Introduction to Real Estate Finance
Gould Winter 2010
I. Financing as a Tool
a. Seller Financing: Buyer enters into a mortgage loan or installment contract obligation with the seller for a large part of the total purchase price. Seller treats this as an investment, since buyer will pay interest. Can also be a PPM
Restatement 1.1 – The Mortgage Concept: No Personal Liability Required
A mortgage is enforceable whether or not any person is personally liable for that performance.
a. 2 kinds of loans – a mortgage can secure either kinds
i. Recourse – Personal Liability on the note
1. If you don’t repay the loan, the payee can choose to sue you on the note Or the lender can foreclose the mortgage (and if there is a deficiency, the lender might be able to sue you for that)
ii. Non-recourse – No Personal liability on the note.
1. If the note is secured with a mortgage that has sufficient value to cover the loan, the payee would foreclose the mortgage and get title to the land if the loan is not repaid
Restatement 1.2 – No Consideration Required
(a) Consideration is not necessary.
(b) A mortgage securing an obligation undertaken as a gift is enforceable in the absence of undue influence, fraud, or mistake, notwithstanding in the unenforceability of the obligation standing alone.
(c) A mortgage that secures a performance of a preexisting legal obligation is enforceable
B. Circumstances where something that constitutes a valid mortgage obligation for the purpose of mortgage enforceability is broader than in contracts.
a. One of which is a gift (enforceable assuming no fraud, duress, etc.)
C. Failure of consideration: If the mortgagor executes a note or contract, secured by a mortgage, but does not receive some or all of the value for which she or he bargained, this is a breach of contract, and the mortgage is unenforceable.
D. The lender can put many obligations in the mortgage
a. Pay taxes: Real Estate Tax liens usually take priority over all other liens on the property
b. Keep property in Good repair: This is the security for the lender
c. Covenant not to perform Waste
Restatement 1.4 – Obligation Must Be Measurable in Monetary Terms
A mortgage is enforceable only if the obligation whose performance it secures is measurable in terms of money or is readily reducible to a monetary value at the time of enforcement of the mortgage.
E. Definiteness of Obligation
a. Monetary Obligation: the obligation doesn’t have to state a monetary amount, but that obligation does have to be capable of being reduced to a monetary amount.
i. If not, it cannot be secured by a mortgage.
ii. At least one court has found that were the note makes no mention of the obligation, it is unenforceable
b. Policy rationale: mortgage enforcement would break down if the law allowed mortgages to secure performance of obligations that can’t be paid off in monetary terms because how would you ever know if the mortgage was paid off or If a junior lien-holder desired to redeem, there would be no means of determining the amount necessary to accomplish a redemption
c. Support Mortgages: When a mortgage is given both to secure a promise of financial support, and also a promise of “love, affection, and kindness” the mortgage is valid to secure the first obligation, but not the second. Why? A promise for emotional support cannot be reduced to a monetary equivalent
The Use of Mortgage Substitutes
I. The Absolute Deed, the Conditional Sale, and Related Transactions
Restatement 3.1- The Mortgagors Equity of Redemption and Agreements Limiting It
(a)From the time the full obligation secured by a mortgage becomes due and payable until the mortgage is foreclosed, a mortgagor has the right to redeem the real estate that is described in the mortgage.
(b) A agreement or separate agreement made at the same time as a mortgage that impairs the mortgages right of equity of redemption is invalid.
(c) Any agreement in or created at the same time with a mortgage that confers on the mortgagee an interest in the real estate is enforceable unless it’s effectiveness is expressly (in the mortgage document) dependent on the mortgagor default.
II. “Anti Clogging Rule”
a. A mortgagor’s equity of redemption cannot be clogged and he cannot, as a part of the original mortgage transaction, cut off or surrender his right to redeem.
i. Option Contract
1. Restatement: An option to obtain ownership is enforceable, unless its effectiveness is expressly dependent on the mortgagor’s default.
a. Watch out for words like “Mortgagor Violates a term in mortgage” that is unenforceable.
2. Common: The mortgagee is not allowed at the time of the loan to enter into an option or contract for the purchase of the mortgaged property
a. Option to buy at Fixed Sum cannot be taken contemporaneously by the mortgagee
b. The Deed in Escrow is a clog and Unenforceable: Sometimes the deed to the land will be put in escrow, and if the loan is not satisfied it is to be returned to the mortgagee if there is a default.
c. Subsequent Conveyances as Clogs: Anti-Clogging is generally inapplicable to transactions that are subsequent to the execution of the mortgage. (i.e. Deed in Lie) unless
i. The subsequent agreement provides for a future waiver of the mortgagor’s redemption rights. For example, an agreement after a default where the mortgagee says if X is not paid within Y time, then you have to give the money back, that is not ok.
d. Conveyance of Other Real Estate Not a Clog: Occasionally, a mortgagor will not only deliver a mortgage on the specific real estate, but will, as further consideration for the loan transaction, make an outright conveyance to mortgagee of some or all of the mortgagor’s other real estate.
i. This type of conveyance does not run afoul of Subsection (b) because it does not impair the mortgagor’s right to redeem the real estate described in the mortgage
ii. However, a court could conclude that the contemporaneous conveyance was, itself, intended as further security and thus susceptible to being treated a mortgage under § 3.2
Disguised Real Estate Security Transactions as Mortgages in Substance
I. Absolute Deed: This is a contract where the Buyer gives the Seller a Deed with an understanding that after the debt is paid off the Seller will re-convey the land.
a. Two Ways to do this
i. Creditor may require the debtor to grant him the land by absolute deed, under oral agreement that he will re-convey only if the debtor repays the debt.
ii. Creditor may get the deed and execute some sort of written agreement to re0convey the property upon receiving payment of the debt.
b. Here Parol evidence can be used to establish that the two writings or agreements really constituted one transaction and intended as a security for a loan or obligation.
i. If the grantor succeeds, he will be permitted to “redeem” the land by paying the obligation.
ii. This creates an “equitable mortgage”
§ 3.2 The Absolute Deed Intended as Security.
(a) Parol evidence is admissible to establish that a deed was intended to serve as security for a debt or obligation. The obligation may have been created prior to or contemporaneous with the conveyance and need not be the personal liability of any person.
(b) Must have Intent that the deed serve as security and can be proved by clear and convincing evidence and can be inferred from the totality of the circumstances, including the following factors:
(1) statements of the parties;
(2 substantial disparity between the value received by the grantor and the FMV of the land at the time of the conveyance; (there must a debt, and when there is a pretty big one, there is strong inference that a security device was intended)
The fact that
(3) the grantor retained possession of the real estate;
(4) the grantor continued to pay real estate taxes;
(5) grantor made post-conveyance improvements to the real estate; and
(6) the nature of the parties and their relationship prior to and after the conveyance. (The disparity between the parties as to their sophistication and the circumstances under which they were operating is particularly relevant. )
(c) Where, in addition to the deed referred to in Subsection (a) of this section, a separate writing exists indicating that the deed was intended to serve as security for an obligation, parol evidence is admissible to establish that the writings constitute a single security transaction.
iii. Intend to Make a Security Device[1]: If the purpose of the conveyance was security, it will be treated as a mortgage, even though the parties may have agreed or understood that the debtor shall have no right to redeem.
iv. No Need for Writing: It is unnecessary to establish either the existence of a promissory note or similar written evidence of the debt or that the grantor is personally liable to repay it. (Totality of Circumstances)
v. BFP right from Grantee: A mortgagor’s right to redeem the lan
d is devalued will want to foreclose to get the deficiency judgment.
ii. Nearly all ILCs have a provision that declares time is of the essence and in the case of default, vendee retains property and all prior payment (vendee interest is extinguished).
c. Note: Even if the court finds the forfeiture clause unconscionable the mortgagor / vendee is still in default and the mortgagee / vendor can foreclose
d. Strict Enforcement Approach[3]
i. Forfeiture enforceable unless it shocks the conscience of the court.
1. In determining whether something shocks the conscience the court should consider
a. The amount of money already paid by the buyer to the seller
b. The period of possession of the real property by the buyer
c. Change in market value of the real estate at the time of default compared to the original sales price
d. and the rental potential and value of the real property
2. During the life of the real estate K any risk of loss or enhancement in value accrues to the purchaser
a. Upon default or forfeiture, the buyer’s interest is terminated and there is no enhancement value to be recovered by the buyer
[1] Perry v. Queen: Facts: A guy had two mortgages on his house that were in default, he received a letter from the D stating that he could help him get his house back. D did in fact give P money to get his mortgage payments current, to pay off future mortgage payments, and some to go to plaintiff. In Exchange, the plaintiff signed a warranty deed, a residential lease, a lease and option disclosure, and a memo of understanding. Issue: Was this transaction secured by plaintiff’s house? (I.e. did the house serve as a security? Held: Yes. The plaintiff here has a high school education and has worked in the printing industry most of his life. There is no evidence in the record that indicates that he has experience in dealings involving property. Additionally, at the time of his transaction with the defendants, the plaintiff faced foreclosure on his second mortgage and felt “extremely desperate” about his financial situation. Also indicating the plaintiff’s intent in this case is the fact that he retained physical possession of his house after he gave the defendants the warranty deed.
[2] Downs v. Ziegler: Plaintiff’s commenced an action to foreclose a mortgage and to hold D, and three doctors, personally liable for any deficiency after the foreclosure sale. D was in the construction business, and built an apartment building on land conveyed to him by the plaintiff’s in exchange for a promissory note secured by mortgage on the land, soon thereafter D ran into some financial difficulties, and three doctors decided to make sure he would not go into default. The Doctors planned to make their credit available so that the mortgage would not go into default and that they would guarantee that D’s obligation to the bank. The K provided that D would convey the interest in the real estate in exchange for the Doctors agreement to bring the payments current. Issue: Can extrinsic Evidence be used to establish that something was use as a security device? Yes. The Extrinsic evidence must be clear and convincing in order to show that a deed absolute and a separate option constitute a mortgage.
[3] Russell v. Richards: Russell Filed an action against the Richards resulting from a default and forfeiture of her interest in a real estate contract. Russell was an assignee-purchaser under a standard form K with the Richards, who were the originally sellers of the real estate. Russell paid 11K and assumed the other 37K. Russell made the first payments, but there was 26K left over, and the property had double in value. Issue: Did the Forfeiture Shock the Conscious of the Court? Held: No. In this case Russell only paid 10,000 on the K, received rents during that time, had been in default several times, the main amount in the land was the increase in value.
