Lesson 12: Real Estate Financing 311

Transcription

1 Real Estate Principles of Georgia 1 of 97 Lesson 12: Real Estate Financing 311 Economics of Real Estate Finance For a lender, a loan is an investment. Interest paid on loan is lender s return. Riskier loan requires a higher return (higher interest rate). 312 Economics of Real Estate Finance Real estate cycles Real estate cycles follow the law of supply and demand. Housing prices go up when demand is high and supply is low. Prices go down when supply is high and demand is low. $ 312 1

2 Federal Economic Policy Monetary policy Monetary policy: Federal government s control of money supply and interest rates. Determined by Federal Reserve ( the Fed ). Federal Reserve chairman sets monetary policy using: key interest rates reserve requirements open market operations 313 Monetary Policy Key interest rates The Fed controls two interest rates: federal funds rate discount rate Rates are charged when a bank borrows money from another bank or from the Federal Reserve Bank. YOUR BANK FEDERAL RESERVE BANK 315 Monetary Policy Key interest rates If the Fed raises interest rates, banks also raise the rates they charge their borrowers. If the Fed lowers interest rates, banks also lower their interest rates. Lower interest rates can stimulate economy

3 Monetary Policy Reserve requirements Reserve requirements: Amount of money banks are required to keep on deposit in order to meet requests for withdrawals. 315 Monetary Policy Reserve requirements Fed raises reserve requirements: less money is available for lending interest rates go up Fed lowers reserve requirements: more money is available for lending interest rates go down 315 Monetary Policy Open market operations Open market operations: When the Fed buys and sells government securities. Primary method of managing money supply. Buying government securities from investors puts more money into circulation: money supply increases, and interest rates go down

4 Summary Economics of Real Estate Finance Real estate cycles Supply and demand Fiscal policy Monetary policy Key interest rates Reserve requirements Open market operations Finance Markets Two mortgage markets: primary market secondary market 316 Finance Markets Primary market Primary market: Local community lending institutions that lend money to local borrowers. Primary market lenders are easily hurt by local economic conditions

5 Finance Markets Primary market When local economy is booming: less money is saved lenders can t keep up with demand for loans When local economy is slow: more money is saved lenders have ample funds but little demand for loans 317 Finance Markets Primary market Disintermediation: Depositors withdraw funds from savings accounts and put them into competing investments offering higher returns. 317 Finance Markets Secondary market Secondary market: Private investors and government agencies that buy and sell mortgages nationwide. Provides liquidity for primary mortgage lenders Allows local lenders to sell loans to obtain more funds. Moderates local real estate cycles

6 Secondary Market Loan discounting Secondary market investors buy loans at a discount (for less than their face value). Discounted loans can be foreclosed for the full face amount if borrower defaults. 318 Secondary Market Government-sponsored agencies When secondary market agency buys mortgage loans, it issues mortgage-backed securities as collateral. Agency sells securities to private investors. 318 Secondary Market Government-sponsored agencies Fannie Mae Freddie Mac Ginnie Mae Farmer Mac 319 6

7 Government-sponsored Agencies Fannie Mae Federal National Mortgage Association (FNMA) y Created in 1938 to establish a secondary market for FHA loans. y Now a government-chartered private corporation supervised by HUD. y Buys conventional, FHA, and VA loans. 319 Government-sponsored Agencies Freddie Mac Federal Home Loan Mortgage Corporation y Created in 1970 to provide a secondary market for savings and loans. y Private corporation supervised by HUD. 319 Government-sponsored Agencies Ginnie Mae Government National Mortgage Association y Government agency within HUD. y Provides assistance for lower income housing loans. y Buys FHA and VA loans

8 Government-sponsored Agencies Farmer Mac Federal Agricultural Mortgage Corporation Buys agricultural real estate loans and rural housing mortgage loans. 319 Government-sponsored Agencies Financial oversight Office of Federal Housing Enterprise Oversight: Monitors Fannie Mae and Freddie Mac to make sure they remain financially sound. 319 Secondary Market Uniform underwriting standards Fannie Mae and Freddie Mac set uniform underwriting standards that lenders follow so their loans can be sold on secondary market

9 Summary Finance Markets Primary market Secondary market Secondary market agencies Loan discounting Uniform underwriting standards Finance Documents Most home buyers must sign two finance documents: promissory note security instrument (mortgage, deed of trust, or security deed) Security Deed Promissory Note FOR VALUE RECEIVED, Maker promises to pay to the order of Seller Sam, or to Bearer, THE SUM of $100,000,000, paid as follows $5000 or more per month including 11% interest per annum. ACCELERATION: In the event of default, Payee or Bearer can declare all sums due and payable at once. Buyer Ben, Maker Jan 1, Finance Documents Promissory Notes Promissory note: Document in which borrower agrees to repay amount borrowed, plus a specified amount of interest. Borrower = Maker = OR Lender = Payee = OR 320 9

10 Promissory Notes Basic provisions Basic elements of promissory note: amount borrowed (principal amount) interest rate (fixed or variable) payment amount when and how payments are made 320 Promissory Notes Basic provisions Interest rates are subject to usury laws that limit rate. 321 Promissory Notes Types of notes Straight note Installment note

11 Types of Notes Straight note Straight note: Promissory note used for a term loan or interest-only loan. Payments made during loan term cover only interest (no principal). At end of term, borrower must pay back entire principal amount with balloon payment. 321 Types of Notes Installment note Installment note: Promissory note used for amortized loan. Part of each payment is interest; part is principal. Each payment gradually reduces principal balance. 321 Promissory Notes Simple interest Interest paid on real estate loan is always simple interest (not compound interest). Computed annually on remaining principal balance

12 Promissory Notes Negotiable instruments Most promissory notes used in real estate are negotiable instruments. Can be assigned to someone else by endorsement (like a check). 321 Promissory Notes Holder in due course Holder in due course: Third party who purchases a negotiable instrument. Entitled to payment even if problems with original transaction between payee and maker. Estoppel Certificate Document sent by holder in due course requesting true current loan balance from borrower. 321 Finance Documents Security instruments Security instrument: Contract that makes a borrower s property collateral for a loan. If borrower doesn t repay loan, lender can foreclose. Forced sale of property. Lender collects debt from sale proceeds

13 Security Instruments Secured creditor Secured creditor: Creditor who has a security interest in debtor s property. Secured creditor is in much better position to collect a debt. 322 Security Instruments Title theory vs. lien theory Hypothecation: Borrower transferred title to lender until loan was repaid. Borrower remained in possession of security property. Lender held legal title (title without possessory rights). Possessory rights retained by borrower: equitable title. 323 Security Instruments Title theory vs. lien theory Title theory: Lender holds legal title throughout loan term. Lien theory: Borrower retains full title while paying loan off. Lender only has a lien against property. Georgia is a title theory state

14 Security Instruments Mortgages, deeds of trust, and security deeds Three types of security instruments: mortgages deeds of trust security deeds Security deed is most commonly used in Georgia. 323 Security Instruments Mortgages Two parties to a mortgage: mortgagor (borrower) mortgagee (lender) 323 Security Instruments Deeds of trust Three parties to a deed of trust: trustor or grantor (borrower) beneficiary (lender) trustee (neutral third party who handles foreclosure if necessary)

15 Security Instruments Security deeds Two parties to a security deed: grantor (borrower) and grantee (lender) Security deeds differ from mortgages in that the instrument conveys legal title to the lender. 323 Security Instruments Recording Lender should record security instrument as soon as loan is made. Recording: gives public notice of lender s lien against property protects lender from subsequent claims 323 Summary Finance Documents Promissory note Straight note Installment note Security instrument Title theory Lien theory Mortgage Deed of trust Security deed 15

16 Security Instrument Provisions Mortgaging or granting clause Security instrument must state that property is pledged as security for loan. Mortgaging clause in mortgage. Granting clause in deed of trust or security deed (in Georgia, it gives title to the property to lender) 324 Security Instrument Provisions Property description Security instrument must contain complete and unambiguous legal description of collateral property. A street address is not enough. 324 Security Instrument Provisions Acceleration clause Acceleration clause: Gives lender right to demand immediate payment of entire amount owed if borrower defaults. If borrower doesn t meet demand, lender can foreclose

17 Security Instrument Provisions Covenants Covenant to pay taxes: borrower promises to pay real estate taxes and special assessments when due. Covenant of insurance: borrower promises to keep property insured against damage or destruction. 324 Security Instrument Provisions Covenants Covenant against removal: borrower promises not to remove or demolish improvements. Covenant of good repair: borrower promises to keep property in good condition. Covenant to acknowledge indebtedness: estoppell certificate. 324 Security Instrument Provisions Alienation clause Alienation clause: Permits lender to accelerate loan if borrower sells property or transfers it to someone else. Also called due-on-sale clause

18 Security Instrument Provisions Alienation clause Alienation clause does not prohibit sale of property. But borrower must be able to pay off loan if property is sold without lender approval. 324 Security Instrument Provisions No alienation clause If no alienation clause in security instrument, new buyer may either: assume seller s mortgage/deed of trust, or take title subject to mortgage/deed of trust. 325 No Alienation Clause Assumption In an assumption: new buyer assumes responsibility for repaying lender original borrower remains secondarily liable unless released from liability by lender

19 No Alienation Clause Taking title subject to existing lien If new buyer takes title subject to an existing mortgage: original borrower remains primarily liable for repaying loan new buyer is not personally liable for the loan But lender can still foreclose if original borrower defaults. 325 Security Instrument Provisions Late payment penalty Late payment charges are allowed only if provided for in the finance documents. Georgia places some limits on late payment penalties: lender may not charge late penalty until payments is past due by ten days or more penalty may not be more than 5% of payment amount 325 Security Instrument Provisions Lock-in clause Lock-in clause: Prohibits borrower from paying the loan off early

20 Security Instrument Provisions Prepayment penalty Prepayment penalty: Borrower pays penalty if more than a specified amount of principal is repaid early. Prepayment penalty not allowed if loan is insured or guaranteed by federal government. 325 Security Instrument Provisions Subordination clause Subordination clause: Makes lien created by instrument with subordination clause have lower priority than mortgage/deed of trust recorded in the future. Often found in security instrument for loan used to buy vacant land. Buyer intends to obtain construction loan later. Later lender will require first lien position for construction loan (high risk). 326 Security Instrument Provisions Condemnation clause Condemnation clause: If property is taken in eminent domain action, clause gives lender right to use all or part of condemnation award to satisfy loan

21 Security Instrument Provisions Assignment of rents clause Assignment of rents clause: If borrower defaults, property s rental income is assigned to lender. 326 Security Instrument Provisions Exculpatory clause Exculpatory clause: States that the property is sole security for debt, and borrower will not be personally liable. Prevents lender from obtaining deficiency judgment. 326 Security Instrument Provisions Defeasance clause Defeasance clause: Lender agrees to cancel security instrument when debt has been paid off. Buyer receives and records: deed of reconveyance, satisfaction of mortgage, or cancellation

22 Summary Security Instrument Provisions Acceleration clause Covenants Alienation clause Assumption Subject to Prepayment Subordination clause Assignment of rents clause Defeasance clause Deed of reconveyance Satisfaction of mortgage Cancellation Foreclosure Foreclosure is real estate lender s remedy when a borrower defaults. Forms and procedures vary from state to state. Typically, mortgages are foreclosed judicially; deeds of trust and security deeds are foreclosed nonjudicially. In Georgia, security deeds are foreclosed nonjudicially. 327 Mortgage Foreclosure Judicial foreclosure process 1. Mortgagee files foreclosure action. 2. Junior lienholders identified in title search 3. Lender records lis pendens. 4. Judge issues decree of foreclosure. 5. Property is sold at public auction

23 Mortgage Foreclosure Reinstatement Depending on the security instrument s terms, reinstatement period allows borrower to cure default by paying all past due amounts. Reinstatement period lasts until foreclosure decree is issued. 327 Mortgage Foreclosure Equitable redemption In Georgia, lender determines if borrower has equitable right of redemption. If so, borrower may redeem property prior to foreclosure sale by paying off entire balance, interest, costs, and fees. 327 Mortgage Foreclosure Statutory Redemption Defaulted borrower may redeem property after foreclosure sale by paying off entire debt

24 Mortgage Foreclosure Surplus or deficiency After liens paid off, borrower receives any surplus from foreclosure sale. If proceeds don t cover loan amount, lender may sue borrower for deficiency judgment. 327 Security Deed Foreclosure Nonjudicial foreclosure process Power of sale clause: Provision in deed of trust or security deed authorizing lender to sell property (without going to court) if borrower defaults. Deed Power of Sale Clause 328 Security Deed Foreclosure Nonjudicial foreclosure process 1. Lender records notice of default and sends copies to borrower. 2. Notice of sale must be published in newspaper of general circulation

25 Security Deed Foreclosure Deficiency judgments In Georgia, a deficiency judgment is permitted in nonjudicial foreclosures. If deficiency judgment is permitted, lender typically must obtain court order to collect judgment. 328 Junior Lienholders Junior lienholders generally entitled to notice of foreclosure sale; notice may not be required in nonjudicial foreclosure. Sale proceeds often aren t enough to cover junior liens. Junior lienholder can protect interest by curing default and foreclosing on own lien. 328 Strict Foreclosure Strict foreclosure: When borrower defaults, lender files lawsuit and court establishes deadline for redemption. If borrower misses deadline, lender is awarded title to property (no public sale). Only allowed in a few states

26 Deed in Lieu Defaulting borrower who cannot cure default can give lender deed in lieu of foreclosure, which transfers title to lender and stops foreclosure. Lender takes title subject to any other liens on property. 329 Foreclosure vs. Bankruptcy Bankruptcy: Federal court procedure enabling debtor to reduce, modify, or eliminate unmanageable debts. If borrower files for bankruptcy, any foreclosure proceedings are put on hold. 329 Summary Foreclosure Judicial foreclosure Lis pendens Reinstatement Equitable redemption Statutory redemption Credit bidding Deficiency judgment Nonjudicial foreclosure Strict foreclosure Deed in lieu Bankruptcy 26

27 Seller Financing Seller financing: Seller extends credit to buyer, accepting a downpayment and arranging to be paid over time. If seller asks buyer to execute mortgage or deed of trust: purchase money loan. Alternatively, seller can use land contract (also called real estate contract, installment sales contract, or contract for deed). 330 Seller Financing Land contract: Vendee (buyer) agrees to pay vendor (seller) purchase price, plus interest, in installments over a specified number of years. Vendee takes possession of property immediately, but title doesn t transfer until full purchase price is paid. Title 330 Types of Mortgage Loans First/second mortgages First mortgage: Loan with first lien priority. Loans with lower priority are known as second mortgages, third mortgages, etc. First mortgage is senior to second mortgage. Second mortgage is junior to first mortgage, but senior to third mortgage

28 Types of Mortgage Loans Purchase money mortgage Purchase money mortgage: Any mortgage loan used to buy property that serves as security for loan. May also refer specifically to mortgage given by buyer to seller in a seller-financed transaction. 331 Types of Mortgage Loans Budget mortgage Budget mortgage: When prorated share of property taxes and insurance is added to monthly principal and interest payment. Helps insure that property taxes and insurance are paid on time. 331 Types of Mortgage Loans Package mortgage Package mortgage: Mortgage used to pay for both real and personal property. For example: Office or farm equipment included in sale of real property

29 Types of Mortgage Loans Construction mortgage Construction mortgage: Temporary loan used to finance construction of improvements on land. Fixed disbursement plan: Loan funds disbursed to borrower as construction proceeds (obligatory advances). 332 Types of Mortgage Loans Construction mortgage Take-out loan: Borrower obtains permanent financing of construction debt after construction completed. Standby loan commitment: Lender s promise to make take-out loan later, when borrower needs it. 332 Types of Mortgage Loans Blanket mortgage Blanket mortgage: When several pieces of property are used to secure one loan. When portion of loan has been repaid, some parcels are released from lien, under partial release clause

30 Types of Mortgage Loans Participation mortgage Participation mortgage: Lender is entitled to portion of mortgaged property s earnings, in addition to interest payments. 333 Types of Mortgage Loans Graduated payment mortgage Fixed interest rate Graduated payment mortgage (GPM): Borrower makes lower payments in early years of loan and later steps up to fully amortized payment. Negative amortization 333 Types of Mortgage Loans Adjustable-rate mortgage Adjustable-rate mortgage (ARM): Interest rate may be increased or decreased periodically to reflect changes in market interest rates

31 Types of Mortgage Loans Wraparound mortgage Wraparound mortgage: New mortgage that incorporates existing first mortgage. Buyer makes loan payments to seller. Seller uses portion of each payment received to make payment on his underlying mortgage. 333 Types of Mortgage Loans Open-end mortgage Open-end mortgage: Mortgage that allows borrower who has paid off part of loan to reborrow funds up to a certain limit. 333 Types of Mortgage Loans Home equity mortgage Home equity mortgage: Loan obtained using equity in borrower s home as collateral. Equity: Difference between property s market value and any liens against it. Market Value Liens = Equity

32 Types of Mortgage Loans Home equity mortgage Home equity line of credit (HELOC): Revolving credit account that borrowers can draw on as need arises. 334 Types of Mortgage Loans Reverse equity mortgage Reverse equity mortgage: Allows elderly person who owns home free and clear to bring in additional income by converting home equity into cash. Owner receives monthly payment in return for mortgaging home. In most cases, mortgage is paid off when home is sold after owner s death. 334 Types of Mortgage Loans Refinance mortgage Refinance mortgage: Using funds from new mortgage loan to pay off existing mortgage loan. Typically used when interest rates drop, or when payoff date approaches and large balloon payment is due

33 Summary Types of Mortgage Loans Purchase money mortgage Swing loan Budget mortgage Package mortgage Construction mortgage Blanket mortgage Participation mortgage Graduated payment mortgage Adjustable-rate mortgage Wraparound mortgage Open-end mortgage Home equity loan Reverse equity mortgage Refinance mortgage 33