Mortgage Financing. Mindy Stern, Esq. Schwartz Sladkus Reich Greenberg Atlas LLP New York, New York

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1 Mortgage Financing by Mindy Stern, Esq. Schwartz Sladkus Reich Greenberg Atlas LLP New York, New York 61

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3 4. Mortgage Financing By Mindy Stern, New York, NY A. Sources of Financing Institutional Lenders (savings banks, commercial banks, savings and loan associations, credit unions) Most common Mortgages securing 1-4 family residences are heavily regulated by consumer protection laws, requiring full written disclosure of loan terms, and restrictions on lenders Private Lenders Typically the seller, sometimes a friend, relative or private investor Assumption of Existing Debt Existing Lender Must Consent Saves mortgage recording tax, some title insurance and other closing costs Seller (original borrower) remains liable unless lender releases original borrower in writing; and unless purchaser expressly assumes mortgage debt through deed or by separate agreement, purchaser takes title subject to the mortgage, but is not personally liable for it Consolidation of Existing Debt with New Loan Purpose: to save mortgage recording tax How it works: the existing note and mortgage are assigned to the new lender; the new lender issues a note and mortgage (commonly referred to as a gap note and a gap mortgage) in a principal amount equal to the difference between the current principal balance of the existing mortgage, and the total loan amount; the two notes and mortgages are then consolidated into a single loan pursuant to a consolidated loan note and a consolidation, extension and modification agreement (commonly referred to as a CEMA ). Mortgage recording tax is paid only on the new loan proceeds (the amount of the gap mortgage ) because mortgage tax has already been paid on the amount of the existing mortgage. CEMAs are common in commercial transactions, but rare in residential transactions, for several reasons. - First, New York law only requires lenders to deliver satisfactions of mortgage when a loan is fully repaid. RPL Section 275. They are not required to deliver assignments of mortgage. - Second, many residential loans are sold on the secondary market, through Fannie Mae and Freddie Mac programs, where CEMAs are customary when the same lender is refinancing an existing loan with the same borrower, but usually not 63

4 permitted when the property is being sold to a new owner, even when the purchaser is obtaining financing from the same lender. - Third, in the case of an assignment, it is unlikely that the new lender will agree to release the seller from liability under the existing debt, and most residential sellers are uncomfortable about retaining that continuing liability after the property is sold. - Fourth, it is not always possible to locate the original note or notes being assigned, and some new lenders are uncomfortable taking an assignment of existing debt without them, even with a replacement note and indemnity from the existing lender. - Finally, the legal fees associated with an assignment typically are higher than those associated with a satisfaction of mortgage, so the CEMA is not cost effective unless the mortgage tax savings outweigh the higher transaction costs. B. Finding Those Sources: Mortgage brokers and mortgage bankers Mortgage Brokers Mortgage brokers do not (and are not permitted to) originate loans. They solicit loans from lending sources. Reasons to Use Mortgage Brokers - Mortgage brokers help borrowers compare loan products, and direct borrowers to lenders and loan products best suited to the borrower s needs and goals. - Mortgage brokers can help borrowers with credit history issues or those looking for financing for property not all institutional lenders would embrace (such as a coop or condo with less than 10 units, or one with a high percentage of non owneroccupied units). - Mortgage brokers help clients challenged by paperwork to close a loan more quickly. Caveats about Mortgage Brokers - Not all institutional lenders work with mortgage brokers, so the universe of loan products available to mortgage brokers may be limited, and a client may find a better loan working directly with an institutional lender, or mortgage banker - Although mortgage brokers often advise clients that because their fees are paid by the lender, their services are free to the borrower, in reality those fees are built into the loan, so a client might be able to save money working directly with an institution with which the client has an existing relationship. Shopping the loan is prudent. One way to do so: HSH Associates Mortgage Bankers Mortgage lenders who make more than five residential loans per calendar year in New York and who are not otherwise regulated by federal or state law (such as banks, thrift institutions 64

5 and credit unions) are required to be licensed by the New York State Superintendent of Banks as a mortgage lender. Banking Law Article 12-D. Federal Law - The mortgage lender s charter often determines the disclosures required to be made in the lending process. Almost all institutional lenders are required by federal law (the Truth in Lending Act, and the Real Estate Settlement Procedures Act) to make various disclosures to borrowers intended to ensure that the borrower understands the true cost of the residential mortgage loan over the life of the loan as well as the up-front closing fees and expenses. New York Law The New York State Banking Department imposes additional disclosure requirements, fee restrictions and operational mandates on residential mortgage lenders. OCC National banking associations with principal offices in New York State also must comply with federal regulations promulgated by the Office of the Comptroller of the Currency. These regulations generally pre-empt state regulations or conflicting federal regulations. But given the relatively few regulations concerning residential mortgages issued by OCC, most such associations generally follow the federal and state requirements. C. Representation of multiple parties (Borrower or Seller and Lender) Under ethical guidelines, an attorney may represent both the borrower and the lender in a real estate transaction with express consent after full disclosure. NYSBA Ethics Op. 438 (1976). However, a lawyer generally should not represent the seller and the lender in the same transaction except under unusual circumstances, and unless the conditions of DR 5-105(C) are met. NYSBA Ethics Op The borrower may (and typically does) pay the legal fee of lender s counsel in a mortgage transaction. In residential transactions, the fee - typically a flat fee - is disclosed in the Good Faith Estimate provided to the borrower when the loan application is submitted. D. Loan application and qualification Types of Loans - Fixed Rate. Interest rate doesn t change. Payments made in equal monthly installments of principal and interest to completely amortize the principal over the term of the loan. - Adjustable. Interest rate varies over the loan term; monthly payments increase or decrease accordingly. Some variable rates change annually; other products have change dates every 3, 5 or 7 years; others are a hybrid: adjustable rate with an option to convert to a fixed rate after a certain period of time. Most have caps - both as to each interest rate adjustment, and the life of the loan. Many also have a floor - that the rate will never be less than a certain amount below the original rate. - Credit Line. Extension of credit secured by real property permitting borrower to borrow, repay and borrow again up to a specified maximum amount. Can be a first mortgage but more commonly a second mortgage loan supplementing an 65

6 earlier or contemporaneous one secured by a first mortgage. Often referred to in residential transactions as a Home Equity Line of Credit ( HELOC ). Can be fixed or adjustable rate. Typically permits advances and re-advances during a finite period up to the maximum amount allowed (not exceeding 20 years under New York Tax Law Section 253-b and Real Property Law Section 281), after which no further borrowing is permitted and the loan must be repaid. - Reverse. A loan program authorized by New York Real Property Law Sections 280 and 280(a) and heavily regulated. They are structured as an annuity which permits a borrower age 60 or older (age 70 under mortgages created pursuant to Section 280(a)) to tap into the equity of a home by receiving monthly payments from a lender for a specified term, and payable in full when the homeowner dies, sells or permanently vacates the home. The loan must be prepayable without penalty, and the lender is permitted to look only to the value of the property for repayment, and not to the borrower s other assets. In recent years these loans have come under greater scrutiny as a result of abuses in loan disclosure and other practices by some lenders, and default rates higher than those for typical mortgages. See October 15, 2012 New York Times article by Elizabeth Ecker entitled Abuse Growing in Loan Option for the Elderly in print version, and A Risky Lifeline for Seniors is Costing Some Their Homes in on-line version. - Government Loans. The Federal Housing Administration ( FHA ) does not issue loans, but has guarantee/insurance programs intended to encourage lenders to make loans secured by 1-4 family residences in certain geographic areas to people who might not otherwise qualify. The Veterans Administration ( VA ) also does not issue loans, but has a similar guarantee/insurance program intended to encourage lenders to make loans to veterans who might not otherwise qualify for them. The State of New York Mortgage Agency ( SONYMA ) was formed pursuant to New York Public Authorities Law Section 2401 to provide a stable supply of adequate funds for residential mortgages in response to a housing shortage for low income borrowers and to spur new housing starts to reduce the hazards of underemployment in the construction industry. It offers an insurance program similar to those of the FHA and VA. Loan Application, Qualification and Costs - Creditworthiness. Suggest to your client that he or she establish his or her creditworthiness before the contract is signed to the extent possible; many can obtain pre-contract credit clearance, and some sellers require it before they will consent to a contract financing contingency. - The Application. o Most banks use the same form- designed by Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). o Requires borrowers to state their assets/liabilities. o Lenders typically order a credit history to verify what s in it. 66

7 - Loan Costs. Pre-Closing: o Application fee o Credit check o Appraisal o Points o Lock-in-Fee Closing: o Escrows for Taxes, Insurance - RESPA prohibits lenders from escrowing more than 1/6 of the annual payments o Various Underwriting Charges o Mortgage Insurance through title company, w/extra endorsements (add-on to title) o Hazard Insurance w/ first year premium prepaid w/lender as additional named insured - required for houses, proof of building insurance required for condos and coops; if it s a condo, w/lender added as named insured for the unit. o Mortgage Recording Tax - depending upon where the property is located, and the type of property, rates range from 3/4 % to close to 3%; o Recording Fees (to record the mortgage and any other documents being recorded such as a deed and/or power of attorney) E. Ability-to-Repay and Qualified Mortgage Rule The Consumer Financial Protection Bureau has issued a new Ability-to-Repay and Qualified Mortgage Rule under Regulation Z of TILA, effective January 10, It requires creditors to make a reasonable and good faith determination based on verified and documented information that the borrower has a reasonable ability to repay the lo an according to its terms. It also establishes a presumption of compliance for qualified mortgages. consumerfinance.gov/ /ability-to-repay-and-qualified-mortgage-standardsunder-the-truth-in-lending- (See online materials) At a minimum, creditors must consider eight underwriting factors: (1) current or reasonably expected income or assets; (2) current employment status; (3) monthly payment on the transaction; (4) monthly payment on any simultaneous loan; (5) monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) monthly debt-to-income ratio or residual income, and (8) credit history. Creditors must use reasonably reliable third-party records to verify the information. For adjustable-rate mortgages, the monthly payment must be calculated using the fully 67

8 indexed rate or an introductory rate, whichever is higher. Special payment calculation rules apply for loans with balloon payments, interestonly payments, or negative amortization. The rule also provides special rules to encourage creditors to refinance non-standard mortgages - which included various types of mortgages that can lead to payment shock and result in default - into standard mortgages with fixed rates for at least 5 years that reduce borrowers monthly payments. As to Qualified Mortgages, the line drawn has long been recognized as a rule of thumb to separate prime loans from subprime loans. Under existing regulations only higher-priced mortgage loans are subject to an ability-to repay requirement and a rebuttable presumption of compliance if creditors follow certain requirements. The new rule strengthens the requirements needed to qualify for a rebuttable presumption for subprime loans and defines with more particularity the grounds for rebutting the presumption. Specifically, the final rule provides that borrowers may show a violation with regard to a subprime qualified mortgage by showing that, at the time the loan was originated, the borrower s income and debt obligations left insufficient residual income or assets to meet living expenses. The analysis would consider the consumer s monthly payments on the loan, loan-related obligations, and any simultaneous loans, as well as any recurring material living expenses. With respect to prime loans, the rule will apply the new ability-repay requirement, but creates a strong presumption for those prime loans that constitute Qualified Mortgages. Qualified Mortgages. The Dodd-Frank Act sets certain product-feature prerequisites and affordability underwriting requirements for Qualified Mortgages. The rule prohibits loans with negative amortization, interest-only payments, balloon payments or terms exceeding 30 years. So-called no-doc loans, where the creditor does not verify income or assets, cannot be Qualified Mortgages. A loan generally cannot be a Qualified Mortgage if the points and fees paid by the borrower exceed 3 percent of the total loan amount, although certain bona fide discount points are excluded for prime loans. The rule provides guidance of the calculation of point and fees and thresholds for smaller loans. Monthly payments must be calculated based on the highest payment that will apply in the first 5 years of the loan and the borrower must have a total (or back-end ) debt-to income ratio that is less than or equal to 43 percent (using FHA guidelines for calculations). The rule also prohibits prepayment penalties except for certain fixed-rate qualified mortgages where the penalties satisfy certain restrictions and the creditor has offered the borrower an alternative loan without such penalties. F. Contract Contingency Clauses and Compliance Standard Blumberg Forms (Residential Contract of Sale Jointly Prepared by NYSBA, NYSLTA, ABCNY, NYCLA; Contract of Sale Cooperative Apartment - Prepared by NYSBA; Contract of Sale - Condominium Unit Jointly Prepared by NYSBA and ABCNY) - Commitment Contingency Clauses, not Funding Contingency Clauses o Most Risks After Commitment Obtained Assumed by Purchaser 68

9 o Satisfactory Appraisal Typical Exception 69

10 - Application to a Mortgage Broker (instead of directly to the Lender) - Good Faith Application Required - Compliance with Specified Time Frame to Apply and Obtain the Commitment Letter Other Standard Forms - Vary from one jurisdiction to another. Most usually state the amount of the loan being sought, a date by which the commitment must be obtained, and the deadline by which either just the purchaser or either party can cancel if the commitment isn t obtained. Beyond that, compare the clauses in your materials. Some state that the Purchaser must apply for the loan by a certain date; others just say "immediately" or "promptly" after the contract is signed. Some specify what type of lender is an acceptable source of financing (some say mortgage bankers are ok; others say VA or FHA loans are not ok; others are silent). Some say it s ok to apply to a mortgage broker; others don t. Some say the contingency extends to the funding of the loan; most do not. Some permit the purchaser to cancel if certain types of commitment conditions aren t met (like a satisfactory appraisal); others are silent or specifically state that all such risks are assumed by the Purchaser. Some include a requirement that the Purchaser act in good faith, or use diligence to apply for the loan, and comply with commitment conditions; others don t. Typical Purchaser Concerns - To Obtain Financing on Acceptable Terms - To Ensure the Contract Downpayment is refundable if any Commitment Conditions Cannot Be Met. Some conditions relate to Purchaser s credit, some to the property being purchased. - To Obtain Financing (both the written commitment letter and the funding) within the times specified in the Contract to (1) apply for a loan, (2) obtain a written commitment letter and (3) close title. If the Purchaser or the lender cannot meet those deadlines, the Purchaser technically is in default, although without a "time of the essence" obligation against the Purchaser, he or she can extend the closing date for a reasonable time. o Sometimes the Seller needs more time to cure title or lien problems and the commitment expires before the Seller is ready to close; in that case, the Purchaser needs the right to cancel the contract and get the downpayment back unless the Purchaser can obtain an extension of the commitment or a new one on the same terms without additional expense. - Cooperation from Seller in Loan Application Process o Access to the premises for the lender s appraiser o Access to the premises for a termite inspection o Access to the premises to update an existing survey or, if the lender requires one, to prepare a new survey 70

11 - To receive the Deposit Back if the Purchaser Doesn t Get the Commitment or Funding - To Recover the Purchaser s Financing Costs If the Seller Defaults Typical Seller Concerns Practice Tips - To know as soon as possible if the Purchaser can obtain financing. - To eliminate the contingency either entirely, or as soon as possible after the contract is signed. - To close within the time set in the contract. - Read the contingency clause carefully. Identify what is a deal breaker for your client (whether seller or purchaser), keeping in mind the limitations of the marketplace. In a seller s market, you cannot get a seller to carry all of the financing risks. If you represent the purchaser, reduce them by having your client s credit and the building pre-qualified, and by having the bank issue a commitment that does not have conditions other than the standard ones relating to title, surveys etc; try to avoid commitments subject to appraisal, or commitments subject to the purchaser satisfying various underwriting criteria because if they are not met, and the contingency clause does not permit the purchaser to cancel the contract in that situation, the purchaser must proceed or risk losing the down payment. - Good Faith is probably the single most critical factual issue in loan contingency clause disputes; because whether or not the contract expressly states that the parties must act in good faith, some courts will read that requirement into residential contracts. See Kapur v. Stiefel (decided 9/16/99), 264 A.D.2d 602, 695 N.Y.S.2d 330 (1st Dep t 1999). See analysis in Recent Financing Contingency Developments 3. G. Loan Commitment - Contains the bank s approval of the borrower s application; provides all the details as to the loan amount, type, interest rate, payments, conditions to funding, requirements for title insurance, surveys, appraisals, casualty insurance, etc. - Read it before your client signs it. - Make sure it conforms to the terms of the contingency clause in the contract as to loan amount, interest rate, maturity date and any other specified terms. 71

12 H. Loan Documentation - Make sure you check the deadline for returning the fully executed commitment to the bank; and the date it expires. Coordinate with contract loan contingency period and closing dates. - Note - Fixed Rate or Adjustable Rate - Mortgage (if it s a condo, expect one or two condo riders) - Closing Disclosure Statements Separate Statements for Seller and Purchaser - Miscellaneous Documents Inspired by Consumer Protection Laws o Institutional lenders typically use standard documents; either self-created like Citibank or Fannie Mae/Freddie Mac forms like many savings banks. If you re unfamiliar with them, ask the lender to send you a set of blanks documents before closing so that you can review them in advance; then check them at closing to make sure they re the same, and that the business terms conform to the terms of the commitment letter. o Explain the documents to your client; don t just have them sign. Even the most sophisticated clients need to know what they re signing, so at least highlight the most important provisions; and make sure the clients understand if they re personally liable for the mortgage debt, which is the case with most residential loans. o Also make sure the client knows that it typically takes between minutes to sign all of the loan closing documents, so they re prepared. o If your client will not be attending the closing, make sure the lender approves beforehand the Power of Attorney from your client you intend to deliver. I. Mortgage Note (State Form 3233; Fannie Mae/Freddie Mac Uniform Instrument - New York Fixed Rate) J. Adjustable Rate Note K. Note any Recent Financing Developments (see following 72