1

Chapter 2

Financing: Notes and Mortgages

2

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

3

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

4

Notes – Continued Major provisions

Prepayment provision Acceleration of note Non-recourse clause Assumability provisions Assignment Future advances Release

Note Example

5

6

The Mortgage Instrument

Note & Mortgage Note: Obligation to pay Mortgage: Pledges property as

security Mortgagor: Borrower Mortgagee: Lender

7

The Mortgage Instrument – Continued Important Clauses

Taxes & insurance fund Charges & liens Hazard insurance Property preservation and maintenance Due on sale clause Taxes & insurance fund Charges & liens Hazard insurance Property preservation and maintenance Due on sale clause

Mortgage Example

8

Mortgage Insurance Rider and PMI Disclosure

9

10

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

11

Acquiring Title “Subject to” a Mortgage “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

12

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

13

Land Contracts

Seller retains naked title Purchaser has equitable title Seller conveys title when

purchaser completes the performance obligations

14

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

15

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

16

Foreclosure There are two forms of 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

17

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 18

Foreclosure Dictionary

19

20

Bankruptcy Chapter 7

Liquidation Chapter 11

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 Reorganization