REAL ESTATE FINANCING – OUTLINE
Professor Mager, Fall 2009
Real Estate Transfer, Finance, and Development, Nelson, Eighth Edition
INTRODUCTION TO MORTGAGE FINANCING
Most Common Types of Residential Financing Methods:
1. Cash sale: Buyer pays all cash to the seller. Buyer may have cash from savings or by borrowing under a new mortgage loan from an institutional seller.
2. Assumption or taking subject to existing mortgage: Buyer “takes over” the seller’s existing mortgage financing and pays cash equal to the difference between the sales price of the property and the balance on the existing loan. The buyer may “take over” the loan either by signing an assumption agreement which makes her personally liable on the mortgage debt, or merely by taking “subject to” the loan without any express promise to pay it. In the latter case, she is not personally liable, but will still have a powerful economic incentive to pay the mortgage loan in order to avoid foreclosure and loss of her cash investment in the property.
3. Land Contract: Buyer enters into a mortgage loan or installment sale contract obligation with the seller for all or a large portion of the total purchase price.
Mortgages or Deeds of Trusts are securities. Securities for the performance of an obligation, maybe to repay a debt or to perform something under a contract. Ex. A home mortgage or a loan for a child’s college fund that you grant a mortgage to secure payment of.
There has to be an obligation for the mortgage to be valid.
A note is governed by the UCC and can be traded or sold. The note has its own terms. If you want to know what the repayment terms are for a mortgage, you look at the note. If you want to know if there is a due on sale clause, you look at the note.
The mortgage is a transfer from a debtor (mortgagor) to a creditor (mortgagee) of a real estate interest.
You sign a promissory note when you buy your house. It’s an obligation to pay your debt. Recently, some lenders are saying, we don’t want the house, we just want the debt paid by you. You may have to come up with it yourself now. These people are not messing around right now. They can go get a judgment on the note without foreclosing and then if they don’t get enough money from you, they can take the house.
Due on sale clause: permits the lender to demand an immediate payoff of the loan if the real estate is transferred. This clause will create problems for any loan assumption, taking subject to, or wrap around.
Balloon: the time when the contract would become payable in full for the amount remaining.
· Judicial – public sale after a full judicial proceeding. Sole method in many states. Expensive and time consuming.
· Power of Sale – after notice to parties, property is sold at a public sale by a public official. No judicial proceeding required. Only available where law doesn’t prohibit and where both mortgage instrument and state statute authorize it.
· Strict Foreclosure: p. 612
· When a mortgage goes into default, the mortgagee normally has the right to accelerate the mortgage, making the entire debt due and payable upon default.
· Usually the mortgagee will foreclose on the property and then may come after the mortgagor for a personal deficiency judgment if the note is not satisfied by the sale of the property.
· Any proceeds in the sale will go to pay off the mortgage debt and expenses of the sale and any surplus will go to subordinate lien holders and then to the mortgagee if any is left over.
· The mortgagee can also go after the mortgagor personally first if permitted by law.
Equity of Redemption: Exists for the mortgagor to cure and redeem property after he has defaulted on the loan. Generally, equity of redemption is not lost until a valid foreclosure has taken place. This right cannot be waived by the mortgagor during the execution of the mortgage and an agreement does so, it is void and unenforceable as against public policy.
Type of redemption option for the mortgagor that comes into play AFTER a valid foreclosure.
This permits the mortgagor, and sometimes junior lien holders, to redeem for some fixed period after the foreclosure sale.
The redemption amount is usually the sale price, not the mortgage debt.
Puts pressure on the mortgagee to bid up the price at the foreclosure sale to at least the mortgage debt amount.
Offered in about 20 states but differs from state to state.
Multiple Mortgage Foreclosures:
· When a first mortgage is in default and is foreclosed upon, the purchaser will obtain title free and clear of all mortgages or other lien junior or subordinate to the mortgage being foreclosed.
· When a second mortgage is in default and is foreclosed upon, the purchaser will take the title to the property subject to the first mortgage. The foreclosure of a junior mortgage will not affect the status of a senior mortgage.
· Assuming the market value of the property is 100,000 and the senior mortgage debt is 70,000, a purchaser would bid at most 30,000, the fair market value less the amount of the senior lien.
Deed of Trust:
Involves a conveyance of the realty to a third person (often the lender’s lawyer, employee, subsidiary) in trust to hold as security for the payment of the debt to the lender-noteholder whose role is analogous to the mortgagee.
Almost always contain a power of sale in the trustee to be exercised after a default at the request of the lender-noteholder.
Essentially the same as a mortgage with a power of sale.
Trustor under deed of trust has the same equity of redemption as a mortgagee.
Anti-Clogging Rule: renders unenforceable any agreement by the m/or that is part of the original mortgage transaction that purports to cut off or modify the equity of redemption. This means once a mortgage, always a mortgage.
Some states have tried to enact legislation to modify this rule
NY does allow this, as long as it’s not dependent on a default
Example: I loan you money and you give me a deed to your land. One year later, you give me the money back. I say that I bought the land. We go into court and say this was really an equitable mortgage. It’s really a disguised mortgage. We want the court to impose a mortgage on this debt and recast this situation so it’s not a sale, it’s a loan, secured by a mortgage.
Deed in lieu: classic example of not clogging the equity of redemption.
· Broad: the anti-clogging rule is broad. The idea of whether or not m/or has to be in default is a RS issue.
· Subsequent documents (other mortgages) are not similarly shielded by the anti-clogging rule. It doesn’t necessarily violate the anti-clogging rule. Don’t assume b/c the agreement has arisen from subsequent agreement it’s good. You can give someone more time, but they can’t exchange it for an equity of redemption.
THE USE OF MORTGAGE SUBSTITUTES
The deed in escrow as a clog: page 276, note 2.
Debtor grants land to creditor under agreement that he will reconvey only if the debtor pays the debt when due.
Important question is whether parties intended the deed to stand as security for a debt.
Where the parties cast their transaction in the form of an absolute conveyance instead of a mortgage, they do not intend to create the relation of mortgagor and mortgagee and this will not be treated as a mortgage.
Where the purpose of the conveyance is a security, it will be treated as a mortgage even though the parties may have agreed or understood that the debtor should have no right to redeem. Because the right to redeem after default is inseparable from the mortgage, the parties cannot contract against it where the transaction is treated like a mortgage and the equity of redemption will be preserved.
Conditional Sale: B gives S $50K. S gives B deed to his house. S also gives deed with an option to buy, but if its not exercised within a year, S gets to keep the house. Here there is a second piece of paper – the option to buy.
(1) Parole evidence rule: if you argue that a contract was intended to represent the entire agreement of the parties, the parol evidence rule bars extrinsic, oral evidence to explain contract. RST: parol evidence is allowed in to prove the fact that the transaction is intended to be a security rather than a conveyance. (Bars extrinsic evidence that would vary the terms of a written document executed with
able to preserve right to forfeiture as to future installments. But if not, the court will generally fix a reasonable time where the vendee can cure and keep the property like an equity of redemption. Further, in some instances, reliance on a formal waiver by the vendor will be enforced.
Many state statutes have sought to ameliorate the harshness of the forfeiture clause. Many provide varying degrees of notice to the defaulting vendee as well as a grace period during which the tender of late payments will reinstate the contract.
OTHER VENDOR REMEDIES:
Specific Performance: vendor tenders title to the land and seeks an equitable decree compelling the purchaser to pay the balance of the contract price. In a contract for deed setting, usually there is no acceleration clause which may create problems for a vender seeking specific performance. Courts sometimes have applied anticipatory repudiation as a basis for acceleration.
Action for Damages: hard to prove damages though because you must convince the jury that the property was worth less on the date of breach than it was worth when the contract was created. “bad deal”
Foreclosure: either judicial or strict, but watch redemption period. More on bottom of p. 325.
However, where the jurisdiction treats the land contract as a mortgage, these contract remedies will be unavailable. There are though very similar remedies available in mortgage law.
Premises liability of vendors: normally, a mortgagee will not be liable for unsafe conditions on mortgaged real estate unless she is in possession or otherwise exercises dominion and control over it.
Election of Remedies: if you pick forfeiture, you may be barred by the election of remedies doctrine from seeking to recover a deficiency judgment. P. 329
Notes, p. 332:
· Note 1: The usual view is the vendor has no duty to perfect the title until the vendee makes the final payment. However if it is clear that the vendee’s ownership in the title is so encumbered that the cannot fulfill his contract, he cannot insist on continued payments if his own performance will not be forthcoming.
· Note 2: may be easier to make the contract unrecordable so that after forfeiture, the title is clear.
· Note 3: usually, possession by vendee under a land contract will operate as full notice of his rights to creditors of the vendor. However some states provide that possession can only confer actual notice.
Vendee’s right to mortgage her equity: The vendee may mortgage her interest as her equity grows in the property. Functionally, this mortgage on the vendee’s equity is the economic equivalent of a second mortgage because the vendor holds an interest analogous to a first purchase money mortgage on the land. Where a vendor has actual knowledge of the vendee’s mortgagee, he cannot invoke forfeiture of the contract without giving the vendee’s mortgagee notification of intent to forfeit and an opportunity to protect himself. When a forfeiture occurs under circumstances where prior notice to the mortgagee is required, courts find that the rights of the mortgagee remain unimpaired. Further, an installment land contract may purport to deny the vendee the power to assign or mortgage his or her interest without the vendor’s consent. This is similar to a due on sale clause.
Cascade Security Bank v. Butler:
Rule: Real estate contract vendee’s interests are real property