CRE Ch 16: Mortgage Basics

Question 1

Describe differences between residential and commercial mortgages

Answer 1

Residential loans are much smaller on average

Residential owner-occupied properties generate no income

Commercial borrowers are staffed by business professionals with much greater
financial expertise than the typical homeowner

Commercial properties tend to be more unique, while single-family homes are
relatively homogeneous

Residential loans are more regulated than commercial loans

The residential mortgage business is a fairly standardized industry, while
commercial mortgages are fairly customized and are created/negotiated one deal
at a time

Question 2

Describe the process of loan securitization

Answer 2

Securitization is when large numbers of individual mortgages are pooled together and
sold into the bond market

The cashflows of the mortgages are then ”passed-through” to the investor

Question 3

Describe two types of commercial mortgages

Answer 3

1. Construction loans: Short-term loans made for financing a construction project
2. Permanent loans: Long-term loans made for financing a completed income
   property

Question 4

Compare and contrast the interest rate and default risk of construction and permanent
loans

Answer 4

Construction loans

Have high default risk, since the underlying building does not exist when the loan
is made

Have low interest rate risk, because the loan has short duration and often made at
floating interest rates
Permanent loans

They have less default risk, as they are secured by a fully operational property

Have more interest rate risk, since the loan is long-term

Question 5

Describe the order in which mortgage payments made by the borrower will get applied
to different components of the debt

Answer 5

The standard order in which payments made by the borrower are applied to different
components of the debt is:
1. Expenses
2. Penalties
3. Interest
4. Principal

Question 6

Describe what an acceleration clause is in a mortgage covenant

Answer 6

Acceleration Clause: Allows the lender to accelerate the loan and make the entire
outstanding principal balance due immediately

This is commonly used when the borrower fails to make loan payments

Allows the lender to obtain the entire remaining loan balance through foreclosure

Question 7

Describe what an exculpatory clause is in a mortgage covenant

Answer 7

Exculpatory Clause: Removes the borrower from responsibility for the debt

If the borrower defaults, the lender will only receive the property that secures the
loan

Loans with this clause are called nonrecourse loans

Question 8

Describe some costs associated with foreclosure

Answer 8

Legal/administrative expenses such as court costs

Deterioration of the property during the foreclosure process

Revenue may be lost by the property (i.e. rent paid by tenants), and interest
payments lost to the lender

Both the borrower and lender can suffer negative reputation effects

Lenders will usually have to write down the value of the assets on their balance
sheets after a foreclosure

Question 9

Describe nonlitigious actions a bank can make in the event of a default

Answer 9

1. Transfer of the loan to a new borrower
2. A procedure called deed in lieu of foreclosure
   Ÿ The borrower gives the property to the lender in return for the lender releasing the
   borrower from the debt
3. Work with the borrower to restructure the loan

Question 10

Describe a situation when a borrower can strategically default

Answer 10

If ”property value - foreclosure costs remaining loan balance”, the borrower can
threaten the lender with default to force a better deal

However, sometimes the lender might consider reputation effects (i.e. being a
”tough guy”) and refuse to negotiate with the borrower

Under this case, foreclosure could still occur, and the borrower could also suffer
from the negative reputation effects of defaulting