Chapter 9 Real Estate Finance: The Laws and Contracts Real Estate FIN 331 Fall 2014 Dr. David P. EchevarriaAll Rights Reserved1

General Characteristics of Real Estate Contracts A.Most real estate transactions involve debt financing B.Most businesses prefer to have their cash in the bank rather than tied up in real estate C.Most investors leverage their investments in order to increase their returns on equity D.Mortgage debt financing is a major aspect of real estate decisions Dr. David P. EchevarriaAll Rights Reserved2

General Characteristics of Real Estate Contracts D.Mortgage lending is a major industry in United States and many other countries E.A mortgage loan creates documents: a note and a mortgage or deed of trust F.Debt financing also has tax advantages  a/releases/mortoutstand/current.htm a/releases/mortoutstand/current.htm Dr. David P. EchevarriaAll Rights Reserved3

The Note A.Interest rates - Interest charges 1.Interest rates may be fixed or variable 2.Mortgages are amortized a.Payments consist of principal and interest b.The principal portion increases over time c.The interest portion decreases over time Dr. David P. EchevarriaAll Rights Reserved4

The Note B.Adjustable Rate Mortgages 1.Adjustable-rate mortgages generally use an index 2.The index might be U.S. Treasury constant maturity rates (10-year) or the LIBOR 3.As the index changes the adjustable rates change 4.All adjustable-rate mortgages have floors and caps a.A floor is the lowest rates can go b.A cap Is the highest rates can go 5.Margin is the lenders markup above the index rate 6.Teaser rates: a reduced interest rate for a short period of time Dr. David P. EchevarriaAll Rights Reserved5

Interest Rate Volatility Dr. David P. EchevarriaAll Rights Reserved6

Disclaimer from BBA Ltd For your information, and for historic reference purposes only, a link to the previous BBA LIBOR website (pre-regulation) can be found here ( Please note that all information contained within the previous website shall from 2 April 2013 be considered to be for historic reference purposes only and BBA, BBA Enterprises Ltd and BBA LIBOR Ltd accept no responsibility for any reliance placed on any such information from such point in time. To the extent permitted by applicable law, BBA, BBA Enterprises Ltd and BBA LIBOR Ltd expressly disclaim all liability howsoever arising whether in contract, tort or otherwise (including, but not limited to, liability for any negligent act or omissions) to any person in respect of any claims or losses of any nature, arising directly or indirectly from: (i) anything done or the consequences of anything done or omitted to be done wholly or partly in reliance upon the whole or any part of the contents of this website; and (ii) the use of any data or materials on this website or unauthorized access to this website or otherwise. Information on this website is not offered as advice on any particular matter and must not be treated as a substitute for specific advice. In particular, information on this website does not constitute professional, financial or investment advice and must not be used as a basis for making investment decisions and is in no way intended, directly or indirectly, as an invitation or offer to buy, sell, hold, lend, subscribe for, or otherwise deal in any legal or beneficial interest in any financial instrument. Dr. David P. EchevarriaAll Rights Reserved7

The Note A.Payments 1.Payments are made at the end of the month 2.Loans may be fully or partially amortized 3.Loans may also have a balloon payment 4.Some loans may be interest only 5.Some loans may involve negative amortization in the early years 6.Terms may be shortened by adding additional principal to each payment a.All “conforming” and FHA/VA loans b.Home equity credit lines Dr. David P. EchevarriaAll Rights Reserved8

The Note 1.Loans with restricted right of prepayment a.Subprime home loans b.“Jumbo” home loans c.Most income property mortgage loans d.Lender may impose prepayment penaltie s D.Other Terms 1.Nonrecourse loan: No personal liability a.Exculpatory clause: relieves one party if damages caused during execution of the contract b.Lender prohibited from charging back unpaid claims due to borrower’s inability to pay. 2.Demand clause: Right of lender to require prepayment 3.Inclusion of mortgage clauses by reference Dr. David P. EchevarriaAll Rights Reserved9

The Mortgage vs. Deed of trust A.Mortgagor: Borrower B.Mortgagee: Lender (holds deed to property) C.Deed of Trust: Deed held by Trustee (not bank) D.Title vs. lien theory 1.Title theory: Mortgage a temporary transfer of title 2.Lien theory: Mortgage is a lien 3.Historic difference was lender’s claim to rents and possession in case of default Dr. David P. EchevarriaAll Rights Reserved10

The Mortgage (Deed of trust) D.Some Important Mortgage (DOT) Clauses 1.Description of the property 2.Insurance clause 3.Escrow clause 4.Acceleration clause 5.Due-on-sale clause 6.Hazardous substances clause 7.Preservation and maintenance clause Dr. David P. EchevarriaAll Rights Reserved11

Default A.Failure to meet requirements of the note or mortgage 1.Technical default: Any violation of terms 2.Substantive default: Three missed payments (90 days) B.Non-Foreclosure Responses to Default 1.Counseling and consumer debt reorganization 2.Temporary reduction of payments 3.Assisted sale 4.Short sale 5.Deed in lieu of foreclosure a.Advantages: quick, quiet, cheap b.Disadvantages: other liens remain; bankruptcy can nullify and wipe out mortgage Dr. David P. EchevarriaAll Rights Reserved12

Default C.Foreclosure 1.Legal process of terminating all claims of ownership and all liens inferior to foreclosing lien 2.Negatives a.Risk of failing to notify a claimant b.Presence of superior liens c.Costly and time consuming d.Distressed sale 3.Importance of lien priority Dr. David P. EchevarriaAll Rights Reserved13

Default 4.Recourses of the defaulted mortgagor a.Equity of redemption b.Statutory right of redemption 5.Deficiency judgment: Judgment against mortgagor for unrecovered balance Example: a.Net foreclosure auction price: $100,000 b.Remaining loan balance: $120,000 c.Deficiency : $20,000 6.Judicial foreclosure vs. power of sale a.Judicial foreclosure: Court-administered public auction b.Power of sale: Public auction conducted by trustee or mortgagee (preferred by lenders) Dr. David P. EchevarriaAll Rights Reserved14

Bankruptcy A.Three forms of bankruptcy 1.Chapter 7: Liquidation 2.Chapter 11: Court supervised “workout” 3.Chapter 13: Wage-earner’s proceeding B.No form of bankruptcy can set aside a mortgage lien C.Chapters 11 and 13 can result in delays Dr. David P. EchevarriaAll Rights Reserved15

Regulation of Home Mortgage Lending A.Equal Credit Opportunity Act: no discrimination (protected classes) B.Federal Truth-in-Lending Act (TILA): full disclosure C.Real Estate Settlement Procedures Act (RESPA): Standard HUD forms/requirements D.Other laws 1.Home Ownership and Equity Protection Act 2.Home Mortgage Disclosure Act 3.Community Reinvestment Act Dr. David P. EchevarriaAll Rights Reserved16

Regulation of Home mortgage Lending A.Dodd-Frank Wall Street Reform and Consumer Protection Act of Given oversight and enforcement power for: a.All federal consumer financial protection laws b.Anti-discrimination laws in consumer finance c.To restrict unfair, deceptive or abusive practices d.Receive consumer complaints e.Promote financial education f.Power to monitor emerging consumer financial risks 2.Centralizes a multitude of regulators within one agency for home mortgage lending Dr. David P. EchevarriaAll Rights Reserved17

Homework Assignment A.Key terms: Adjustable-Rate Mortgage, Balloon Loan, Contract For Deed, Deed Of Trust, Default, Foreclosure, Libor, Negative Amortization, Nonrecourse Loans, Recourse Loans, Short Sale, Term To Maturity, LIBOR B.Study Questions: 1, 4, 6 - parts a, b, c, d Dr. David P. EchevarriaAll Rights Reserved18