Washington Real Estate Fundamentals
Lesson 10:
Principles of
Real Estate Financing
© 2011 Rockwell Publishing
Economics of Real Estate Finance
For a lender, a loan is an investment.

Interest paid on loan is lender’s return.

Riskier loan requires higher return
(higher interest rate).
Interest rate charged on a loan also depends
on market forces and real estate cycles.
© 2011 Rockwell Publishing
Economics of Real Estate Finance
Real estate cycles
Real estate cycles: Periodic shifts in level of
activity in real estate market.
 Real estate cycles generally follow
principle of supply and demand.
© 2011 Rockwell Publishing
Real Estate Cycles
Law of supply and demand
Home prices go up when demand is high and
supply is low.
 Seller’s market.
 High prices stimulate home construction.
Home prices go down when supply is high
and demand is low.
 Buyer’s market.
 Low prices stimulate demand, and cycle
begins again.
© 2011 Rockwell Publishing
Real Estate Cycles
Mortgage loan funds
Demand for homes tied to changes in supply of
and demand for mortgage loan funds.

When supply of mortgage funds is large:
 interest rates low
 demand for home loans increases

When funds are scarce:
 interest rates high (tight money market)
 demand for home loans decreases
© 2011 Rockwell Publishing
Real Estate Cycles
Mortgage loan funds
Supply of mortgage loan funds depends on:
 how much money investors have available
 how much they choose to invest in
mortgage loans
This is affected by:
 overall economy
 market interest rates
 how mortgage lending compares to other
investments
© 2011 Rockwell Publishing
Economics of Real Estate Finance
Interest rates and federal policy
Federal government influences real estate
financing and rest of economy through:
 fiscal policy
 monetary policy
© 2011 Rockwell Publishing
Interest Rates and Federal Policy
Fiscal policy
Fiscal policy includes:
 spending
 taxation
 debt management
Set by Congress and the President, through
tax legislation and federal budget.
© 2011 Rockwell Publishing
Interest Rates and Federal Policy
Fiscal policy
Federal deficit: Shortfall created when U.S.
government spends more than it collects in
revenue.
 To cover deficit, Treasury borrows money by
selling interest-bearing securities to investors.
 Less money available for investment in
private sector.
 Increase in deficit tends to make interest
rates rise.
© 2011 Rockwell Publishing
Interest Rates and Federal Policy
Monetary policy
Monetary policy: Federal government’s direct
efforts to control money supply and interest
rates.
 Monetary policy determined by Federal
Reserve (“the Fed”).
 Major goals:
 economic growth
 stability in interest rates and markets
© 2011 Rockwell Publishing
Interest Rates and Federal Policy
Monetary policy
Federal Reserve sets monetary policy using
these tools:
 key interest rates
 reserve requirements
 open market operations
© 2011 Rockwell Publishing
Monetary Policy
Key interest rates
Fed has control over two interest rates:
 federal funds rate
 discount rate
These are rates charged when a bank
borrows from another bank or from a Federal
Reserve Bank.
© 2011 Rockwell Publishing
Monetary Policy
Key interest rates
If Fed raises key rates, banks also raise
interest rates they charge borrowers.
If Fed lowers key rates, banks also lower their
interest rates.

Lower interest rates usually stimulate
economy.
© 2011 Rockwell Publishing
Monetary Policy
Reserve requirements
Reserve requirements: Amount of money
(percentage of deposits) banks must maintain
on deposit, to meet requests for withdrawals.

If Fed raises reserve requirements:
 less money available for lending
 interest rates go up

If Fed lowers reserve requirements:
 more money available for lending
 interest rates go down
© 2011 Rockwell Publishing
Monetary Policy
Open market operations
Open market operations: When Fed buys and
sells government securities (such as Treasury
notes).
 Fed’s primary method of managing
money supply.
© 2011 Rockwell Publishing
Monetary Policy
Open market operations
Buying government securities from investors
puts more money into circulation, so that:
 money supply increases
 interest rates go down
Selling government securities to investors
takes money out of circulation, so that:
 money supply decreases
 interest rates go up
© 2011 Rockwell Publishing
Interest Rates and Federal Policy
Other agencies that affect financing
Several other federal agencies also affect real
estate financing, such as:
 Federal Home Loan Bank System
 Federal Deposit Insurance Corp. (FDIC)
 Dept. of Housing and Urban
Development (HUD)
 Rural Housing Service
© 2011 Rockwell Publishing
Summary
Economics of Real Estate Finance
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Real estate cycles
Supply and demand
Fiscal policy
Federal deficit
Monetary policy
Key interest rates
Reserve requirements
Open market operations
© 2011 Rockwell Publishing
Real Estate Finance Markets
Two finance markets supply funds for real
estate loans:
 primary market
 secondary market
© 2011 Rockwell Publishing
Real Estate Finance Markets
Primary market
Primary market: Market in which mortgage
lenders make loans to home buyers.

Historically, primary market was strictly
local: local banks and savings & loans.

Now much more diverse, but local
economic conditions still have impact on
amount of funds lenders have available.
© 2011 Rockwell Publishing
Real Estate Finance Markets
Primary market
When local economy booming:
 less money saved
 local lenders can’t keep up with demand
for loans
When local economy slow:
 more money saved
 local lenders have ample funds but little
demand for loans
© 2011 Rockwell Publishing
Real Estate Finance Markets
Primary market
For lenders, it’s a problem to have either too
much or too little money on deposit.
To address this problem, lenders look for
opportunities beyond the local market.
© 2011 Rockwell Publishing
Real Estate Finance Markets
Secondary market
Secondary market: Market in which private
investors and government-sponsored entities
buy and sell mortgages secured by real
estate nationwide.

Allows local lenders to sell loans, to
obtain more funds to make more loans.

Moderates local real estate cycles
because it’s a national market.
© 2011 Rockwell Publishing
Secondary Market
Buying and selling loans
Mortgage loans can be bought and sold like
other investments (such as stocks or bonds).
 Value of loan depends on rate of return
and risk of default.
 Investors generally buy loans at a
discount (for less than face value).
 But discounted loans can be foreclosed
for face value if borrower defaults.
© 2011 Rockwell Publishing
Secondary Market
Government-sponsored agencies
Federal government established three
secondary market entities:
 Fannie Mae
 Freddie Mac
 Ginnie Mae
© 2011 Rockwell Publishing
Secondary Market Agencies
Securitizing loans
Role of secondary market entities:
 buying loans from primary market
lenders
 issuing securities using the loans as
collateral
 selling these mortgage-backed securities
to investors
 guaranteeing investors a return even if
borrowers default
© 2011 Rockwell Publishing
Secondary Market Agencies
Underwriting standards
To reduce risk of default, agencies
established their own underwriting standards.

Underwriting standards: Criteria used to
evaluate loan applicant and property
offered as security.

Primary market lenders that want to sell
loans on secondary market generally
must meet agencies’ standards.
© 2011 Rockwell Publishing
Secondary Market Agencies
Fannie Mae
Federal National Mortgage Association
(FNMA)
 Created as federal agency in 1938 to
establish secondary market for FHA loans.
 Reorganized as private corporation
(government-sponsored enterprise, or
GSE) in 1968.
 Buys and securitizes conventional, FHA,
and VA loans.
© 2011 Rockwell Publishing
Secondary Market Agencies
Freddie Mac
Federal Home Loan Mortgage Corporation
 Created in 1970 to provide secondary
market for savings and loans.
 Like Fannie Mae:
 government-sponsored enterprise
 buys and securitizes conventional,
FHA, and VA loans
© 2011 Rockwell Publishing
Secondary Market Agencies
Ginnie Mae
Government National Mortgage Association
 Government agency within HUD.
 Guarantees securities backed by FHA
and VA loans.
© 2011 Rockwell Publishing
Secondary Market Agencies
Recent developments
Because of severe financial problems brought
on by the recession, federal government
placed both Fannie Mae and Freddie Mac in
conservatorship in 2008.
 Also created new regulator for them:
Federal Housing Financing Agency
(FHFA).
© 2011 Rockwell Publishing
Summary
Real Estate Finance Markets
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Primary market
Secondary market
Secondary market agencies
Government-sponsored enterprises
Loan discounting
Mortgage-backed securities
Underwriting standards
© 2011 Rockwell Publishing
Real Estate Finance Documents
Most real estate buyers are required to sign
two finance documents:
 promissory note
 security instrument
(either a mortgage or a deed of trust)
© 2011 Rockwell Publishing
Real Estate Finance Documents
Promissory notes
Promissory note: Written promise to repay a
debt (plus interest, in most cases).
 Borrower = Maker
 Lender = Payee
© 2011 Rockwell Publishing
Promissory Notes
Basic provisions
Promissory note states:
 amount borrowed (principal)
 interest rate (and whether fixed or variable)
 payment amount
 when and how payments are to be made
 maturity date (when loan to be paid in full)
 consequences of default
Does not include property description.
© 2011 Rockwell Publishing
Promissory Notes
Types of notes
Promissory notes classified according to how
principal and interest are repaid:
 Straight note
 Installment note
© 2011 Rockwell Publishing
Types of Notes
Straight note
Straight note: Promissory note used for term
loan, also called interest-only loan.
 Payments during loan term cover only
interest (no principal).
 At end of term, borrower must pay back
entire principal amount with one balloon
payment.
© 2011 Rockwell Publishing
Types of Notes
Installment note
Installment note: Promissory note used for
amortized loan.
 Part of each payment is interest and the
rest is principal.
 Each payment gradually reduces loan’s
principal balance.
 If note fully amortized, payments pay off
all principal and interest by end of term.
© 2011 Rockwell Publishing
Promissory Notes
Simple interest
Interest paid on a real estate loan is almost
always simple interest, as opposed to
compound interest.
 Interest is computed only on remaining
principal balance.
 Not computed on previously accrued
interest as well as on principal.
© 2011 Rockwell Publishing
Promissory Notes
Negotiable instruments
Most promissory notes used in real estate
transactions are negotiable instruments.
 Negotiable instrument: Debt can be
assigned to someone else by
endorsement (like a check).
 Endorsing note transfers right of payment
to new party.
© 2011 Rockwell Publishing
Real Estate Finance Documents
Security instruments
Security instrument: Contract that makes
borrower’s property collateral for loan.
 Either a mortgage or a deed of trust.
 If borrower doesn’t repay loan,
lender can foreclose on property.
Foreclosure: Forced sale of debtor’s property
so that creditor can collect debt from sale
proceeds.
© 2011 Rockwell Publishing
Security Instruments
Secured creditor
Secured creditor: Creditor who has security
interest in debtor’s property.
 Promissory note can be enforced without
security instrument.
 Creditor can sue to enforce note.
 But secured creditor more certain of
collecting debt than unsecured creditor.
© 2011 Rockwell Publishing
Security Instruments
Historical background
Hypothecation: Borrower transferred title to
lender as security, but retained possession of
collateral property.
 Lender held legal title (also called naked
or bare title): title without possessory
rights.
 Borrower had equitable title: possessory
rights without legal title.
In theory, some states still take this approach.
© 2011 Rockwell Publishing
Security Instruments
Historical background
In title theory states, lender holds legal title
throughout loan term.
In lien theory states:
 Borrower retains full title while paying
loan off.
 Lender only has lien against property.
Most states, including Washington, are lien
theory states. Little actual difference.
© 2011 Rockwell Publishing
Security Instruments
Types of security instruments
Two types of real estate security instruments:
 mortgages
 deeds of trust
Main difference: Foreclosure easier with deed
of trust.
 Deeds of trust much more widely used
than mortgages in Washington and some
other states.
© 2011 Rockwell Publishing
Types of Security Instruments
Mortgage
Two parties to a mortgage:
 mortgagor (borrower)
 mortgagee (lender)
But note that “mortgage” and “mortgage loan”
are commonly used to refer to any loan
secured by real estate, regardless of type of
security instrument actually used.
© 2011 Rockwell Publishing
Types of Security Instruments
Deed of trust
Three parties to a deed of trust:
 trustor or grantor (borrower)
 beneficiary (lender)
 trustee (neutral third party who handles
foreclosure if necessary)
Language in deed of trust based in title
theory; says legal title conveyed to trustee
pending repayment of debt.
© 2011 Rockwell Publishing
Security Instruments
Recording
Lender should record security instrument as
soon as loan is made.
Recording:
 gives public notice of lender’s lien against
the property
 protects lender from subsequent claims
© 2011 Rockwell Publishing
Summary
Real Estate Finance Documents
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Promissory note
Straight note
Installment note
Security instrument
Foreclosure
Secured creditor
Mortgage
Deed of trust
Hypothecation
Title theory and lien theory
© 2011 Rockwell Publishing
Finance Document Provisions
Mortgaging or granting clause
 Taxes and insurance
 Acceleration clause
 Alienation clause
 Late payment penalty provision
 Lock-in clause
 Prepayment provision
 Subordination clause
 Defeasance clause

© 2011 Rockwell Publishing
Finance Document Provisions
Mortgaging or granting clause
Security instrument must include statement
that property is pledged as security for loan.
 Mortgaging clause in mortgage.
 Granting clause in deed of trust.
Must also include description adequate to
identify the security property.
© 2011 Rockwell Publishing
Finance Document Provisions
Taxes and insurance
Security instrument provides that borrower
must:
 keep security property adequately
insured against hazards such as fire
 pay all property taxes and special
assessments
Failure to comply is default on the mortgage,
just like failing to make loan payments.
© 2011 Rockwell Publishing
Finance Document Provisions
Acceleration clause
Acceleration clause: Gives lender right to
demand immediate payment of entire
principal balance if borrower defaults.

AKA call provision (“calling the note”).

Clause in both note and security
instrument.
 Triggered by any default on terms of
either document.
© 2011 Rockwell Publishing
Finance Document Provisions
Alienation clause
Alienation clause: Gives lender right to
accelerate loan if borrower sells security
property or transfers an interest.

Also called due-on-sale clause.

Doesn’t prohibit sale of property.

Does allow lender to force borrower to
pay off loan if property sold without
lender’s approval.
© 2011 Rockwell Publishing
Alienation Clause
Sale without loan payoff
If loan not paid off when property sold, buyer
takes title subject to lender’s lien.

Buyer may assume mortgage or deed of trust.
 Buyer has primary liability to lender.
 Original borrower has secondary liability.

If buyer does not assume loan:
 buyer not personally liable for repayment
 lender can still foreclose in case of default
© 2011 Rockwell Publishing
Alienation Clause
Assumption with lender’s approval
If mortgage or deed of trust has alienation
clause, lender has opportunity to screen
buyer.
 If buyer creditworthy, lender will:
 approve buyer’s assumption of loan
 release original borrower from liability

Lender charges buyer assumption fee
and may raise interest rate.
© 2011 Rockwell Publishing
Alienation Clause
Assumption with lender’s approval
Buyer assuming loan should ask lender to
provide certificate of reduction.
 Certificate of reduction: States loan’s
principal balance as of assumption date.
 Also called estoppel certificate.
© 2011 Rockwell Publishing
Finance Document Provisions
Late payment penalty provision
Late payment charges allowed only if clearly
defined in finance documents and
reasonable.
 Federal law limits late fees for many
residential loans.
IRS does not regard late payment penalties
as interest, so not tax-deductible.
© 2011 Rockwell Publishing
Finance Document Provisions
Prepayment provision
Prepayment penalty: Charge borrower must
pay lender if more than a specified amount of
principal repaid before payment due.

Many loans have no prepayment penalty.
 This type is called an open mortgage.

Prepayment penalties are:
 more common with subprime loans
 limited by federal and state law
© 2011 Rockwell Publishing
Finance Document Provisions
Subordination clause
Subordination clause: Gives this security
instrument lower lien priority than another
security instrument to be recorded later.

Common in loans for purchase of vacant
land that borrower intends to develop.
 When construction loan obtained, that
later lender will demand first lien
position.
 Construction loans are high-risk.
© 2011 Rockwell Publishing
Finance Document Provisions
Defeasance clause
Defeasance clause: Provision in which lender
agrees to cancel security instrument when
debt has been paid off.

Lender must provide lien release
document for recording:
 deed of reconveyance
 satisfaction of mortgage
© 2011 Rockwell Publishing
Summary
Finance Document Provisions
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Mortgaging or granting clause
Acceleration clause
Alienation clause
Assumption
Prepayment provision
Subordination clause
Defeasance clause
Deed of reconveyance
Satisfaction of mortgage
© 2011 Rockwell Publishing
Foreclosure Procedures
Foreclosure: Forced sale of debtor’s property
so that creditor can collect debt from sale
proceeds.
Foreclosure is real estate lender’s remedy
when borrower defaults. Default may be:
 failure to repay loan
 failure to insure property or pay taxes
 breach of other loan agreement provision
© 2011 Rockwell Publishing
Foreclosure Procedures
Two main forms of foreclosure:
 judicial foreclosure
 nonjudicial foreclosure
As a general rule:
 mortgages are foreclosed judicially
 deeds of trust are foreclosed nonjudicially
© 2011 Rockwell Publishing
Foreclosure Procedures
Judicial foreclosure
Main steps in judicial foreclosure:

Mortgagee files lawsuit against
mortgagor called foreclosure action.

Junior lienholders notified.

Judge issues decree of foreclosure.

Property sold at public auction called
sheriff’s sale.

Highest bidder given certificate of sale.
© 2011 Rockwell Publishing
Judicial Foreclosure
Equitable redemption
Equitable redemption period: Period from
filing of foreclosure action until sheriff’s sale.
During this period, borrower may stop
foreclosure and redeem property by paying:
 mortgage debt in full, including all
principal and interest
 costs incurred because of foreclosure
© 2011 Rockwell Publishing
Judicial Foreclosure
Statutory redemption
Statutory redemption period: Period after
sheriff’s sale when borrower has final chance
to redeem property. In Washington:
 eight months if lender waives right to
deficiency judgment
 one year if lender does not
Sheriff’s deed: Deed given to holder of
certificate of sale at end of statutory
redemption period if property not redeemed.
© 2011 Rockwell Publishing
Judicial Foreclosure
Surplus or deficiency
After judicial foreclosure:
 Borrower entitled to any surplus left after
mortgage and other liens paid off.
 But if proceeds don’t even cover loan
amount, lender may be entitled to
deficiency judgment for the difference.
Non-recourse mortgage: Mortgage that does
not permit deficiency judgment.
© 2011 Rockwell Publishing
Foreclosure Procedures
Nonjudicial foreclosure
Power of sale clause: Provision always found
in deed of trust authorizing trustee to sell
property (without going to court) if borrower
defaults.
© 2011 Rockwell Publishing
Nonjudicial Foreclosure
Main steps

Trustee sends borrower notice of default.

Trustee issues notice of sale one month later.
 Notice of sale recorded and sent to
borrower, junior lienholders, and anyone
who recorded request for notice.

Trustee conducts auction called trustee’s
sale.

Successful bidder receives trustee’s deed.
© 2011 Rockwell Publishing
Nonjudicial Foreclosure
Reinstatement and redemption
Borrower may reinstate loan and stop
foreclosure:
 by paying only past due amount plus costs
 until shortly before date of trustee’s sale
Or borrower may redeem property:
 by paying off entire debt plus costs
 at any time until trustee’s sale held
No post-sale redemption allowed.
© 2011 Rockwell Publishing
Nonjudicial Foreclosure
Surplus or deficiency
As with judicial foreclosure, borrower entitled
to any surplus after deed of trust and other
liens paid off.
However, deficiency judgment not permitted
after nonjudicial foreclosure.
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If proceeds don’t cover amount owed,
lender can’t sue borrower for difference.
© 2011 Rockwell Publishing
Alternatives to Foreclosure
Three alternatives to foreclosure for
defaulting borrower:
 loan workout
 deed in lieu of foreclosure
 short sale
© 2011 Rockwell Publishing
Alternatives to Foreclosure
Loan workouts
Loan workout: Arrangement in which lender
agrees to change payment schedule or other
loan terms to help borrower avoid foreclosure.
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Forbearance: Extra time to repay.

Loan modification might involve:
 changing variable interest rate to fixed
 lowering interest rate
 reducing principal amount owed
© 2011 Rockwell Publishing
Alternatives to Foreclosure
Deeds in lieu of foreclosure
Deed in lieu: Borrower who can’t arrange loan
workout may ask lender to accept a deed in
lieu of foreclosure.
 Deed transfers title from borrower to
lender.
 Lender takes title subject to any liens
other than its own.
 Borrower should make sure lender can’t
sue for deficiency.
© 2011 Rockwell Publishing
Alternatives to Foreclosure
Short sales
Short sale: When security property is sold for
whatever it will bring on open market, but
“short” of amount still owed on loan.
 Lender generally agrees to accept
proceeds from sale as payment in full.
 Borrower wants to avoid possibility of
deficiency judgment.
 Difficult to arrange if multiple lenders.
© 2011 Rockwell Publishing
Summary
Foreclosure and Alternatives
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Judicial foreclosure
Nonjudicial foreclosure
Reinstatement
Redemption
Deficiency judgment
Loan workout
Deed in lieu
Short sale
© 2011 Rockwell Publishing
Land Contracts
Land contract: Financing agreement in which
real estate buyer agrees to pay seller
purchase price in installments over time.

Alternative to note plus mortgage or deed
of trust, in seller-financed transaction.

Also called real estate contract, real
property sales contract, conditional sales
contract, installment sales contract, or
contract for deed.
© 2011 Rockwell Publishing
Land Contracts
Vendor and vendee
Seller = Vendor
Buyer = Vendee

Vendee agrees to make regular
payments of principal and interest to
vendor over specified period.

Vendee takes immediate possession of
property.
© 2011 Rockwell Publishing
Land Contracts
Equitable title and legal title
Although vendee takes possession
immediately, holds only equitable title to
property during contract term.

Vendor keeps legal title until contract
price paid in full.

When contract paid off, vendor delivers
deed to vendee, transferring fee simple
estate.
© 2011 Rockwell Publishing
Land Contracts
Rights and responsibilities

Vendee should record land contract to
protect equitable interest.

Vendee responsible for paying property
taxes and insuring property while paying off
contract.

Vendor may encumber property, but not in
a way that prevents delivery of clear title
when contract paid off.
© 2011 Rockwell Publishing
Land Contracts
Default
If vendee defaults on land contract, vendor
may:
 foreclose judicially
 declare a forfeiture
© 2011 Rockwell Publishing
Land Contracts
Forfeiture
Forfeiture allows vendor to terminate land
contract and regain possession of property:
 without having to go to court
 without refunding vendee’s payments
In Washington, this option applies only if
contract has forfeiture clause and is recorded.

Law also gives vendee with substantial
equity some protection against forfeiture.
© 2011 Rockwell Publishing
Summary
Land Contracts
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Land contract
Vendor
Vendee
Legal title
Equitable title
Forfeiture
© 2011 Rockwell Publishing
Types of Mortgage Loans
Mortgage loans may be classified by various
features.
 In spite of term “mortgage loan,” deed of
trust would almost always be used in
Washington.
© 2011 Rockwell Publishing
Types of Mortgage Loans
First or second
First mortgage: Loan against a property that
has higher lien priority than any other loans.

Loans against same property with lower
priority are second mortgage, third
mortgage, and so on.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Senior or junior
First mortgage is senior to second mortgage.
Second mortgage is junior to first mortgage,
but senior to third mortgage.

Lien priority determines order in which
loans will be paid off in foreclosure.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Purchase money
Purchase money mortgage: In general, any
mortgage loan used to buy the property that
will serve as security for the loan.
 But also used more narrowly to refer to
mortgage in seller-financed transaction.
 Seller extends credit to buyer and
“carries back” mortgage.
 Buyer pays seller in installments.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Soft or hard money
Soft money mortgage: When seller gives
buyer credit in exchange for mortgage.
 Another term for purchase money
mortgage in narrower sense.
Hard money mortgage: When lender gives
borrower cash in exchange for mortgage.
 May be purchase money mortgage in
broader sense, unless borrower already
owns security property.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Budget
Budget mortgage: When borrower’s monthly
payment includes prorated share of property
taxes and insurance in addition to principal
and interest.
 Lender holds funds in reserve account,
pays taxes and insurance when due.
 Reserve account also called impound
account.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Package
Package mortgage: When single loan is used
to purchase personal property along with real
property.
 Example: Buyer purchases commercial
ovens, freezers, and other equipment
along with restaurant property.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Construction
Construction loan: Temporary loan used to
finance construction of improvements on
land. Also called interim loan.
 Take-out loan: Permanent financing of
construction debt, replacing interim loan
after construction completed.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Construction
Construction loans are risky: borrower could
exhaust loan funds before construction finished.
 To prevent that, construction lenders have
various ways of disbursing funds, such as:
 Fixed disbursement plan: Borrower
receives obligatory advances at various
stages in construction process.
 Lender may also hold back 10% or more
for mechanic’s lien claims.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Blanket
Blanket mortgage: When several pieces of
property secure a single loan.
 Common in subdivision development.
 Partial release clause: Requires lender to
release some parcels from blanket lien
once certain portion of loan repaid.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Participation
Participation mortgage: Lender entitled to
portion of security property’s earnings, in
addition to interest on principal.
 Most common on large commercial
projects.
 Lender is insurance company or other
large investor.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Shared appreciation
Shared appreciation mortgage: Lender
entitled to portion of security property’s
appreciation in value.
 Part of increasing equity will belong to
lender rather than borrower.
 Equity: Difference between property’s
market value and liens against it.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Wraparound
Wraparound mortgage: New loan to buyer that
“wraps around” seller’s existing first loan.
 Buyer makes payment on wraparound to
seller.
 Seller uses portion of buyer’s payment to
make payment on underlying loan.
 Underlying loan:
 can’t have alienation clause
 should be paid off before wraparound is
© 2011 Rockwell Publishing
Types of Mortgage Loans
Open-end
Open-end mortgage: Allows borrower who
has paid off part of loan to reborrow funds
without arranging new loan.
 Can reborrow up to the amount originally
borrowed.
 Loan usually has variable interest rate.
 Often used by builders and farmers.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Graduated payment
Graduated payment mortgage (GPM):
Borrower allowed to make smaller payments
in early years of loan, then steps up to larger
payments.
 Good for borrowers who expect income
to increase.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Swing
Swing loan: Temporary loan to buyer who
needs funds to close purchase of new
property because old property hasn’t sold yet.
 Secured by equity in old property.
 Paid off when sale of that property
closes.
 Also called gap loan or bridge loan.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Home equity
Home equity loan: Loan secured by
borrower’s equity in home she already owns.
 Usually a second mortgage, junior to
existing purchase money loan.
 May be used for remodeling or other
improvements, or for expenses unrelated
to property.
HELOC: Home equity line of credit; works like
credit card, but secured by equity in home.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Reverse
Reverse mortgage: Provides source of
income for elderly person who owns home
free and clear, by converting equity into cash.
 Owner receives monthly payment from
lender in return for mortgaging home.
 Mortgage typically paid off when home
sold after owner’s death.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Subprime
Subprime loan: Loan made to borrower who
doesn’t qualify for traditional (prime) mortgage
loan.
 Credit scores or income ratios don’t meet
usual standards.
 Or may be unable or unwilling to provide
standard documentation.
Subprime lenders charge higher interest rates
and fees to compensate for higher risk.
© 2011 Rockwell Publishing
Types of Mortgage Loans
Refinancing
Refinancing: New loan used to pay off existing
loan secured by same property.
 May be from same lender or new lender.
 Common reasons for refinancing:
 to take advantage of lower interest rates
 to make balloon payment on old loan
Cash-out refinancing: New loan is for more
than amount needed to pay off old loan.
© 2011 Rockwell Publishing
Summary
Types of Mortgage Loans
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Purchase money mortgage
Budget mortgage
Package mortgage
Construction loan
Blanket mortgage
Participation mortgage
Wraparound mortgage
Open-end mortgage
Home equity loan
Reverse mortgage
Subprime loan
Refinancing
© 2011 Rockwell Publishing