LESSON 6: INSTRUMENTS OF REAL ESTATE FINANCE Flashcards
What is a security instrument or device in real estate?
A conditional conveyance of property to ensure the payment of a debt.
What does a deed of trust or mortgage secure?
It secures the promissory note by pledging the land as security for the loan.
What are the two main types of security instruments used in real estate?
Mortgage and Deed of Trust.
How do states differ in using security instruments?
Some states use a Mortgage, some use a Deed of Trust, and some allow either.
What is the key difference between an encumbrance and a lien?
All liens are encumbrances, but not all encumbrances are liens.
What is an encumbrance?
Any claim on another person’s personal or real property that may include liens, easements, or deed restrictions.
What is a lien?
A creditor’s legal right or interest in a property, which may result in foreclosure if the debt is unpaid.
What is the purpose of a title company in a real estate transaction?
To conduct a title search and identify any reported liens and encumbrances.
What are title insurance exceptions?
Standard exceptions like easements that typically do not deter homebuyers.
What is the lien theory of financing?
The borrower retains ownership of the property while the lender holds a lien as security.
What happens in a lien theory state if the borrower defaults?
The lender must go through a judicial foreclosure process.
What is the title theory of financing?
The lender holds the legal title until the debt is fully paid, allowing foreclosure without court involvement.
Is Texas a lien or title theory state?
While often called a title theory state, Texas operates as a lien theory state.
How does foreclosure work in lien theory states?
A judicial foreclosure is required, beginning with a Lis Pendens complaint.
What is an intermediary theory state?
A state where the borrower holds title, but the lender can reclaim it without judicial proceedings if the borrower defaults.
What is a promissory note?
A written promise to repay a debt, serving as the fundamental loan document.
What are the key terms of a promissory note?
Borrower and lender names, loan amount, interest rate, payment terms, late fees, prepayment penalties, and maturity date.
What are the two parties in a mortgage?
The borrower (mortgagor) and the lender (mortgagee).
What are the three parties in a deed of trust?
Borrower (trustor), lender (beneficiary), and a neutral third-party trustee.
What is the primary difference between a mortgage and a deed of trust?
A mortgage involves judicial foreclosure, while a deed of trust allows for a non-judicial foreclosure process.
Who holds the legal title in a deed of trust?
The trustee holds the title until the loan is fully paid.
What are the duties of a trustee in a deed of trust?
Releasing liens, conducting foreclosure sales, and issuing trustee deeds.
What is hypothecation?
Pledging property as collateral without giving up possession unless there is a default.
What is the difference between a mortgage and a deed of trust?
A mortgage involves two parties: the borrower (mortgagor) and the lender (mortgagee). A deed of trust involves three parties: the borrower, the lender, and a trustee who holds legal title until the debt is paid.
How do lenders foreclose on a mortgage vs. a deed of trust?
Mortgages are typically foreclosed through judicial foreclosure (court process), while deeds of trust usually allow for nonjudicial foreclosure (handled by a trustee without court involvement).
Who are the parties involved in a mortgage?
The borrower (mortgagor) and the lender (mortgagee).
Who are the parties involved in a deed of trust?
The borrower, the lender, and the trustee.
Why is the trustee important in a deed of trust?
The trustee manages the foreclosure process and sells the property at auction if the borrower defaults. The trustee is often chosen by the lender and may be affiliated with them.
How does judicial foreclosure work?
The lender files a lawsuit in court, and if they win, they get a judgment allowing them to sell the property to recover the loan. This process can take months or years.
How does nonjudicial foreclosure work?
The trustee follows state laws to notify the borrower, record the default, publish the sale, and auction the property without court involvement. This process is usually much faster.
Can a lender foreclose a mortgage nonjudicially?
Some states, like Alabama and Michigan, allow nonjudicial foreclosures of mortgages based on contract terms and state laws.
When might a lender choose judicial foreclosure for a deed of trust?
If the deed of trust has a legal flaw (e.g., incorrect property description), the lender may file a lawsuit to resolve the issue in court.
How can you find out if you signed a mortgage or a deed of trust?
Check your loan documents, ask your mortgage servicer, or review county land records where the property is located.
What are the two main documents in a real estate loan?
A promissory note (promise to pay) and a security instrument (either a mortgage or a deed of trust).
What is a mortgage rider?
A legal addendum to a loan document highlighting non-standard mortgage terms. It protects lenders by ensuring borrowers understand their loan conditions.
What is a contract for deed?
A property sale agreement where the buyer makes payments directly to the seller and receives the deed after full payment.
How does a contract for deed differ from a traditional mortgage?
A contract for deed does not involve a third-party lender; the seller retains ownership until the final payment, whereas a mortgage transfers ownership upfront with a loan.
Why might a buyer choose a contract for deed?
It is an option for buyers who cannot secure a traditional mortgage due to credit issues or lack of a down payment.
What are the risks of a contract for deed?
The buyer risks losing all payments made if they default, and they have fewer legal protections compared to traditional mortgages.
How can a buyer protect their interest in a contract for deed?
By recording the contract in the county deed records, which provides legal recognition and foreclosure protections.
What information must a seller provide in a contract for deed?
Property condition, legal status, ownership claims, liens, and financing terms.
Can a buyer cancel a contract for deed?
Yes, within 74 days for any reason, or at any time if the property is not properly subdivided.
When can a seller terminate a contract for deed?
If the buyer breaches the contract, the seller must give notice and allow a chance to catch up on payments before eviction or foreclosure.
What happens if a buyer has paid more than 40% of the purchase price?
The seller must use foreclosure procedures instead of simple contract cancellation.
What is an All-Inclusive Trust Deed (AITD)?
An AITD is a mortgage that includes an underlying mortgage balance. It is a type of wraparound loan where the seller finances the buyer’s purchase while retaining responsibility for the original loan.
How does an AITD work?
The seller issues a new loan that “wraps around” the existing mortgage. The buyer makes payments to the seller, who then pays the original lender. The seller’s equity position is the difference between the buyer’s payments and what is owed to the lender.
What document is issued to the buyer in an AITD transaction?
A Grant Deed conveying full title to the buyer, along with Title Insurance.
Who is responsible for the original loan in an AITD?
The seller remains liable for the original loan, even though they issue a new loan to the buyer.
What does “wrap-around” mean in a wraparound mortgage?
The term describes the lien arrangement where the seller carries back a second trust deed that wraps around the seller’s existing trust deed.
How is the amount of the second trust deed determined in a wraparound mortgage?
It is equal to the total of the senior lien(s) plus the seller’s equity.
Can a wraparound mortgage be done without lender approval?
No, if the senior lien contains a due-on-sale clause, lender approval is required.
What happens if the buyer defaults in a wraparound mortgage?
The seller must still make payments on the original loan. If the seller defaults, the buyer should have the right to make payments directly to the original lender.
How is title insurance handled in a wraparound mortgage?
The title insurance policy will have two exceptions: one for the first loan and another for the wraparound.
Why should a wraparound note and deed be prepared by a specialist?
Due to the complexity of the transaction, it is best handled by an attorney or specialist in this type of financing.
What was the financing challenge in the given example?
The buyers could afford only $1300/month PITI, but a 90% conventional loan at 7.00% would result in payments of $1476/month, which was too high.
How was the wraparound mortgage used to solve the financing issue?
The seller provided a $180,000 all-inclusive deed of trust at 6.00% interest, reducing the buyer’s payments to $1079/month, making the home more affordable.
Why was this beneficial for the seller?
The seller planned to invest their equity in a certificate of deposit at 5% but could earn a higher return by offering the AITD at 6%.
Did the buyers accept the proposal for the wraparound mortgage?
Yes, the buyers accepted the proposal because it allowed them to afford the home within their budget.
What are subordinate loans?
Subordinate loans are a type of subordinated debt recorded behind primary debt, often with higher interest rates and restrictive terms.
Why do subordinate loans have higher interest rates?
Due to additional risk to the lender, they typically have higher interest rates, shorter repayment periods, and higher closing costs.
What is required for a secured asset in a subordinate loan?
The asset must be sufficient to cover both primary and subordinate debt.
What is a Real Estate Equity Line of Credit?
It is a secondary loan recorded after primary financing, securing the ownership amount of real estate.
How do small business owners use equity loans?
They secure them with their primary residence to generate funds for their business.
How does a second mortgage differ from an equity loan?
Second mortgages provide a lump sum with a formal repayment term, while equity loans are often lines of credit.
What happens if a borrower defaults on a second mortgage?
The second mortgage lender must buy out the first mortgage to remove the lien.
What are SBA subordinate liens?
Loans backed by the Small Business Administration that are subordinate to the borrower’s primary mortgage.
What assets can be used to secure SBA subordinate loans?
Business property such as furniture, equipment, vehicles, inventory, and computers.
How can primary loans become subordinate?
If another creditor, such as the IRS or a municipality, records a lien on the collateral.
What is a subordination agreement?
A contract allowing a lender to take priority over existing lenders for a new loan.
When do sellers use subordination in real estate?
When allowing their equity to be used as collateral for a buyer’s loan, often in construction financing.
What are the risks of subordination for a seller?
If the buyer misuses the funds, the seller may lose their collateral and have no recourse.
What is the Community Reinvestment Act (CRA)?
A law encouraging banks to provide credit to low- and moderate-income communities.
When was the CRA enacted, and why?
In 1977, to prevent redlining and encourage banks to serve their entire community.
How do regulators assess banks under the CRA?
They review performance records when banks apply for charters, mergers, or branch openings.
Does the CRA require high-risk loans?
No, CRA activities must be consistent with safe and sound banking operations.
What financial regulators oversee CRA compliance?
OCC, Federal Reserve, FDIC, and OTS.
What institutions are excluded from CRA requirements?
Credit unions, brokerage firms, mortgage companies, venture capitalists, and insurance companies.
How do banks fulfill CRA requirements?
By funding community development corporations, minority-owned businesses, and affordable housing programs.
What role do Community Development Corporations (CDCs) play?
They direct improvement projects and provide funding for high-risk borrowers in distressed areas.
How has Texas benefited from the CRA?
Millions of dollars have been reinvested, with incentives for banks to serve low-income communities.
How does Texas encourage CRA participation?
The state reduces fees for banks opening branches in underserved areas and raises lending limits for CRA projects.
How does Texas enforce CRA compliance?
It prohibits state revenue deposits in banks that fail to maintain a satisfactory CRA rating.
What is a potential downside of the CRA?
Some research suggests possible inefficiencies or risks, as with other government programs.
What is the Southern Dallas Development Corporation (SDDC)?
A nonprofit focused on economic revitalization and job creation for low-income residents in southern Dallas.
What promises does a borrower make in a security instrument?
Pay taxes, keep property insured, not commit waste, allow lender property access, and prohibit hazardous materials storage.
What is an acceleration clause?
It allows the lender to demand full repayment if the borrower defaults, damages the property, or transfers ownership without approval.
What is an alienation clause?
It prevents the property from being sold without lender approval unless the loan is paid off.
What are common types of mortgage riders?
Second Home Rider, One to Four Family Rider, Planned Unit Development (PUD) Rider, Condominium Rider, and Adjustable Rate Rider.
What is the purpose of a mortgage rider?
To highlight unique loan features and provide legal protection for the lender.
How are mortgages ranked?
By the order of recording: the first recorded mortgage is the first mortgage, the second recorded is the second mortgage, etc.
What is a piggyback loan?
A loan structure using a first and second mortgage to reduce the down payment and avoid mortgage insurance.
What is subordination in mortgages?
When a second mortgage lender allows a new refinance loan to take first position.
How are multiple mortgages affected in foreclosure?
The first mortgage is paid off first, followed by the second and third mortgages, if funds remain.
What mortgages are exempt from TRID rules?
Home Equity Lines of Credit (HELOCs), reverse mortgages, and mortgages secured by mobile homes or non-attached dwellings.
What is the purpose of a settlement statement (HUD-I)?
To disclose all charges and credits in a transaction to ensure transparency.
What is TRID, and what disclosures did it replace?
The TILA-RESPA Integrated Disclosures (TRID) replaced the Good Faith Estimate (GFE) and Truth-in-Lending Disclosure with a Loan Estimate and replaced the HUD-I and final Truth-in-Lending Disclosure with a Closing Disclosure.
What is a Loan Estimate (LE)?
A three-page document detailing mortgage terms, monthly payments, and estimated closing costs.
What is a Closing Disclosure (CD)?
A five-page document providing final loan terms, received at least three days before closing.
What should borrowers do if they find discrepancies between the Loan Estimate and Closing Disclosure?
Contact the lender or real estate agent to resolve errors before signing.
What is a promissory note?
A legal IOU that serves as an unconditional promise to repay a loan.
What is included in a promissory note?
Borrower/lender names, loan amount, interest rate, payment terms, late fees, due date, and prepayment penalties.
What is a deed of trust?
A legal document securing a loan by transferring title to a trustee until the loan is repaid.
What is the power of sale clause in a deed of trust?
It allows the trustee to sell the property if the borrower defaults.
What happens when a loan is fully repaid under a deed of trust?
A reconveyance deed is issued, transferring legal title back to the borrower.
How is a deed of trust different from a mortgage?
A deed of trust involves a trustee holding title, whereas a mortgage typically gives the lender legal title until repayment.
