Rockwell publishing real estate law chapter 13

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© 2009 Rockwell Institute

1

California Real Estate Law

© Copyright 2007 Rockwell Publishing, Inc.

Lesson 13:Real Estate Financing


Introduction

This lesson will discuss:

l liens

l security instruments

l key provisions in loan agreements

l foreclosure

l protecting the borrower


Liens

Encumbrance: an interest held by someone other than property owner or tenant

l nonpossessory interest

l may be financial or nonfinancial

Financial encumbrance also known as lien.

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Liens

Lien: creditor’s claim against real property that is owned by the debtor

l If debtor fails to pay, creditor can foreclose.

Secured creditor: creditor who holds a lien


Liens

Liens don’t prevent owner from selling or transferring property.

l However, new owner takes title subject to liens.

l Creditors still have right to foreclose.


Liens

Liens classified as:

l general or specific

l voluntary or involuntary

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Liens

Voluntary: property owner gives lien voluntarily to creditor, usually to secure loan

l Example: mortgage

Involuntary: also called statutory lien; attaches without owner’s consent

l Example: property taxes


Liens

General: lien attaches to all debtor’s property, real and personal

Specific: lien attaches only to particular piece of property

Mortgages and deeds of trust are voluntary, specific liens.

Summary


Liens

l Financial encumbrance

l Secured creditor

l General lien

l Specific lien

l Voluntary lien

l Involuntary lien

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Security Instruments

In loan transaction, loan agreement consists of two documents:

l promissory note

l security instrument

Promissory note establishes borrower’s obligation to pay; security instrument makes real property collateral for the debt.



Promissory note: written promise to pay money

l basic evidence of debt

l shows who owes money to whom

Security instrument: mortgage or deed of trust

l turns real property into collateral (security) for the loan



Security property can be:

l property borrower already owns

l property borrower plans to purchase with loan funds

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Earliest form of lending:

l borrower gave lender personal property

l lender held property until loan repaid

Example still exists today: pawnshop

Hypothecation



However, when land is used as collateral, transferring possession is:

l complicated and inconvenient

l unnecessary, since borrower can’t hide collateral (the land)

Hypothecation



Hypothecation: offering property as collateral without giving up possession

l borrower transfers title

l lender holds title until debt repaid

l borrower remains in possession of land

Hypothecation

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Hypothecation led to development of security instruments.

Two ways in which security instruments work:

l title theory

l lien theory

Hypothecation



Title theory: security instrument transfers legal titleto lender or trustee

l borrower keeps possession and equitable title

l generally associated with deed of trust

Hypothecation



Lien theory: security instrument only gives lender lien against property

l until loan is paid off, borrower keeps both possession and legal title

l generally associated with mortgage

Hypothecation

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Title theory vs. lien theory:

l little practical difference between them today

l rights of borrower/lender depend on type of security instrument used

Hypothecation



Mortgages and deeds of trust serve same basic purpose: to secure debtor’s obligation to repay loan.

l difference is foreclosure procedure

Mortgages vs. deeds of trust



Mortgage: two-party security instrument

l borrower (mortgagor)

l lender (mortgagee)


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Deed of trust: three-party security instrument

l borrower (grantor or trustor)

l lender (beneficiary)

l independent third party (trustee)




Mortgage foreclosure process (judicial foreclosure) involves:

l court proceeding

l court-supervised auction




Deed of trust foreclosure process (nonjudicial foreclosure) involves:

l trustee’s auction

l no court supervision

Nonjudicial foreclosure requires power of sale clause in security instrument.


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Power of sale clause:

l authorizes trustee to sell property if borrower defaults

l standard in deed of trust

l can also be used in mortgage (less common)




Deeds of trust:

l more common than mortgages

l preferred by lenders


Summary



l Promissory note

l Security instrument

l Hypothecation

l Title theory

l Lien theory

l Power of sale clause

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Key Provisions in a Loan Agreement

Terms of loan agreement are contained in:

l promissory note (amount borrowed, interest rate, etc.)

l security instrument (lender’s rights, borrower’s obligations, etc.)



Key provisions include:

l taxes, insurance, and maintenance clauses

l acceleration clause

l alienation clause

l late payment penalty provision

l prepayment provision

l subordination clause

l defeasance clause



Various clauses in security agreement require borrower to:

l pay property taxes (to prevent tax foreclosure)

l keep property insured (to prevent uninsured destruction)

l perform adequate maintenance (to prevent waste)

Taxes, maintenance, and insurance

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Acceleration clause: provision in loan agreement that allows lender to accelerate loan if borrower defaults

Accelerate: to declare entire remaining loan balance due immediately, including interest and penalties

l also referred to as “calling the note”

l if borrower doesn’t pay off, lender begins foreclosure

Acceleration clause



Alienation clause: allows lender to demand full payment of loan if borrower sells or otherwise transfers security property (or interest in it) to someone else

l also known as due-on-sale clause

Alienation: any transfer of an interest in real property

Alienation clause



Alienation clause doesn’t prohibit borrower from selling property.

l but does require payment of loan in full if borrower sells

Alienation clause

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Lender may allow buyer to assume loan.

Assumption: new owner agrees to take on primary liability for loan

l original borrower remains secondarily liable (unless lender releases the borrower)

Alienation clause



Under Civil Code, certain restrictions on alienation clause if security property is 1- to 4-unit residential property:

l clause is enforceable only if contained in both promissory note and security instrument

l certain transfers can’t trigger alienation clause (example: if borrower’s spouse becomes co-owner)

Alienation clause



Lender can charge late payment only if loan agreement provides for it.

California law limits late penalties on single-family, owner-occupied housing:

l 6% of overdue principal and interest, or $5.00, whichever is more

l can’t charge unless payment is at least ten days overdue

Late payment penalty

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Prepayment: when borrower repays all or portion of loan before payment is due

Some loan agreements allow lender to charge prepayment penalty, to compensate lender for interest it wasn’t able to collect.

Prepayment provision



California law limits prepayment penalty on owner-occupied residential property with up to four units:

l allowed only during first 5 years of loan

l borrower may prepay 20% of loan amount in any 12-month period without penalty

l if prepayment exceeds 20% of loan, penalty only permitted on excess

Prepayment provision



Subordination clause: gives loan agreement lower priority than another security instrument that will be recorded later

l common with loans to buy vacant land, since lenders often require construction loans to have first lien position

First lien position: highest priority

Subordination clause

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Defeasance clause: requires lender to release property from lien when debt has been fully repaid

Once mortgage is paid off, lender must record certificate of discharge (also called satisfaction of mortgage) within 30 days.

Defeasance clause



Once deed of trust is paid off, beneficiary (lender) must submit request for reconveyance to trustee within 30 days.

l Trustee then has 21 days to record deed of reconveyance.

Defeasance clause

Summary



l Acceleration clause

l Alienation clause

l Subordination clause

l Defeasance clause

l Certificate of discharge

l Request for reconveyance

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Foreclosure

Main difference between mortgage and deed of trust is foreclosure procedure.

l mortgage: judicial foreclosure

l deed of trust: nonjudicial foreclosure


Foreclosure

When borrower defaults on mortgage:

l Step 1: accelerate loan

l Step 2: initiate lawsuit called foreclosure action

Judicial foreclosure


Foreclosure

Foreclosure action: legal proceeding asking judge to order seizure and sale of property

l must be filed in county where property is located


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Foreclosure

Parties to lawsuit include:

l borrower (mortgagor)

l junior lienholders

Junior lienholders: creditors who have liens against the property with lower priority than the foreclosing lender’s mortgage; junior liens will be eliminated by foreclosure sale



Foreclosure

When foreclosure lawsuit is started, mortgagee (lender) also records lis pendens.

Lis pendens: document stating that property is subject to foreclosure action

l gives constructive notice to potential buyers or lenders



Judicial Foreclosure

In some states, only way borrower can stop foreclosure is through equitable right of redemption.

Equitable right of redemption: right to redeem property by paying off entire outstanding balance (not just missed payments) plus interest, penalties, and costs

l stops foreclosure

l satisfies debt

l terminates lender’s interest in property

Cure and reinstatement

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California has replaced equitable right of redemption with:

l right to cure default

l right to reinstate loan




To cure default, borrower must:

l pay delinquent amount, plus interest, penalties, and costs

l rectify breach of covenants (example: pay taxes, if unpaid)




Once default has been cured, foreclosure is terminated:

l loan reinstated

l parties back to where they were before default


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Default can be cured at any time:

l while judicial foreclosure action is pending

l up until court issues decree of foreclosure

Decree of foreclosure: court order directing sheriff to seize and sell property

l issued by judge if borrower fails to cure and reinstate




Once decree of foreclosure is issued, next step is notice of levy.

l sheriff records notice; serves it on mortgagor and other parties

Decree and sale



At least 20 days before sale date, notice of salemust be:

l posted on property

l posted in public place

l published in newspaper of general circulation once a week for three weeks

l mailed to the parties

l mailed to anyone who has submitted request for notification

Decree and sale

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Sheriff’s sale: public auction (sometimes called execution sale)

l usually held at county courthouse

l anyone may bid

l highest bidder receives certificate of sale

Decree and sale



Statutory right of redemption: right to redeem property following sheriff’s sale

l borrower must pay purchaser amount paid for property, plus interest accrued from time of sale

Post-sale redemption



In California, length of post-sale redemption period varies:

l three months: if sale proceeds enough to pay off debt, plus interest, costs, and fees

l one year: if proceeds weren’t enough to fully pay off amount owed


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During post-sale redemption period, mortgagor is still entitled to possession.

l must pay reasonable rent to holder of certificate of sale




At end of post-sale redemption period, holder of certificate of sale receives sheriff’s deed.

Sheriff’s deed: transfers title and right of possession to new owner




Deficiency judgment: personal judgment against borrower to recover difference between amount owed and foreclosure sale proceeds

To obtain judgment, lender must apply to court within three months after foreclosure sale.

l court will determine amount of deficiency and enter judgment

Deficiency judgments

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Deficiency Judgments

Anti-deficiency rules: California rules prohibit deficiency judgments in certain types of foreclosures

l purpose: to protect defaulting property owners

1. Deficiency judgments are never allowed in nonjudicial foreclosures.

Anti-deficiency rules



2. In judicial foreclosure, deficiency judgment not allowed when:

l property’s fair market value is greater than amount of debt;

l security instrument is purchase money mortgage given to seller (seller financing) for all or part of purchase price; or




l security instrument is mortgage given to third-party lender to finance purchase of owner-occupied residential property with up to four dwelling units

Result: Lender can’t sue for deficiency judgment after foreclosure on a typical home purchase loan.


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Summary



l Foreclosure action

l Lis pendens

l Equitable right of redemption

l Cure and reinstate

l Decree of foreclosure

l Statutory right of redemption


Foreclosure

When trustor (borrower) defaults on deed of trust, foreclosure process is different.

l Beneficiary (lender) isn’t required to file lawsuit or obtain court order.

Nonjudicial foreclosure


Foreclosure

Instead, beneficiary asks trustee appointed in deed of trust to arrange for property to be sold at trustee’s sale.

Trustee’s sale: public auction where trustee sells property to highest bidder, on beneficiary’s behalf

l sheriff and court not involved


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Foreclosure

Nonjudicial foreclosure:

l less expensive

l faster

l only permitted if security instrument contains power of sale clause



Nonjudicial Foreclosure

To foreclose deed of trust nonjudicially, trustee must follow certain steps.

1. Trustee must:

l record notice of default and election to sell

l mail copy to trustor, junior lienholders, anyone who requested notification

Notices of default and sale



2. At least three months after notice of default and at least 20 days before sale, trustee must issue notice of trustee’s sale.

Notice must be:

l recorded

l sent to everyone who received notice of default

l posted on property and public place

l published in newspaper once a week for three weeks

Notices of default and sale

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Borrower has right to cure default and reinstate loan, up to 5 days before trustee’s sale.

During 5 days before trustee’s sale, borrower can redeem by paying whole debt, plus costs, penalties, fees, etc.

Reinstatement



Statutory right of redemption (after sheriff’s sale in judicial foreclosure) doesn’t apply to trustee’s sale.

l highest bidder obtains title immediately, through trustee’s deed

Reinstatement


Foreclosure

Lenders usually choose to foreclose nonjudicially.

l saves time

l saves money

l no statutory redemption period after sale

Choosing between judicial/nonjudicial

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Foreclosure

Lenders usually only choose judicial foreclosure when:

l lender thinks sale will result in deficiency

l deficiency judgment would be allowed

Choosing between judicial/nonjudicial

Summary



l Trustee’s sale

l Notice of default and election to sell

l Notice of trustee’s sale

l Reinstatement

l Trustee’s deed


Protecting the Borrower

Laws intended to help protect borrowers:

l Truth in Lending Act

l California financing disclosure laws

l predatory lending laws

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Truth in Lending Act (TILA): federal law that went into effect in 1969, designed to help consumers compare financing offers from competing lenders

Statute is implemented by Federal Reserve Board’s Regulation Z.

Regulation Z: requires disclosure of interest rates or other finance charges to consumer

Truth in Lending Act



Consumer loans: loans used for personal, family, or household purposes

TILA applies to consumer loans if they are:

l to be repaid in more than four installments;

l subject to finance charges;

l for $25,000 or less; or

l secured by real property

Types of loans covered



TILA does not apply to:

l loans for business, commercial, or agricultural purposes

l seller financing

Types of loans covered

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TILA requires lenders to provide residential mortgage loan applicants with disclosure statement containing good faith estimate of:

l total finance charge

l annual percentage rate

Disclosure statement must be provided within 3 days after written application received.

Disclosure statement



Total finance charge: sum of all charges borrower will pay in connection with loan

Includes interest on loan plus:

l origination fee

l discount points

l finder’s fee

l service fees

l mortgage broker’s commission

l mortgage insurance premiums




Annual percentage rate (APR): yearly cost of financing expressed as percentage of loan amount

l APR usually higher than quoted interest rate


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TILA disclosure statement must also include:

l identity of lender

l amount financed

l payment schedule (number, amounts, timing)

l total of payments

l prepayment penalties and late charges (if any)

l loan’s assumption policy




When security property is borrower’s principal residence, borrower may rescind loan agreement anytime within three days after (whichever happens last):

l signing the loan documents

l receiving a disclosure statement

l receiving notice of the right of rescission

Right of rescission



If borrower doesn’t receive disclosure statement or rescission notice ? right of rescission lasts for three years.

Right of rescission

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Right of rescission doesn’t apply:

l when proceeds are for purchase or construction of borrower’s principal residence

l to refinance of principal residence when lender made original loan

Right of rescission



TILA governs advertising by:

l lenders

l mortgage brokers

l anyone else who advertises consumer credit (including real estate brokers)

Advertising under TILA



Legal:

l stating cash price or APR in ad

l using general terms such as “low interest rate”

But if any other particular loan terms are mentioned (downpayment, interest rate, monthly payment amount, etc.), full disclosure required in ad.

Advertising under TILA

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California financing disclosure laws include:

l Mortgage Loan Broker Law

l seller financing disclosure law

California financing disclosure laws


California Financing Disclosure Laws

In California, real estate agent who negotiates loan for compensation is considered to be acting as mortgage broker and must comply with Mortgage Loan Broker Law.

Mortgage Loan Broker Law:

l requires agents to provide disclosure statement

l restricts size of commissions and costs

l restricts balloon payments

Mortgage Loan Broker Law



Disclosure statement contains:

l all charges associated with loan

l amount of loan proceeds remaining after charges deducted


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Must be delivered to borrower no later than three days after (whichever comes first):

l lender’s receipt of loan application

l borrower signing loan agreement




Real estate agents must:

l use disclosure form whenever negotiating loan or providing other services for borrowers or lenders in connection with financing

l keep a copy of statement on file for three years

Disclosure requirement applies to both residential and commercial property.




Commission and fee limits apply to loans secured by residential property (up to four units) when lien is:

l first position deed of trust (for under $30,000)

l junior deed of trust (for under $20,000)

No commission limits on larger loans.

Commissions and costs

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Commission limits are tiered.

For loans in first lien position:

l loan term under three years: commission can’t exceed 5% of principal

l loan term over three years: commission can’t exceed 10%




For loans in junior position:

l loan term of two years or less: commission can’t exceed 5%

l loan term of more than two years but less than three years: commission can’t exceed 10%

l loan term over three years: commission can’t exceed 15%




Borrower’s costs for loans (appraisal fees, escrow fees) cannot exceed $390 or 5% of loan (whichever is greater) up to maximum of $700.

l Charges can’t exceed actual costs incurred.


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Balloon payment: loan payment that is significantly larger than regular loan payment (more than twice size of smallest required loan payment)

l illegal in loans of less than 3 years if secured by real property

l illegal in loans of less than 6 years if secured by owner-occupied real property

Balloon payment prohibition doesn’t apply to seller financing.

Balloon payments



If seller finances all or part of purchase price for one- to four-unit residential property, and arranger of credit is involved in negotiating or setting up transaction:

l borrower entitled to loan disclosures similar to those required in conventional financing

Arranger of credit: someone who negotiates or sets up financing; includes real estate agents

Seller financing disclosure law



Seller financing disclosure statement includes:

l copy or description of promissory note and security instrument

l warning regarding balloon payments (if one is required)

l explanation of title insurance

l information about buyer’s employment and financial status


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Arranger of credit is responsible for making sure buyer and seller receive disclosure statement before signing offer, acceptance, or other binding agreement.




Predatory lending: practices used by mortgage lenders and mortgage brokers to profit from unsophisticated borrowers

Predatory lending


Predatory Lending

Predatory practices may be:

l practices that are always abusive

l ordinary practices and loan terms used for predatory purposes

Predatory practices

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Predatory Practices

Predatory steering: steering buyer to more expensive loan when buyer could qualify for less expensive loan

Predatory steering


Predatory Practices

Fee packing: charging interest rates, points, or processing fees that far exceed norm and are not justified

Fee packing


Predatory Practices

Fraud: using fraudulent means to induce borrower to enter into loan agreement

l misrepresenting unfavorable loan terms or fees

l concealing unfavorable loan terms or fees

l falsifying documents

Fraud

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Predatory Practices

Property flipping: not automatically illegal, but considered predatory when agent, appraiser, or lender commits fraud in order to make buyer believe property is worth more than it is

Property flipping


Predatory Practices

Loan in excess of value: loaning home buyer more than appraised value of property

l usually involves fraudulent appraisal

l may involve collusion between lender and appraiser

l may involve collusion between mortgage broker and appraiser

Loan in excess of value


Predatory Practices

Unaffordable payments result from:

l failure to use appropriate qualifying standards

l borrower convinced to commit mortgage fraud

Mortgage fraud: providing inaccurate information to lender in order to get a larger loan; usually backfires on borrower

Unaffordable payments

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Predatory Practices

Impound waiver: not requiring borrower to make monthly deposits for property taxes/insurance

l encourages home buyers to borrow more than they can afford

l result: borrower often unable to pay taxes/insurance when due

Impound waivers


Predatory Lending

Predatory lending targets borrowers who aren’t able to understand transaction or don’t know of better alternatives.

Includes:

l elderly

l limited education

l speak limited English

l low income

l poor or no credit history

Targeted victims


Predatory Lending

Subprime lenders: make riskier loans than prime lenders

l Predatory issues often overlap with fair lending issues.

Targeted victims

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Predatory Lending

Predatory lending laws include:

l federal law (HOEPA)

l state law

Predatory lending laws


Predatory Lending Laws

Home Ownership and Equity Protection Act (HOEPA): applies to high-cost home equity loans

l secured by applicant’s principal residence

l high APR or points and fees

HOEPA



If a loan is covered by HOEPA:

l lender must regard applicant’s ability to repay

l disclosure statement must explain that defaulting applicant could lose home

l interest rate can’t be raised on default

HOEPA

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California’s predatory lending law is broader than federal version.

l applies to purchase loans as well as home equity loans

State law



Under state predatory lending law:

l Loan applicants can’t be steered to subprime loan if they qualify for standard financing.

l Loan applicants must be given disclosure statement.

l Loan agreement can’t include discretionary acceleration clause (acceleration without default).

State law



l Lender can’t charge prepayment penalty if loan is accelerated by default.

l Refinancing is prohibited unless there’s identifiable benefit to borrower.

State law

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Predatory lending laws enforced by:

l Department of Financial Institutions (certain lenders)

l Department of Corporations (other lenders, mortgage brokers)

l Department of Real Estate (real estate agents)

State law



Penalties for willful and knowing violation of law:

l civil penalty up to $25,000 per violation

l damages to consumer

l disciplinary action

l loss of license

State law

Summary



l Truth in Lending Act (TILA)

l Annual percentage rate (APR)

l Mortgage Loan Broker Law

l Seller Financing Disclosure Law

l Predatory lending

l HOEPA

l California predatory lending law

Legal Aspects of Real Estate Lesson 13 Cumulative Quiz

1. A lien is:

A. a financial encumbrance and a nonpossessory interest B. a financial encumbrance and a possessory interest C. a nonfinancial encumbrance and a nonpossessory interest D. a nonfinancial encumbrance and a possessory interest

2. Which document makes a property collateral for repayment of a debt?

A. Deed of trust B. Mortgage C. Promissory note D. Either A or B

3. The lender in a deed of trust is the:

A. beneficiary B. mortgagee C. trustee D. trustor

4. What type of clause in a security instrument is necessary to be able to foreclose nonjudicially?

A. Acceleration B. Alienation C. Power of sale D. Subordination

5. A borrower fails to make a monthly payment on a mortgage. The lender demands that the borrower repay the entire loan balance immediately, pursuant to the:

A. acceleration clause B. alienation clause C. defeasance clause D. prepayment penalty

6. A late payment penalty is allowed under state law only if the payment is how many days overdue?

A. 6 B. 10 C. 14 D. 30

© 2009 Rockwell Publishing 1

7. A construction loan receives higher priority than the deed of trust used to purchase the land where the house will be constructed, despite the fact that the deed of trust was recorded first. The deed of trust must contain a/an:

A. acceleration clause B. alienation clause C. defeasance clause D. subordination clause

8. Which of the following is not related to a judicial foreclosure?

A. Lis pendens B. Sheriff's sale C. Statutory redemption period D. Trustee's sale

9. In California, a borrower has the right to reinstate a:

A. deed of trust B. mortgage C. Both A and B D. Neither A nor B

10. The statutory redemption period following a sheriff's sale is:

A. one year, if the sale proceeds were adequate to pay off the debt plus costs B. six months, if the sale proceeds were adequate to pay off the debt plus costs C. three months, if the sale proceeds were adequate to pay off the debt plus costs D. three months, if the sale proceeds were not adequate to pay off the debt plus costs

11. The statutory redemption period following a trustee's sale is:

A. six months, if the sale proceeds were adequate to pay off the debt plus costs B. three months, if the sale proceeds were adequate to pay off the debt plus costs C. three months, if the sale proceeds were not adequate to pay off the debt plus costs D. There is no statutory redemption period in a nonjudicial foreclosure

12. In which scenario would a deficiency judgment be allowed?

A. Debt owed on commercial building is greater than its fair market value B. Fair market value of commercial building is greater than the debt owed on it C. Mortgage for purchase of owner-occupied house D. Seller-financed transaction


13. Which type of loan would be covered by the Truth in Lending Act?

A. Home equity loan B. Loan for business purposes C. Loan for $50,000 to purchase boat D. Seller-financed loan

14. Which of the following best describes a loan's annual percentage rate?

A. Cost of credit expressed as a yearly rate B. Good faith estimate of finance charges associated with loan C. Nominal interest rate for loan D. Sum of all fees and charges borrower will pay over loan's life

15. Which of the following, if it appeared in an advertisement, would not be a trigger term that requires disclosure of all loan terms?

A. Annual percentage rate B. Downpayment C. Interest rate D. Monthly payment amount

16. Which of the following is a California state law, rather than a federal law?

A. Home Ownership and Equity Protection Act B. Mortgage Loan Broker Law C. Real Estate Settlement Procedures Act D. Truth in Lending Act

17. What is the absolute maximum amount of costs that may be charged by a real estate agent for mortgage brokering services, under the Mortgage Loan Broker Law?

A. $390 B. $700 C. $10,000 D. $20,000

18. Which of the following is the term for charging interest rates or fees that exceed the norm and are not justified by the actual cost of services provided?

A. Fee packing B. Impound waivers C. Predatory steering D. Property flipping


19. The Home Ownership and Equity Protection Act is limited to high-cost:

A. business and agricultural loans B. home equity loans C. residential purchase loans D. seller-financed loans

20. Which of the following activities concerning high-cost loans is not prohibited under state predatory lending laws?

A. Charging a prepayment penalty if the loan is accelerated because of default B. Purchasing a home for more than its fair market value C. Refinancing when there is no identifiable benefit to the consumer D. Steering loan applicants to subprime loans when they could qualify for a standard loan


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Rockwell publishing real estate law chapter 13