Lesson 13: Real Estate Financing Flashcards
nonfinancial encumbrances
There are financial and nonfinancial encumbrances. Nonfinancial encumbrances include easements and restrictive covenants.
security interest
A lien is a creditor’s claim against property owned by a debtor. The lien gives the creditor the right to foreclose on the property if the debtor defaults on the debt.
In a foreclosure, the property is sold against the owner’s will, and the debt is paid out of the proceeds of the sale.
Since the lien secures the payment of the obligation, it is known as a security interest, and a lienholder is often referred to as a secured creditor.
voluntary liens
Liens are classified as either general or specific, and as either voluntary or involuntary. Examples of involuntary liens include tax liens, attachment liens, and judgment liens.
This lesson focuses on voluntary liens, which are created with a mortgage or a deed of trust.
loan agreement
When a real estate loan is made, a lender and a borrower enter into a contract commonly known as a loan agreement. The lender agrees to loan money to the borrower; the borrower agrees to repay the loan according to its terms.
The loan terms include the loan amount, the interest rate, the payment amount, the repayment period, the lender’s right in case of default, penalties for late payment, and the borrower’s collateral.
promissory note
The loan agreement is embodied in two separate documents: the promissory note and the security instrument.
The promissory note is simply a written promise to pay money.
It is evidence of the debt; it shows who owes money to whom.
security instrument
The security instrument is either a mortgage or a deed of trust.
Although the promissory note establishes the borrower’s obligation to repay the loan, it’s the security instrument that turns the borrower’s real property into the collateral (the security) for the loan.
This is true whether the security instrument is a mortgage or a deed of trust. If the borrower defaults on the note, the lender can sell the security property.
mortgage
A mortgage is a two-party security instrument, in which the borrower mortgages her property to the lender.
The borrower is called the mortgagor and the lender is called the mortgagee.
deed of trust
A deed of trust, on the other hand, is a three-party security instrument between the borrower (the trustor or grantor), the lender (the beneficiary), and a third party (the trustee), who acts on behalf of the lender.
The trustee’s job is to release the property from its lien when the loan is paid off, or to initiate the foreclosure process if the loan isn’t paid as agreed.
judicial foreclosure
As noted, the key difference between a mortgage and a deed of trust is in the foreclosure process.
A mortgage is foreclosed through a process called judicial foreclosure, which involves a court proceeding and a court-supervised auction of the security property.
nonjudicial foreclosure
On the other hand, a deed of trust is foreclosed through nonjudicial foreclosure. The trustee can auction the property without court supervision.
Since nonjudicial foreclosure is faster and less expensive than judicial foreclosure, lenders have made the deed of trust the most common type of security instrument in California and many other states.
(Note that even if the security instrument is a deed of trust, the arrangement is often referred to as a “mortgage.”)
power of sale clause
Nonjudicial foreclosure is permitted only if the security instrument contains a power of sale clause. This clause, standard in deeds of trust, authorizes the trustee to sell the property in the event of default.
Mortgages may be foreclosed nonjudicially if they contain a power of sale clause, but most don’t. Deeds of trust may also be foreclosed judicially if the trustee so chooses, but there is usually little incentive to do so.
acceleration clause
An acceleration clause states that if the borrower defaults, the lender has the right to accelerate the loan.
In other words, the lender can require the borrower to pay the entire loan balance immediately.
(This is also referred to as “calling the note,” which is why an acceleration clause is sometimes known as a “call provision.”)
alienation clause
An alienation clause, also called a due-on-sale clause, gives the lender the right to accelerate the loan if the borrower sells the property or otherwise transfers an interest in it.
An alienation clause is an acceleration clause—but a particular type: it kicks in if a sale occurs, rather than being triggered by a breach of the loan agreement.
prepayment penalty
Some loan agreements state that the lender can impose a prepayment penalty if the borrower prepays the loan.
subordination clause
A subordination clause in a security instrument subordinates that security instrument to another security instrument that will be recorded later.
In other words, it gives the mortgage recorded first a lower lien priority than another mortgage that will be recorded later.
Usually lien priority is established by the recording date; a subordination clause, however, changes the priority.
defeasance clause
A defeasance clause requires the lender to release its lien on the security property once the loan is paid off.
Under California law, once a mortgage loan is repaid, the lender must record a document called a certificate of discharge (or a satisfaction of mortgage) within 30 days.
deed of reconveyance
The law is slightly different for deeds of trust.
A lender has 30 days after the loan is paid off to submit a request for reconveyance to the trustee. The trustee then has 21 days in which to record a deed of reconveyance.
If these requirements are violated, the responsible parties may be fined. They may also be required to pay the borrower any damages that resulted from the failure to promptly record the appropriate release document.
foreclosure action
When a mortgagor defaults, by failing to make payments or by breaking other promises in the mortgage, the lender can accelerate the loan and demand payment in full. If payment doesn’t occur, the lender begins a lawsuit, called a foreclosure action, in the county where the property is located. In this proceeding, the lender asks the judge to order the property seized and sold.
Junior lienholders
Junior lienholders will also be made parties to the lawsuit. These are other creditors who have liens against the property with lower priority than the foreclosing lender’s lien.
The junior lienholders’ liens will be eliminated by the foreclosure sale, so their interests need to be represented in the lawsuit.
lis pendens
When the lawsuit is filed, the lender records a document known as a lis pendens (also called a notice of pendency). The lis pendens states that the property is subject to a pending foreclosure suit.
By recording the lis pendens, the lender provides constructive notice to anyone interested in buying the property that title may be affected by the lawsuit’s outcome.
right to cure the default
In California, however, the equitable right of redemption has been replaced by the right to cure the default and reinstate the loan.
Instead of having to pay off the entire loan balance, the borrower must pay only the delinquent amount, plus interest, penalties, and costs.
decree of foreclosure
The trial in the foreclosure action is held unless the borrower reinstates the loan or pays off the entire balance.
The judge reviews the loan documents and the facts of the default, and, in most cases, issues an order directing the sheriff or a court-appointed receiver to sell the property. This order is called a decree of foreclosure.
notice of levy
The first step in the foreclosure sale is the notice of levy, which is recorded and served on the judgment debtor (the borrower) and other parties.
Second, the sheriff will issue a notice of sale.
(In some cases, 120 days must elapse between the notice of levy and the notice of sale.)
sheriff’s sale
The property is sold at a public auction called a sheriff’s sale (or an execution sale).
The auction is usually held at the county courthouse, and anyone may bid on the property.
The property is sold to the highest bidder, who receives a certificate of sale.
