The Fannie/Freddie
Uniform Instruments
(Note and Mortgage/Deed
of Trust)
• Fannie Mae was founded by the U.S. government in
1938, in the wake of the mortgage foreclosure crisis
occasioned by the Great Depression
– Purpose: to make home mortgage credit widely available
(at time, today’s “30-year mortgage” didn’t exist)
• In 1968, Fannie Mae was re-chartered as a for-profit,
publicly-traded corporation
Fannie Mae’s Role
• In the “old days,” a mortgage
was a “local” transaction; banks
and thrifts (S&Ls) made loans
using funds on deposit
– Once lender made a mortgage
loan, it held it in its “portfolio” until
repaid
– Supply of mortgage funds was
limited; only high-credit borrowers
could get mortgages (low rates of
homeownership)
Who Are Fannie and Freddie?
• Increase the supply and availability of mortgage
credit (and thus rates of homeownership)
Jimmy Stewart as
George Bailey,
It’s a Wonderful
Life (1945)
– Fannie Mae agreed to buy mortgage loans that met
certain “underwriting” criteria (i.e., it created a
“secondary market” for mortgage loans)
– Once banks/thrifts could sell mortgage loans to
Fannie, their capacity to make loans was no longer
limited by the amount they held on deposit!
• Over time, Fannie and Freddie began to facilitate the
securitization of mortgage loans
– E.g., Fannie buys 100,000 home mortgage loans which are
“pooled” together and placed in a trust, which then securities
(e.g., bonds) to private investors
– Through a loan servicer, Trustee of trust collects mortgage
P&I payments from mortgagors
– Trustee uses those sums to pay bond principal and interest
payments to the private investors (an obligation secured by
the underlying mortgage loans)
Uniform Instruments
• Note: evidences borrower’s obligation to repay the
debt, sets forth terms of that obligation (governed by
UCC Article 3 or common law of Contracts)
• Mortgage/Deed of Trust: conveyance in which
owner (mortgagor) grants lien to lender (mortgagee)
to secure repayment of debt evidenced by the Note
Ostensible Benefits of Securitization
• Has increased the flow of investment capital into the
mortgage market (disintermediation)
– Private investor would be reluctant to buy a single loan or a
small pool of loans (undiversified risk)
– By creating huge pools, the risks (i.e., risk of mortgagor
default) are spread, attracting private investment
– Greater supply of mortgage money leads to lower interest
rates, higher homeownership rates
Uniform Instruments
• Fannie/Freddie drafted Uniform instruments for
lender use; lenders can modify the forms based
on negotiation with the borrower, BUT
• If Lender modifies the form, Fannie/Freddie won’t
buy loan!
– Thus, lender typically won’t modify the forms (to
preserve its ability to sell loan on secondary market)
• On the one hand, this limits borrowers from negotiating
for different/more favorable terms (other than the
interest rate, loan term)
• On the other hand, many of the standard terms are very
borrower-favorable, e.g.,
– Right to prepay mortgage debt, without fee [Note ¶ 4]
– Right to reinstate loan after acceleration [DOT ¶ 19]
– Right, in some cases, to use insurance proceeds for
rebuilding in event of casualty [DOT ¶ 5]
Why a Separate Form for Each State?
• Second reason is state-to-state variation in mortgage law
rules (especially with respect to remedies)
• Uniform Covenants ¶¶ 1-21 are the same in all 50 states
• Covenants ¶ 22 et seq. vary by state, b/c of state variation
in substantive law
– Most significantly, judicial vs. nonjudicial foreclosure (only ½ of
states allow nonjudicial foreclosure)
Why a Separate Form for Each State?
• First reason is state-to-state custom in loan documentation
• Some states use the “mortgage,” which is a two-party
agreement between Lender (“mortgagee”) and Borrower
(“mortgagor”)
• Other states (e.g., Missouri) use the “deed of trust,” a
three-party agreement between Lender (“beneficiary”),
Borrower (“trustor”) and a “trustee”
Occupancy [¶ 6 DOT]
• Why does ¶ 6 require the Borrower to
occupy the Property w/in 60 days and use
it as his/her principal residence for one
year?
• Would this prevent Borrower from
obtaining mortgage loan for a second
(vacation) home?
• Lenders (and investors buying loans on the secondary
market, or buying mortgage-backed securities) have
different standards for underwriting an owner-occupied
home loan vs. a rental home
– An owner-occupied home loan is underwritten based on
borrower’s income (e.g., salary)
– A loan for a rental home is underwritten based on net cash
flow generated by renting the home (e.g., gross rent –
property expenses)
• Which is a “riskier” loan?
• What if Borrower lied (and was planning to “flip” the
house or rent it)?
– Failure to comply with ¶ 6 is a default
– ¶ 22 would allow lender to “accelerate” the maturity of the
debt and demand FULL payment of the entire debt (even if
Borrower was actually current on its payments!)
– Other consequences of lying: (1) lying on loan application
is punishable as crime under both federal and state laws;
(2) lying on loan application could render the debt
nondischargeable if Borrower later filed for bankruptcy
• Secondary market investors would require a larger return to
invest in securities backed by “riskier” loans (e.g., rental
homes) as compared to securities backed by owner-occupied
home loans
• To attract capital at the lowest rates, Fannie and Freddie
must assure secondary market investors that loans being
purchased and securitized as “owner-occupied home loans”
really are “home” loans, not commercial loans
– Uniform Covenant ¶ 6 “operationalizes” this concern (reflects
underwriting mandated by secondary market investors)
Second/Vacation Homes
• Suppose Abrams applies for a loan to buy a vacation
home in ND
– The Uniform Instrument would be unsuitable for the Lender to
use for this loan, if ¶ 6 is not removed/modified
• In this case, lender can have Abrams sign both the
Uniform Instrument and the “Second Home Rider” [Def. H]
– Second Home Rider modifies Uniform Instrument by deleting ¶
6 and replacing it with “second home” covenant
Other Riders (DOT Def. H)
• Other “Riders” are used if the Uniform Instrument lacks a
provision needed for the specific transaction
– E.g., “Condo” Rider: includes covenants to pay all condo
association fees, comply with condo rules, etc.
– E.g., “1-4 Family Rider”: b/c owner will likely be renting the
units he/she is not occupying, the Rider has an “Assignment
of Rents/Leases” (granting Lender a lien on rents payable by
the Owner’s other tenants, and allowing Lender to collect
those rents directly from the other tenants if owner defaults)
• The higher the loan-to-value (LTV) ratio, the greater the risk
that a foreclosure sale may produce a “deficiency” (i.e., not
enough to pay off the debt)
• Low down-payment borrower has to pay for PMI to protect
lender against this risk (so that mortgage-backed securities
will get favorable risk ratings)
• If borrower defaults, and foreclosure sale results in a
deficiency, lender can recover this loss from PMI insurer
• Once borrower builds up enough equity (20-23%, depending
on loan type), borrower has right to cancel PMI coverage
[Homeowner’s Protection Act of 1998]
Mortgage Insurance [DOT ¶ 10]
• Lender typically requires private mortgage insurance (or
“PMI”) for any mortgage loan where the original principal
amount of the debt >>> 80% of fair market value (FMV)
of mortgaged land
– PMI allows someone to buy a home with a smaller
downpayment, rather than having to wait to accrue 20% cash
for a “downpayment”
PMI Insurance Rates
• Rates vary from between 0.3% to 1.5% of original principal
amount per year, depending upon
– Amount of downpayment (i.e., original loan-to-value ratio)
– Borrower’s credit score
– Insurer
• E.g., for $180,000 loan by Borrower who paid 10% down
(90% loan), w/credit score = 740, rate = 0.44%
– This would be $792/year, or $66/month
Escrow [DOT ¶ 3]
• In addition to P&I each month, borrower must also pay
into escrow 1/12th of the estimated annual cost of (a) real
estate taxes + (b) casualty insurance premiums + (c) PMI
premiums
• This escrow is held by the lender (or loan servicer), who
uses the escrow funds to pay taxes and insurance
premiums directly, as they come due
Waiver of Escrow
• ¶ 3: “Lender may waive Borrower’s
obligation to pay to Lender Funds for
any or all Escrow Items at any time.
Any such waiver may only be in
writing.”
• Do Lenders agree to waive escrow?
Why would they, since they’re
earning “float” off the escrow funds?
• If taxes, insurance premiums, and PMI premiums are
not paid by Borrower, Lender’s lien is threatened
– Nonpayment of real estate taxes = tax lien in favor of
taxing authority (e.g., city or county), which lien has priority
over all other interests, including the Lender’s mortgage!
– Nonpayment of casualty insurance = cancelled insurance
= risk of uninsured loss
– Nonpayment of PMI = loss of recourse to PMI insurance if
borrower defaults and foreclosure results in deficiency
• Escrow enables Lender to minimize/avoid these risks
• Unless state law requires, the lender does not have to pay
borrower any interest on the escrowed funds
– ¶ 3: “Unless an agreement is made in writing or Applicable Law
requires interest to be paid on the Funds, Lender shall not be
required to pay Borrower any interest or earnings on the Funds.”
– Essentially, Borrower is making interest-free loan to Lender!
• Residential borrowers rarely obtain waivers (RESPA limits
excess cushion lender can require)
• In commercial loans, where escrow requirements might result
in huge escrow amounts, borrowers more often negotiate for
and obtain waivers
Loan Charges [¶ 14 DOT]
• “Lender may charge Borrower fees for services
performed in connection with Borrower’s default ...
including, but not limited to, attorneys’ fees, property
inspection and valuation fees”
• What’s the point? If the debtor is in default and can’t
pay, what’s the point of allowing this charge?
Payment of Debt/Offsets [¶ 1 DOT]
• DOT ¶ 1: “No offset or claim which Borrower might have
now or in the future against Lender shall relieve Borrower
from making payments due under the Note and this
Security Instrument....”
• What is this provision trying to address when referring to
a Borrower’s “offset or claim”?
• Loan contracts commonly obligate Borrower to pay all “costs
of collection” incurred by Lender
– See Uniform Note ¶ 6(E), page 1435 (Borrower agrees to pay costs
of enforcement of note)
• DOT ¶ 14 also relates to DOT ¶ 9 (Protection of Lender’s
Interest in the Property)
– Under ¶ 9, amounts/costs incurred by Lender in enforcement for
purpose of protecting Lender’s interest “shall become additional
debt of Borrower, secured by this Security Instrument”
– If Borrower doesn’t pay, and Lender forecloses, Lender can recover
those costs from foreclosure sale proceeds
Common Law Right of Offset
• At common law, mutual debts that are liquidated and
undisputed can be “set off”
– E.g., Nelson owes Wells Fargo $200,000 on mortgage loan
– Nelson then obtains a judgment against Wells Fargo for
$50,000 for unpaid consulting fees
– At common law, unless Nelson had agreed otherwise, he
could simply “set off” the unpaid judgment against his debt
obligation (reducing the mortgage debt to $150,000)
• Why would ¶ 1 require Borrower to waive its common
law right of offset?
– This loan will be sold and “pooled” with other loans to serve
as collateral for mortgage-backed securities
– Buyers of MBS expect the underlying loans will obligate the
borrowers to “pay off” the full amount of the loans
– Theoretically, offsets by borrowers could result in the “pool” of
mortgages not generating enough income to repay the
investors holding mortgage-backed securities
– Offset waiver protects against that risk
• DOT ¶ 13 addresses the possibility that someone signs
the DOT but NOT the underlying note
– E.g., Margaret Freyermuth gets $100,000 mortgage loan from
Bank to buy a home
– She will live there, but title will be held by her and her son,
Richard, as joint tenants with right of survivorship
– Richard does not sign the Note, but he signs the DOT
• This will allow Bank to foreclose and sell full fee simple
title if Margaret defaults
– But, Bank could not get a personal judgment against Richard
Co-Signers [Note ¶ 8, DOT ¶ 13]
• What is the form DOT saying with respect to co-signer
liability in paragraph 13? Does it differ from what the
Note provides in ¶ 8?
– The Note reflects personal liability for repayment of debt
– Anyone who signs Note is jointly/severally liable to repay the
debt (although Lender can get only 1 recovery)
– Lender could get a judgment against each signer of Note and
enforce that judgment from any of their assets
“Lease of the Property” [DOT ¶ 25]
• “Trustee hereby leases the property to Borrower until
this Security Instrument is either satisfied and released
or until there is a default ....”
• Rent is stated as one cent per month
• What’s the purpose of this. Legally speaking, is the
mortgagor really only a Tenant?
Acceleration [Note ¶ 6(C), DOT ¶ 22]
• Q: If a person can’t make a payment it seems highly
unlikely they could pay off the entire debt. Am I
misunderstanding the point or effect of the acceleration
clause?
– Practically, Lender must accelerate before it forecloses its
mortgage lien (Lender can only foreclose once; foreclosure sale
will extinguish Lender’s mortgage lien)
– If debt is not accelerated, all that is “due” are the unpaid
installments (not the full principal amount)