Financing: Notes and Mortgages Chapter 2 Financing: Notes and Mortgages

Overview Notes The Mortgage Instrument Assumption of Mortgage Acquiring Title “Subject to” a Mortgage Other Financing Sources Land Contracts Default Alternatives to Foreclosure: Workouts Foreclosure Bankruptcy

Notes Evidence of debt Major provisions: Financial Amount borrowed and interest rate Payment amount and maturity date Application of payments Reference to security for the loan Default conditions and penalties

Notes – Continued Major provisions Prepayment provision Acceleration of note Non-recourse clause Assumability provisions Assignment Future advances Release

Note Example

The Mortgage Instrument Note & Mortgage Note: Obligation to pay Mortgage: Pledges property as security Mortgagor: Borrower Mortgagee: Lender

The Mortgage Instrument – Continued Important Clauses Taxes & insurance fund Charges & liens Hazard insurance Property preservation and maintenance Due on sale clause

Mortgage Example

Mortgage Insurance Rider and PMI Disclosure

Assumption of Mortgage Assumption – A property may be sold/granted with the condition of new buyer/grantee taking over the responsibility of the loan Liability – since the agreement is not with the lender original borrower is still responsible for the loan Release conditions – the lender may or may not release the original borrower

Acquiring Title “Subject to” a Mortgage Loan is a liability of the grantor Property covered by a mortgage Land Improvements Easements Fixtures Special case of trade fixtures Mineral rights Junior mortgages – unsecured bridge loan with high interest rate and short-term

Other Financing Sources Seller financing: Source of credit for real property purchaser from the seller It is used when third party mortgage is expensive The buyer does not qualify for a loan The seller wants to use installment method to report gain on sale for tax purposes The seller artificially increases the selling price by offering a lower than market interest rate and therefore create more capital gain and less interest or ordinary income from seller financing Purchase money mortgage in addition to another loan – the lender may require use of subordination clause

Land Contracts Seller retains naked title Purchaser has equitable title Seller conveys title when purchaser completes the performance obligations

Default Failure to fulfill contract, agreement, or duty, especially obligation such as a note. The most common default is failure to make installment payment Beyond installment, failure to pay taxes or insurance premium can also result in default Even failure to repair the property may result in default called technical default

Alternatives to Foreclosure: Workouts Restructure the loan Recasting – changing mortgage terms to avoid default Extension agreement between borrower and lender Alternatives – temporary extensions Transfer of mortgage to a new owner “Subject to” the existing mortgage. The buyer is not responsible for the original loan Purchase an option on property value What are the characteristics of this option? Voluntary conveyance – transfer of title to lender with an agreement. The process is fast and less costly Deed in lieu of foreclosure Friendly foreclosure – borrower fully cooperates Prepackaged bankruptcy – agreement between creditors and a borrower to speed up the process

Foreclosure There are two forms of foreclosure: Judicial foreclosure: Judicial foreclosure or property sale Judicial foreclosure: Lawsuit against the property owner to execute a judgment to recover losses on the loan Redemption – process of canceling a foreclosure sale by fulfilling debt obligations Equity of redemption – prior to foreclosure Statutory right of redemption – after foreclosure Not in every state

Foreclosure – Continued Property sale Pricing: Public auction Upset price – sets a minimum price for a valid sale Deed of Trust: Trustor (creator of trust – borrower), Trustee (holds the title), Beneficiary (the lender) Power of sale clause – court authority not necessary Used in a limited number of states Purchaser buys any title defects Parties Senior & junior lien claimants Deficiency judgment Property price does not cover claim Tax issues Tax sales

State Foreclosure Laws Source: http://www.foreclosures.com/pages/state_laws.asp?ChangeStatePref=true

Foreclosure Dictionary

Bankruptcy Chapter 7 Chapter 11 Chapter 13 Liquidation Available to business owners Reorganization Cramdown – reorganization plan that is not fully supported by all creditors but approved by the court Chapter 13 Available to individuals