized by the method for repayment of the debt as either:

• installment notes
• straight notes

A STRAIGHT NOTE calls for the entire amount of its principal to be paid in a single lump sum due at the end of a part of time. Thus this form of real estate financing is sometimes referred to as a sleeper trust deed. Straight note is typically used by Bankers for short-term mortgages since a banker’s short-term note is not usually secured by real estate. In real estate transactions, the note evidence was generally called a bridge loan, a short-term obligation.

Question 30

Describe the variations on interest rates and repayment schedules contained in the installments and straight notes to meet the specific needs of the lender and the borrower.

Answer 30

While the installment note and a straight note are common, variations on the interest rate and repayment schedule is contained in the installment and straight notes are available to meet the specific needs of the lender and the borrower.

The variations include the:

• adjustable rate mortgage (ARM)
• graduated payment mortgage (GPM)
• all inclusive trust deed (AITD) - typ for carryback
• shared appreciation mortgage (SAM) - typ for carryback