Chapter 9 Real Estate Finance The Laws and

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Chapter 9 Real Estate Finance: The Laws and Contracts Real Estate FIN 331 Dr.

Chapter 9 Real Estate Finance: The Laws and Contracts Real Estate FIN 331 Dr. David P. Echevarria All Rights Reserved 1

General Characteristics of Real Estate Contracts A. Most real estate transactions involve debt financing

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. Echevarria All Rights Reserved 2

General Characteristics of Real Estate Contracts E. Mortgage lending is a major industry in

General Characteristics of Real Estate Contracts E. Mortgage lending is a major industry in United States and many other countries F. A mortgage loan creates documents: a note and a mortgage or deed of trust G. Debt financing also has tax advantages Dr. David P. Echevarria All Rights Reserved 3

The Note A. Interest rates - Interest charges 1. Interest rates may be fixed

The Note A. Interest rates - Interest charges 1. Interest rates may be fixed or variable 2. Mortgages are amortized a. b. c. d. Payments consist of principal and interest The principal portion increases over time The interest portion decreases over time The mortgage rate determines when the 50/50 point occurs 1) The lower the rate, the sooner the 50/50 point occurs 3. Extra payment toward Principal reduces maturity. Dr. David P. Echevarria All Rights Reserved 4

Principal & Interest: 30 Year Mortgage $100, 000 @ 8% per annum Total Interest:

Principal & Interest: 30 Year Mortgage $100, 000 @ 8% per annum Total Interest: $166, 482. 30 Distribution of Principal and Interest 30 -Yr Mortgage 100. 00% 90. 00% Yearly PMT = $8, 882. 74 80. 00% 70. 00% 60. 00% 50. 00% 40. 00% 30. 00% 20. 00% 10. 00% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Int% Dr. David P. Echevarria All Rights Reserved Prn% 5

Principal & Interest: 15 Year Mortgage $100, 000 @ 8% per annum Total Interest:

Principal & Interest: 15 Year Mortgage $100, 000 @ 8% per annum Total Interest: $75, 244. 32 Distribution of Principal and Interest 15 -Yr Mortgage 100. 00% 90. 00% Yearly PMT = $11, 682. 95 80. 00% 70. 00% 60. 00% 50. 00% 40. 00% 30. 00% 20. 00% 10. 00% 1 2 3 4 5 6 7 Int% Dr. David P. Echevarria All Rights Reserved 8 9 10 11 12 13 14 15 Prn% 6

Principal & Interest: 30 Year Mortgage $100, 000 @ 8% per annum: Extra Principal

Principal & Interest: 30 Year Mortgage $100, 000 @ 8% per annum: Extra Principal Effects of Extra $1000 per Year to Principal (30 -Yr Mortgage) Extra $1000 per year PMT =9882. 74 100. 00% 90. 00% 80. 00% 70. 00% Total Interest Paid: $113, 009. 61 60. 00% Savings: $53, 472. 89 20. 00% 50. 00% 40. 00% 30. 00% 10. 00% 1 2 3 4 5 6 7 8 9 10 Int% Dr. David P. Echevarria All Rights Reserved 11 12 13 14 15 16 17 18 19 20 21 22 Prn% 7

The Note B. Adjustable Rate Mortgages 1. Adjustable-rate mortgages generally use an index 2.

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 rate changes 4. All adjustable-rate mortgages have floors and caps a. b. A floor is the lowest rates can go 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. Echevarria All Rights Reserved 8

Interest Rate Volatility Libor vs 10 -Yr Treasuries Frequency: Weekly, Ending Wednesday 12. 00

Interest Rate Volatility Libor vs 10 -Yr Treasuries Frequency: Weekly, Ending Wednesday 12. 00 10 -Year Treasury 10. 00 Libor 8. 00 6. 00 4. 00 2. 00 All Rights Reserved -08 20 16 -01 -08 -01 14 20 -01 -08 20 12 -01 10 -08 20 -01 08 20 20 06 -01 -08 -01 20 04 -01 -08 02 20 20 00 -01 -08 -01 98 19 19 96 -01 -08 -01 94 19 -01 92 19 19 -08 -01 -08 Dr. David P. Echevarria 90 -01 88 19 19 86 -01 -08 0. 00 9

Interest Rate Volatility October 2007 – Sept 2017 Libor vs. 10 -Yr Treasuries Frequency:

Interest Rate Volatility October 2007 – Sept 2017 Libor vs. 10 -Yr Treasuries Frequency: Weekly, Ending Wednesday 6. 00 5. 00 4. 00 3. 00 2. 00 1. 00 Series 1 Dr. David P. Echevarria 03 20 16 -1 0 - 03 -1 15 14 20 20 0 -1 -1 13 20 0 - 03 03 0 - 03 -1 20 12 0 -1 11 20 0 - 03 03 20 10 -1 0 - 03 20 09 -1 0 - 03 0 -1 08 20 20 07 -1 0 - 03 0. 00 Series 2 All Rights Reserved 10

The Note C. Payments 1. Some loans may be interest only 2. Some loans

The Note C. Payments 1. Some loans may be interest only 2. Some loans may involve negative amortization 3. Additional principal to each payment reduces term a. b. All “conforming” and FHA/VA loans Home equity credit lines 4. Loans with restricted right of prepayment a. b. c. d. Subprime home loans “Jumbo” home loans Most income property mortgage loans Lender may impose prepayment penalties Dr. David P. Echevarria All Rights Reserved 11

The Note D. Other Terms 1. Nonrecourse loan: No personal liability a. Exculpatory clause:

The Note 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. Echevarria All Rights Reserved 12

The Mortgage vs. Deed of trust A. B. C. D. Mortgagor: Borrower Mortgagee: Lender

The Mortgage vs. Deed of trust A. B. C. D. Mortgagor: Borrower Mortgagee: Lender (holds deed to property) Deed of Trust: Deed held by Trustee 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. Echevarria All Rights Reserved 13

Mortgage versus Deed of Trust Dr. David P. Echevarria All Rights Reserved 14

Mortgage versus Deed of Trust Dr. David P. Echevarria All Rights Reserved 14

The Mortgage (Deed of trust) E. Some Important Mortgage (DOT) Clauses 1. 2. 3.

The Mortgage (Deed of trust) E. Some Important Mortgage (DOT) Clauses 1. 2. 3. 4. 5. 6. 7. Description of the property Insurance clause Escrow clause Acceleration clause Due-on-sale clause Hazardous substances clause Preservation and maintenance clause Dr. David P. Echevarria All Rights Reserved 15

Default A. Failure to meet requirements of the note or mortgage 1. 2. Technical

Default A. Failure to meet requirements of the note or mortgage 1. 2. Technical default: Any violation of terms Substantive default: Three missed payments (90 days) 1. 2. 3. 4. 5. Counseling and consumer debt reorganization Temporary reduction of payments Assisted sale Short sale Deed in lieu of foreclosure B. Non-Foreclosure Responses to Default a. b. Advantages: quick, quiet, cheap Disadvantages: other liens remain; Dr. David P. Echevarria All Rights Reserved 16

Default C. Foreclosure 1. Legal process of terminating all claims of ownership and all

Default C. Foreclosure 1. Legal process of terminating all claims of ownership and all liens inferior to foreclosing lien 2. Negatives a. b. c. d. Risk of failing to notify a claimant Presence of superior liens Costly and time consuming Distressed sale 3. Importance of lien priority Dr. David P. Echevarria All Rights Reserved 17

Default 4. Recourses of the defaulted mortgagor a. b. Equity of redemption Statutory right

Default 4. Recourses of the defaulted mortgagor a. b. Equity of redemption Statutory right of redemption 5. Deficiency judgment: Judgment against mortgagor for unrecovered balance Example: a. Net foreclosure auction price: b. Remaining loan balance: c. Deficiency : $100, 000 $120, 000 $20, 000 6. Judicial foreclosure vs. power of sale a. b. Judicial foreclosure: Court-administered public auction Power of sale: Public auction conducted by trustee or mortgagee (preferred by lenders) Dr. David P. Echevarria All Rights Reserved 18

Bankruptcy A. Three forms of bankruptcy 1. Chapter 7: 2. Chapter 11: 3. Chapter

Bankruptcy A. Three forms of bankruptcy 1. Chapter 7: 2. Chapter 11: 3. Chapter 13: Liquidation Court supervised “workout” 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. Echevarria All Rights Reserved 19

Bankruptcy Act Important Changes to 2005 Rev. A. law passed in 2005 prohibits some

Bankruptcy Act Important Changes to 2005 Rev. A. law passed in 2005 prohibits some filers with higher incomes from using Chapter 7 bankruptcy (liquidation) vs. Chapter 13 (repayment) B. Before you can file for bankruptcy under either Chapter 7 or Chapter 13, you must complete credit counseling with an agency approved by the United States Trustee's office: www. usdoj. gov/ust

Bankruptcy Act Important Changes to 2005 Rev. C. How property is valued: at replacement

Bankruptcy Act Important Changes to 2005 Rev. C. How property is valued: at replacement cost instead of at auction value, which means more debtors are at risk of having their property taken and sold by the trustee. D. How long a filer must live in a state to use that state's bankruptcy exemption laws E. Chapter 13: repayment from disposal income under numbers provided by IRS rather than bankrupt’s budget info.

Regulation of Home Mortgage Lending A. Equal Credit Opportunity Act: no discrimination (protected classes)

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. Echevarria All Rights Reserved 22

Regulation of Home mortgage Lending A. Dodd-Frank Wall Street Reform and Consumer Protection Act

Regulation of Home mortgage Lending A. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 1. Given oversight and enforcement power for: a. b. c. d. e. f. All federal consumer financial protection laws Anti-discrimination laws in consumer finance To restrict unfair, deceptive or abusive practices Receive consumer complaints Promote financial education Power to monitor emerging consumer financial risks 2. Centralizes a multitude of regulators within one agency for home mortgage lending Dr. David P. Echevarria All Rights Reserved 23

Homework Assignment A. Key terms: Adjustable-Rate Mortgage, Balloon Loan, Contract For Deed, Deed Of

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. Echevarria All Rights Reserved 24