Flashcards in Chapter 12: Residential Mortgages Deck (163)
Title theory is the oldest form of mortgaging, which originated under English common law. Under this system, the borrower was required to temporarily convey ownership of the property to the lender for the duration of the loan period. If the borrower defaulted on the loan during the loan period, the lender took possession of the property.
Deed of Trust
A deed of trust is used in title theory states in place of a mortgage. The deed of trust temporarily conveys title to a property to a third party called a trustee until the mortgage loan debt is repaid or until default occurs. The borrower is called a trustor; the lender is called the beneficiary. Upon satisfaction of the debt, the title is returned to the borrower by using a reconveyance deed.
Several states still use
Several states still use a modified form of the title theory of mortgaging. However, today, all states require some form of foreclosure in the event of a default. When the loan is satisfied, a reconveyance deed is executed to the borrower.
Lien Theory of Mortgages
Florida is a lien theory state. Lien theory allows the borrower to retain the ownership of the property during the loan period. The lender records the mortgage, which creates a lien against the property.
Under the lien theory, the foreclosure process is more involved than under title theory; the borrower is given the right to cure the default instead of simply forfeiting the property.
When money is borrowed to purchase real estate, the lender requires the borrower to sign a promissory note, also called a note or bond.
The promissory note is a legal instrument that includes the borrower’s promise to repay the loan with interest according to the terms of the note. The note is evidence of a personal debt, and contains the names of the parties, the rate of interest, the amount of money borrowed, and the loan repayment terms. The note is a contract between the lender and the borrower.
Note of Even Date
The promissory note is often identified as a note of even date, meaning that the promissory note was created on the same day as the mortgage. A promissory note provides no collateral to the lender other than the borrower’s promise to repay the loan. When the promissory note is unsecured, the lender is in a risky position if the borrower defaults and fails to repay the loan as agreed. Consequently, lenders prefer to have some security that helps assure repayment of the note.
A promissory note that is secured by a mortgage.
What is a Mortgage?
A mortgage accompanies a note and is security for its repayment. A mortgage is the borrower’s pledge of the mortgaged property to secure the repayment of the note. Obtaining the mortgage from the borrower reduces a lender’s risk of loss resulting from a borrower’s default on the loan. The lender records the mortgage on the public record, which creates a lien against the property. This gives the lender the ability to foreclose on the borrower’s property in the event of default. The proceeds of a foreclosure sale can be applied to the outstanding balance of the note.
The pledge of property as security for a loan
Parties to a Mortgage
The property owner, the mortgagor, is the party who gives the mortgage to the lender to secure the loan. The lender, the mortgagee, is the party who receives the mortgage from the property owner. The mortgagor owns the real property, while the mortgagee owns the mortgage, which is personal property.
Requirements for a Valid Mortgage
A valid mortgage must:
• Be in writing,
• Be signed by the mortgagor,
• Conform to the same requirements as any valid contract,
• Contain the legal description of the property, and
• Be witnessed by two persons.
Recording the Mortgage
Normally, the mortgagee records the mortgage to provide constructive notice of the lien. The promissory note is rarely recorded, but the note is referred to in the recorded mortgage. Recording the note would allow other lenders to know the exact details of the loan, which would give them the ability to offer better terms and “raid” the originating lender’s customers.
Satisfaction of Mortgage
When a loan has been paid in full in a lien theory state, such as Florida, the mortgagor should receive a letter of satisfaction from the mortgagee within 60 days of the loan payoff. This letter states that the loan terms have been fully satisfied. It should be recorded in the public records to offset the lien that was created when the original mortgage was recorded.
The first mortgage, also referred to as the first lien, is the primary claim on a property that takes precedence over all other subsequent (junior) mortgage claims and most other liens. A first mortgage is often used to purchase the property. In the case of foreclosure, the first mortgage will be paid first.
Mortgage liens are given priority by the date they were received. When a loan is used to finance a property, it is usually the first lien placed against the property and, therefore, has the highest priority over all liens with the exception of real estate taxes and special assessments.
A junior mortgage is one that is subordinate to a first or prior (senior) mortgage. A junior mortgage often refers to a second mortgage, but it could also be a third or fourth mortgage. A home equity loan and home equity line of credit (HELOC) are two common types of junior mortgages.
A subordination agreement is a written contract in which a lender who has secured a loan by a mortgage or deed of trust agrees with the property owner to subordinate the first loan to a new loan (giving the new loan priority in any foreclosure or payoff). The agreement must be acknowledged by a notary so it can be recorded in the official county records.
A subordination agreement is used to grant first lien status to a lienholder who would otherwise be secondary to a first lien.
A mortgage subordination agreement is frequently used when there are two mortgages on a property, a first mortgage and a second mortgage, and the mortgagor wants to refinance the first mortgage.
What happens if the holder of the second mortgage does not subordinate the lien of its mortgage to the new mortgage?
the new lender will not refinance the first mortgage. This is due to the fact that when the first mortgage is refinanced, it is essentially paid off and replaced with a new loan.
What was the second mortgage then becomes the first mortgage, and the newly refinanced mortgage would become a lower priority lien. The second mortgage holder does not want to incur the additional costs of releasing its mortgage and re-filing, so the second mortgage holder will subordinate its lien to the lien of the replacement (refinanced) mortgage to all the refinanced first mortgage to remain in first lien status.
What are the provisions designed to protect both the lender and the borrower?
Due-on-Sale Clause (alienation clause)
Escalation (or Escalator) Clause
Insurance Clause or Covenant of Insurance
Maintenance Clause or Covenant of good repair
Tax Clause or Covenant to Pay Taxes
allows the lender to declare the entire outstanding balance due and payable immediately whenever default occurs. Without having this ability, the lender would have to sure each time the borrower defaulted, month after month. By calling the entire balance due at one time, this clause avoids the time and expense of that process.
gives a lender the right to foreclose at its option by requiring a borrower to admit any future default at the time a loan is obtained. The borrower is prevented from defending against a foreclosure, which results in an automatic judgment in favor of the lender when the loan documents are presented in court. This is obviously a very harsh provision and is not allowed in Florida.
provides protection for the borrower as it requires the lender to acknowledge performance by the borrower. The defeasance clause holds the lender’s rights in check as long as the borrower performs as agreed in the note and mortgage. The defeasance clause is the only legally necessary clause in a mortgage.
Due-on-Sale Clause or alienation clause
in a loan or promissory note stipulates that the full balance may be called due-on-sale upon transfer of ownership of the property used to secure the note. This clause prevents a borrower from transferring any interest in the mortgaged property without permission of the lender. If the property is sold, or any substantial interest in it is conveyed, the lender has the right to declare the entire loan balance due and payable immediately. The due-on-sale clause prevents an assumption of the mortgage by an unqualified borrower. Any borrower interested in assuming the existing loan would have to apply and be approved by the lender.
Escalation (or Escalator) Clause
allows a lender to increase the interest rate based on the occurrence of an event, such as a change in the use of the property or consistently late payments.
limits the lender’s rights in a foreclosure to the amount received from the sale of the foreclosed property. If the balance of the promissory note has not been paid in full from the proceeds of the sale, the lender cannot obtain a deficiency judgment for the unsatisfied amount. This is referred to as nonrecourse financing since the lender has no recourse against the borrower for the unsatisfied portion of the loan.
Insurance Clause or Covenant of the Insurance
is the borrower’s promise to maintain adequate insurance coverage. Mortgages typically require the borrower to carry fire and hazard insurance in an amount at least equal to the unpaid balance of the loan. Should a property burn to the ground or be severely damaged in a storm, the borrower may not be financially able to replace or repair the structure, thereby exposing the lender to the possibility of loss.
Maintenance Clause or Covenant of good repair
is a provision that requires the borrower to maintain the property properly during the term of the loan, to protect the property’s value. If a property is not maintained properly and the value diminishes, a lender could lose money in a foreclosure action.
allows a borrower to borrow additional funds based on the same mortgage after the loan balance has been paid down. This ability is usually limited to the amount of the original loan amount. This can reduce the cost involved in obtaining an entirely new loan. The lender generally reserves the right to increase the interest rate. A mortgage containing this provision is similar to an equity loan or revolving line of credit.
allows a borrower to pay off a loan early, thereby avoiding the interest that would otherwise have to be paid. In Florida, a borrower has the right to prepay a loan whether this right is expressed in the mortgage or not. When interest rates are high, lenders would prefer that a loan not be paid ahead of schedule. During these times, some loans may include a prepayment penalty clause within the prepayment clause. A penalty clause requires the borrower to pay a certain amount to the lender for the privilege of prepaying the debt.
is used in mortgages on income-producing real estate. If the investor should default, the lender may ask the court to appoint a trustee, referred to as a receiver, to manage the property during the foreclosure process, collect the rents, and maintain the property. This serves to protect the asset that serves as security for the loan. Without this provision, the borrower could pocket the rents and allow the property to deteriorate, thereby reducing its value.