Financing is of major importance when investing in real estate. In today’s credit-driven economy, there are very few people who are financially able to pay cash for their new homes.
Leverage is usually described as making use of other people’s money, such as, making a low down payment and borrowing the rest of the money for a home purchase.
A mortgage involves the transfer of an interest in land as security for a loan or other obligation. It is the most common method of financing real estate transactions.
A mortgage lender is an investor that lends money secured by a mortgage on real estate.
A mortgagor is the borrower in a mortgage—he or she owes the obligation secured by the mortgage.
There are two common legal documents that are used to finance real estate in California:
A promissory note (usually referred to as a “note”) and establishes legal evidence of the debt incurred.
The two most common types of promissory notes are:
A note does not need to be tied to either a mortgage or a deed of trust to be valid. When a note has no related collateral, it is said to be unsecured.
Mortgage Release
Once the mortgagor has paid off the mortgage in full, the lender will execute and record a document indicating that the loan terms have been met.
A deed of trust is a legal document which transfers title to a property to a third-party trustee as security for an obligation owed by the trustor (the borrower) to the beneficiary (the lender). A deed of trust is also called a trust deed.
The deed of trust conveys title rights in the property over to an assigned trustee. When the borrower repays the note secured by the deed of trust, the trustee will reconvey title back to the borrower using a deed of reconveyance, also called a release deed.
Like a mortgage, a deed of trust document:
Unlike a mortgage, a deed of trust conveys the title to a trustee.
Late Payment Penalty
This clause requires the borrower to pay a penalty or late charge for any payments that are considered to be late.
Prepayment Privilege
If there is not a prepayment clause, the borrower can repay the balance of the loan at any time without being assessed a penalty.
Prepayment Penalty
Lenders typically do not want loans that are bringing in high interest to be paid off early. Consequently, a lender will try to control prepayments by including a provision that allows the lender to assess a penalty to the borrower for paying early.
Lock-In Clause
This is a very drastic form of a prepayment clause as it actually prohibits the borrower from paying the mortgage loan in full before a specific date.
Due-On-Sale Clause
This is a form of acceleration clause that requires the borrower to pay off the entire mortgage debt when the property is sold. The due-on-sale clause is also known as an alienation clause, a nonassumption clause, a call clause or a right-to-sell clause.
“Subject To”
If there is no due-on-sale clause, property loans are assumable by the new buyers of the property.
Whether a buyer assumes a loan or purchases “subject to” the existing loan, the seller is still the person primarily responsible to the lender until the note is fully paid. For the seller to “get off the hook,” the buyer must go through a process of full substitution, called novation.
Subordination Clause
This clause is an agreement to reduce the priority of an existing loan to a new loan that will be recorded in the future.
Release Clause
This clause is often used when two or more properties are pledged as collateral for a single loan. Many transactions that involve land development use release clauses. As the developer sells off each lot, a portion of the money from the sale is used to pay part of the mortgage. In return, the lender executes and records a release of the lot that was sold, so that the buyer can get a clear title. This is also known as a partial release cause.
Exculpatory Clause
This clause is inserted in a financing document when the lender agrees to waive the right to a deficiency judgment.
A mortgage is normally paid in installments that include both interest and a payment on the principle amount that was borrowed. Failure to make payments results in the foreclosure of the mortgage.
By definition, a foreclosure is a legal procedure in which the property that is used as security for a debt is sold to satisfy the debt in the event of a default.
Foreclosure allows the mortgagee to declare that the entire mortgage debt is due and must be paid immediately. This is accomplished through an acceleration clause in the mortgage.
Mortgage lien foreclosures
There are three types of foreclosure processes that enforce mortgage liens:
Judicial foreclosure occurs in states that use a two-party mortgage document (borrower and lender) that does not contain a "power of sale" provision. Lacking this provision, a lender must file a foreclosure suit and undertake a court proceeding to enforce the lien.
A judicial foreclosure allows a property to be sold by court order after sufficient public notice. An attorney for the lender files a suit to foreclose the lien on the mortgage. Once the facts are presented in court, the court will order that the property be sold. A public sale will be advertised and held and the real estate will be sold at auction to the highest bidder.
Any outstanding debt remaining after foreclosure and sale of a property is known as a deficiency judgment.
Deficiency judgments are unsecured claims and take the place alongside the borrower’s other debts. Unlike with the mortgage, the lender has no priority position. Deficiency judgments attach only to real estate or other property that the defaulted borrower currently holds or may hold in the future. Most lenders will seek a judicial foreclosure when they want to get a deficiency judgment.
When there is a "power of sale" provision in the mortgage or trust deed document, a non-judicial foreclosure can force the sale of the liened property without a foreclosure suit. The "power of sale" clause in effect enables the mortgagee to order a public sale without court decree.
With a non-judicial type of foreclosure, a lender or a trustee has the right to sell the property without spending the time, effort, and money involved in a court foreclosure. This form of foreclosure also shortens a borrower's redemption time by eliminating the statutory redemption period that is allowed in the judicial foreclosure process.
Because this is a non-judicial remedy, there are very stringent notice requirements.
The primary method of foreclosure in California is the non-judicial foreclosure.
Using the strict foreclosure method, a lender could get ownership to a property that has a value above the loan balance.
The conventional mortgage is the most common type of loan and is generally viewed as the most secure. Conventional loans are typically uninsured. The mortgage itself provides the only security for the loan.
Most conventional loans require the borrower to make a down payment of 20% or more, making the loan 80% or less of the property’s sale price. A borrower can get a conventional loan with a lower down payment by insuring the loan through a private mortgage insurance program (PMI). PMI usually insures the top 30% of a loan, protecting the lender in case the borrower defaults on the loan.
Most conventional loans have traditionally been designed as fixed-rate loans. The most common fixed-rate loans are 30-year mortgages, because the payment is stable and there is always the opportunity to pay the balance down or to refinance for a better rate at a later date.
There are also conventional mortgages that have an adjustable rate. Adjustable-rate mortgages (ARMs) are appealing to borrowers when interest rates are high. The components of an ARM include:
Other types of loans offered by financial institutions or sellers are:
The Real Estate Settlement Procedures Act (RESPA) of 1974 was created to ensure that the buyer and seller in a residential real estate transaction involving a new first mortgage loan have knowledge of all settlement costs.
Effective October 2015, TRID rules are as follows:
Closings that must comply with TRID include any closed end-loan secured by real property, including unimproved property.
Truth in Lending Act
The Truth in Lending Act, Title I of the Consumer Credit Protection Act, is implemented by Regulation Z. This law requires lenders to disclose to buyers the true cost of obtaining credit, so that borrowers can compare the costs of various lenders.
Right to Rescind
In most cases the borrower has a right to cancel the transaction by notifying the lender within three days. This does not applyto residential first mortgage loans, but does apply to refinancing and home equity loans.
Equal Credit Opportunity Act
The Equal Credit Opportunity Act (ECOA) prohibits lenders from discriminating against applicants on the basis of
Home Mortgage Disclosure Act
Financial institutions are required to fairly and impartially make credit available to all credit-worthy applicants. The Home Mortgage Disclosure Act of 1975 requires that lenders report statistical information each year to insure that lenders are not restricting loans to certain individuals or neighborhoods to exclude them from obtaining a mortgage (called “redlining”).
The Fair Credit Reporting Act, or Title VI of the Consumer Credit Protection Act of 1968, requires that lenders:
Predatory lending is any lending practice that requires unfair or abusive loan terms to a borrower. It often involves a borrower taking a loan he or she doesn’t need, doesn’t want, or can’t afford. The most common example of predatory lending is subprime lending.
Subprime lending involves mortgages with above prime rates made to borrowers with lower credit ratings who wouldn’t typically qualify for a conventional mortgage. Loan conditions often lead to the borrower not being able to afford the loan in a few years.
Warning signs of predatory lending include:
