Closing Agent Checklist
Closing Agent's Responsibilities Before and After Closing
To Do Before
Hold the buyer's deposits in a separate escrow account
Receive transactional paperwork and review instructions from the parties
Perform the title search
Calculate prorated expenses, such as property taxes
Work with the seller's lender to get loan payoff amount
Work with the buyer's lender to get closing amount and loan documents
Follow up on any special instructions within the purchase agreement
Receive broker instructions for commission
Prepare the closing statements
Obtain title insurance (buyer/seller pay for this)
Conduct the closing meeting, explain documents to parties, obtain identification and signatures, and make copies for the
parties
To Do After
Record the deed and verify funding of buyer's loan
Arrange payoff of existing loans
Distribute funds to the seller and brokers
File form 1099-S with the IRS, if necessary
Closing Process Summary
The closing process varies from one state to another, and sometimes even from one geographical area in a state to another. We
can make some generalizations about what happens throughout the process, though, no matter where it is.
The process begins when a seller and a buyer have come to an agreement on the terms of a sale. They're said to be under contract
. The contract is sent to the closing agent, and the closing process begins.
Prior to Closing
Both the buyer and the seller have tasks to perform to prepare for closing. The closing agent is responsible for several tasks, as
well, which may be performed by the agent or by others within the closing company.
Buyer
Obtains binder for insurance coverage on home.
Performs inspection.
Negotiates inspection issues with seller.
Finalizes loan application.
Performs the final walk-through.
Seller
Maintains property in good condition.
Cooperates with the closing agent to provide necessary information about loan payoff, etc.
Cooperates with the buyer to schedule inspections and appraisal.
Performs any agreed-upon repairs noted in an inspection.
Closing attorney or agent
Performs title search and orders title policy; presents title commitment to the buyer. The title commitment is the title
company's promise to provide a title insurance policy at closing, provided that all conditions noted in the commitment
have been met.
Calculates the necessary proration of expenses.
Obtains necessary information from all parties and prepares closing documents.
Tells the buyer (and sometimes the seller) how much money to bring to closing (usually through the delivery of a
settlement statement that shows each party its respective financial calculations)
Before closing, the parties have assured themselves that the conditions/contingencies of the purchase agreement have been met.
The Actual Closing Process
Depending on circumstances, the parties may all meet around a big table to close the sale, or the parties may close on different
days in different locations. No matter how the closing process is handled, these tasks are performed in order for the closing to
take place:
The buyer provides funds for the purchase through personal funds, a loan, or (most likely) both.
The seller is paid the balance of the purchase price, either by check, a certified check, or wire transfer.
The title insurance company issues the title insurance policy.
The parties meet with the closing agent to sign all required documents as the closing agent presents and explains them.
The closing agent ensures that all documents (promissory note, deed, etc.) are properly recorded.
The buyer gets the keys and takes title to the property.
The brokerage firms/licensees receive their commissions.
Consummation of Contracts
The closing represents the consummation of several different contracts:
Seller and buyer: Close on the sale agreement.
Buyer and lender: Close on mortgage loan commitment.
Buyer and title representative: Close on their contract.
Seller: Closes on contract with the listing agent.
Seller and buyer agents: Close on their cooperative brokerage agreement.
Agents' brokers: Close on their compensation agreement.
Principles of Value
Anticipation
The value of property today is the current value of the total anticipated future benefits. For example, a commercial property is
leased for $12,000 per year for 30 years. The value of the property is based on the income that is expected to be received in the
future.
Competition
The more similar properties that are on the market, the lower the price will be driven. Competition is related to supply and
demand. The greater the supply (the more competition), the lower the demand (and price). Less competition increases demand
and drives pricing upward.
Conformity
Value is created and maintained when the characteristics of a property conform to the demands of the market. For example, a
house built in the middle of a commercial zone (due to zoning changes) would be valued differently than a house in the middle of
a neighborhood made up of similar houses.
Contribution
A change in a property impacts the value as a whole. Does converting a garage into a family room contribute to or detract from
value? That would be in the eyes of the buyer.
Highest and Best Use
This is the most profitable use that is both legal (conforms to zoning) and economically feasible (won't cost more than the
increase in value).
Plottage
The joining or assemblage of two neighboring land parcels increases the property value. In such a case, 1+ 1 often equals 3 or
even 5. So two parcels worth $40,000 separately might be worth $120,000 when joined.
Regression
This is the value a higher-quality property loses by being near a lower-quality property.
Progression
This is the value a lower-quality property gains by being near a higher-quality property. For example, a neighboring home
built on a good-quality second-story quality remodel. The bump in value that the neighboring properties
gained in value represent the principle of progression
Progression and regression are based in the economic belief that it's better to have the cheapest house in the nicest neighborhood
than the nicest house in the cheapest neighborhood.
Substitution
A property's value is determined by what it would cost to purchase a similar substitute property. If someone offered you a car that
is an exact replica of another car but was $3,000 less, it would impact your perceived value of the other car.
The CMA Unveiled
A comparative market analysis (CMA) is an evaluation that you'll use to determine an appropriate listing price range. When
you're representing buyers, you can use a CMA to help determine an appropriate offer price, too.
Sold and Expired Listings
First, you'll need to collect some data. Research recent similar properties that have sold. If you can, stay within the last three
months or six months at the most. You may have to go farther back than that, but your numbers could easily be off, so adjust
based on the current market conditions.
You'll also want to look at expired listings. An expired listing will tell you the price at which a property will notsell, and that's
good information to have when you have a seller who's shooting for the moon price-wise.
Active Listings
Active listings are your competition. See how they're priced and how long they've been on the market. Pending sales are also
helpful in that they can tell you how quickly a home in a given price range received an accepted offer. Of course, you won't know
the actual sales price until that transaction has closed and the listing broker has posted that data. Typically, if it sold in its first day
or two on the market, it got at or near the asking price. This isn't always the case, but it's likely. A quick sale can also tell you that
the market for similar homes is good.
A Word on Comparables
The solds you select for your CMA-your comparables-should be as closely matched to the subject property as possible in terms of
location, size, style, amenities, and age. You'll want at least three and no more than six comparables. More than that, and the
information can get confusing for your client.
Even though you've selected similar properties, there will be some differences between them and your subject property. As part of
the CMA, you'll make adjustments based on direct comparisons of your property to the comparable properties.
A Few Final Tips
Unless the subject property is on a busy street, try not to select comparables on busy streets. In addition, don't compare a short
sale or a foreclosure to a home that's selling the traditional way. And fixer-uppers are another iffy choice for comparables. If a
listing reads "cash sale only," it's likely the home can't be financed because it needs major repairs. That wouldn't be a good
comparable for a home that's in market-ready condition. Every CMA is different, and you'll get a feel for them as you do a few.
The Cost Approach
The cost approachto finding appraised value involves combining separate estimates of value for the building and the land to get
the estimated value of the entire improved property. This approach measures value as a cost of production, including the
acquisition of the land and the construction costs. Its reliability depends on valid reproduction costestimates (i.e., the cost of
rebuilding) and appropriate depreciationestimates.
This approach is best and most often used in non-income-producing, unique properties, or special-purpose properties, such as in
these circumstances:
New construction of both residential and commercial property (that don't have comparable sales data available)
Unique properties , such as highly energy-efficient houses, residential acreage with excess land, historic houses, and
high-dollar houses with many amenities
Special-purpose commercial uses , such as hospitals, some manufacturing plants, hotels, schools, houses of worship,
and other single-purpose properties
The cost approach is NOT used in condominium and cooperative properties and isn't used as often with older properties, because
accurately estimating depreciation is difficult. However, it's essential when pricing historic properties. Why? Because the
depreciation is difficult to appraise, but the uniqueness of an historic property is likely to carry more weight than the difficulty of
adjusting for depreciation. Fannie Mae doesn't require a cost approach, but many lenders do, particularly when appraising highvalue properties.
As applied in the cost approach, site value is based on the opinion of the subject's highest and best use, as though the land is
vacant. Land is NEVER depreciated. The replacement costreflects the cost to build a functionally equivalent improvement. The
reproduction cost is the cost to build an exact replica of the subject, with the same materials and deficiencies.
Three Types of Depreciation Considered
Depreciation is a loss in value. The three types of depreciation are:
1. Physical depreciationis a loss in value caused by deterioration in physical condition.
2. Functional obsolescence is a loss in value caused by defects in design, such as a poor floor plan or atypical or
inconvenient sizes/types of rooms. Examples include houses where there are bedrooms on a level without a bath(s), or
where the only access to a bedroom is through another bedroom.
3. External depreciationor " economic obsolescence"is a loss in value caused by an undesirable or hazardous influence
offsite. Examples are heavily trafficked areas, industrial odors, or airport noise
When physical depreciation or functional obsolescence is present, the appraiser determines if the situation is curable or incurable.
Curable depreciation refers to an item that can be repaired or replaced, and where the cost to cure the item is less than or
the same as the anticipated increase in the property's value after the item is cured. This includes items of deferred
maintenance, such as painting or repairing faucets. The cost to cure should be reasonable and economically feasible.
Incurable depreciation includes items not practical to correct. Examples are a furnace or a roof that hasn't reached the
end of its economic life.
The appraiser describes these conditions in comments and also indicates the cost to cure if repairs and replacement are feasible.
Determining Indicated Value
The cost approach determines the indicated value by estimating the reproduction cost of the new improvement and subtracting the
amount of depreciation from all causes described above. Then, the appraiser adds an estimate of the site value as if it were vacant
and available to be developed to its highest and best use.
Determining Cost
So where do appraisers get their replacement and reproduction costs? To estimate the cost of improvements, residential appraisers
usually follow these steps:
1. Use published indexes and tables to source the data, such as Marshall & Swift Tables™.
2. The cost is then adjusted by its loss in value due to depreciation from all causes.
3. Accurate site (land/lot) value is required as a separate figure. (The sales comparison approach is used most commonly to
estimate this value.)
Comparative Square-Foot or Unit Method
A common method for estimating costs used by residential appraisers is the comparative square-foot or the comparative unit
method. It's used to estimate cost of a structure by taking the cost per square foot of a recently built comparable structure and
applying that cost per square foot to the subject property.
Site Value
In residential appraisals, the assessed value of the site is frequently used. The site value is added to the depreciated value of the
improvements to estimate the value by the cost approach.
Example
The appraiser determines the site value of the subject is $25,000, and the cost of the improvements is $100,000. The
incurable depreciation (due to age of the improvements) is $10,000. The curable depreciation estimate is $2,000 (say, for
replacing fencing and broken gutters). No functional obsolescence was noted. The value estimated by the cost approach is
$113,000.
$25,000 (site value) + 100,000 (replacement cost) - 10,000 (incurable depreciation) - 2,000 (curable depreciation)
= $113,000 (estimated value)
All About 1031 Tax-Deferred Exchanges
Under section 1031 of the Internal Revenue Code, the owner of real property can sell that property and then reinvest the proceeds
in a "like-kind" property to defer paying capital gains taxes. To qualify as "like-kind," the exchange must be done according to
the tax-code rules; it does not mean you have to replace an apartment building with an apartment building, etc.
Investors can reap significant tax benefits by taking advantage of the 1031 exchange, and in some areas, it's considered one of the
best-kept secrets in the Internal Revenue Code. A properly structured exchange can provide investors with the opportunity to
defer all of their capital gains taxes. This results in an essentially interest-free, no-term loan from the government. Instead of
paying the taxes now, the investor can put those dollars to work on other investment properties.
To qualify:
The property must be held for investment or business purposes.
Sale proceeds must be passed through the hands of a qualified intermediary and must not be received directly by the
investor, or they will become taxable.
All proceeds must be reinvested; any cash proceeds retained will be taxable.
The replacement property must involve an equal or greater level of debt than the relinquished property (if not, the investor
will have to either pay taxes on the difference or put in additional cash funds to offset the lower level of debt in the
replacement property).
All timelines must be met (property identification within 45 days; closing within 180 days from the closing date on the
relinquished property).
Foreign investors may also participate in the 1031 tax exchange and are subject to the same rules of qualification.
An investor can't defer capital gains taxes on a warehouse by purchasing a family home in which the investor intends to live. Nor
does most personal property qualify for the 1031 exchange, even if it's used for business purposes.
Investors can exchange property that's residential, commercial, industrial, or even leased (if the lease is for 30 years or more and
includes ownership interest). Investors can exchange into vacant land, hotels, motels, etc., provided the exchange meets certain
IRS rules.
Parsing the IRS Rules
First, there's the like-kind rule, which we've already discussed. Second, the basis of the original property carries over to the new
property. It doesn't change. So if your investor has a property worth $500,000 with a basis of $100,000, and then exchanges it for
a property also worth $500,000, the basis in the new property is $100,000 plus any new debt taken on and any cash paid out.
Rule Number Three
Rule number three is that the new property has to come with the same or greater debt load for the investor. If it doesn't, the
investor will be liable for gains on the difference. The IRS doesn't want the investor pocketing any change on gains realized-this
is simply a way to defer gains from one property by investing those gains in another. To be clear: Any cash your investor receives
from the proceeds of the sale is taxable. It's called boot . It doesn't mean there can't be a tax-deferred exchange, but the taxes on
the boot are due and payable.
Rule Number Four
Rule number four is that the investor has to use a qualified intermediary to conduct the exchange. What makes an intermediary
qualified, according to the IRS? Simple: He or she is not unqualified. In case that's clear as mud, your clients can't do the
exchange for themselves. And if they've worked with the investor in the past two years, neither can the investor's attorney, CPA,
or you-the real estate broker. You're not qualified. Joe Blow, unlicensed and uncredentialed, who doesn't know your client from
Miley Cyrus, is qualified. So Joe Blow, whoever he is, is called a QI, or qualified intermediary.
The QI will coordinate the exchange between the parties and their attorneys or agents, coordinate documents and money transfer
through escrow, and submit a 1099 to the taxpayer and the IRS for proceeds paid.
Rule Number Five
Rule number five-and it's a biggie-is that the investor has only 45 days from the day of closing on one property to identify and
commit in writing to the next property. The investor has 180 days from the date of sale of Property #1 to close on Property #2.
These are firm dates, and there is only one way to extend those dates: The president of the United States has to declare a natural
disaster area that affects the properties or parties involved. No foolin'
This time frame can get hairy if you're in the middle of negotiations and the clock is ticking-your investor client has a lot more to
lose than the seller of Property #2 at this point, so keep these deadlines in mind and identify early, negotiate expediently, and sew
up the deal before you run into trouble.
Rule Number Six
Disclosure of the exchange is rule number six. The 1031 must be disclosed to the buyer. At the time of the sale and at the time of
the purchase, you have to tell the parties to the transactions that you're doing a like-kind exchange.
If your client changes her mind about the property in the middle of the exchange, her tax deferral may be in jeopardy due to the
deadlines involved. If the change of heart occurs during the 45-day identification period-and by the way, the 45 days includes
Saturdays, Sundays, and your birthday, so don't even think about any grace period until the next business day-it's 45 calendar
days, period. If it happens during these 45 days, and your client hasn't yet closed on the sale of the property being sold, ask for an
extension from the other party.
Hopefully, though, you've identified a back-up property, just in case. If so, extricate yourself from the first transaction and
quickly get the other in writing within that 45-day window. This formal identification has to be made with the QI through fax,
mail, or courier. The investor must do this in writing during that 45-calendar-day identification period. Once the 45 days is up,
that's it. Revoking and submitting a new property for exchange will not reset the deadline. So unless you think you can get the
POTUS to write you a note for the teacher, fuhgettaboutit. And if you get a slippery QI who suggests changing or back-dating the
paperwork, fire him on the spot. This is called criminal income tax fraud, and even the president can't write you a note for that.
Let's say you fail to identify a property in 45 days, or the deal falls apart and you can't cobble another one together within that 45
days. What happens? It's not the end of the world, but it is the end of your investor's chance to do a 1031 for that deal. Game over,
pay your capital gains tax.
The 180 days is also firm unless the deadline becomes shorter. The rule is that you have to complete the 1031 exchange by the
earlier of either midnight of the 180th calendar day following the close of Property #1 or the due date of your client's federal
income tax return for the tax year in which the relinquished property was sold, including any extensions. This only becomes a
problem if Property #1 is sold between October 17 and December 31 of any given tax year, because that would mean that the
180th calendar day would fall after April 15, tax day.
Additional IRS Rules
Just in case you think you were done with the rules, remember: we're talking about the IRS. There are three more rules you should
be aware of related to the identification of the replacement property:
200% rule: Multiple properties are okay, but may not exceed 200% of value of the relinquished property.
95% rule: Multiple properties are okay, as long as they total at least 95% of the value of the relinquished property.
Three-property rule: Up to three properties are okay with no fair market value restrictions.
First, let's talk about the 200% rule. Your client could decide to exchange into more than one property. That's perfectly
permissible. Remember that the debt load has to be equal or more than the current debt load. There's also a cap. While your client
can identify multiple properties to exchange into, the combined fair market value of the properties can't be more than 200% of the
value of the relinquished property. So if your client has a property worth $100,000 and can find 18 properties to exchange into,
that's fine, as long as those properties' total value isn't more than $200,000.
Then there's the 95% rule, which says that your clients can identify a bunch of properties with no regard to their value if the
exchange they're moving into has a total value of at least 95% of the value of the property they're selling. So if your client has a
property worth $1 million and identifies six properties with a total value of $950,000 or more, you're good to go.
Because both of these rules can be a bit confusing, most people go by the three-property rule. That's the last of the property
identification rules from our friends at the IRS. The three-property rule says that your investors can identify up to three
replacement properties and, in this situation, fair market value doesn't matter, provided they meet the debt load requirement we've
already discussed.
For simplicity's sake, you can think of these as just two rules. As long as you meet the debt requirement, you can exchange up to
three properties at any value. If you exchange more than three, they have to have a value of 95 to 200% of the relinquished
property.
If your client finds and closes on an investment property and then decides to sell another property, he can do a tax deferral
"backward." This is called a reverse exchange . You're still strapped to the 45- and 180-day deadlines, though, and it can get
hairy.
Environmental Hazards Outside the Home
Underground Storage Tanks
Residential use: May contain household heating oil
Industrial use: May contain fuel or chemicals
Older tanks may leak
Piping or vents may stick out of the ground
Common in older homes, commercial, or industrial
Waste Disposal Sites
Property may have been used as dump site
Landfill indicators: discolored soil, soft spots, mounds
Commercial properties should be inspected
Federal Taxation
STUDY SHEET
Permitted Deductions on Primary and Secondary Residences
Deductions for Primary Residences
Interest
Homeowners can deduct the interest paid on the loan with certain IRS restrictions.
The loan has to be for home acquisition financing, which can be a mortgage to buy, build, or improve a property. This
may include a personal residence, a vacation home, an investment property, vacant land, or a timeshare.
The loan amount has to be secured by the property itself.
The total amount that's treated as home acquisition debt for tax purposes has to be less than:
$750,000 for married couples filing jointly
$375,000 if married but filing separately
Homeowners with loans taken out prior to Dec. 14, 2017 aren't subject to the new $750,000 cap.
Home Equity Loans
Homeowners can write off the interest on a home equity loan, provided that the total home debt doesn't exceed fair market
value, and the owner uses the funds to improve the home.
Anything used for other purposes isn't deductible as of 2018. At tax time, homeowners declare it as an itemized deduction
on Schedule A.
Property Taxes
Homeowners can also deduct up to $10,000 of combined state and local taxes. This includes:
Property taxes
State income taxes
State sales taxes
Local taxes
Property taxes are deducted as an itemized deduction on the tax return, just like mortgage interest, on Schedule A.
Deductions for Second Homes
As long as it is used as a second home, rather than as a rental property or as a business property, the owner can deduct the
interest on the mortgage in the same manner as the first home, not to exceed $1.1 million for both homes combined.
Property taxes can also be deducted.
There are different tax rules, depending on how much the owners are charging for rent and how much time is for personal
use of the property.
Owners can rent the second home out for up to 14 days per year and pocket the cash tax free.
The 14-day rule also means that the house is considered a personal residence, so owners can deduct mortgage
interest and property taxes just like the primary residence.
When owners rent their second home for 14 days a year or more, they have to report all of their rental income.
However, they can deduct rental expenses, which involves separating the costs used for personal use and the costs
for renting the property.
Any rental expenses can only be deducted up to the amount of rent reported. For instance, an owner couldn't claim
$25,000 in rental expenses on $2,000 in rent.
Real estate losses are generally considered passive losses under tax law and are not deductible, but if the rental income
doesn't exceed a certain threshold, sometimes owners can deduct passive losses against their income.
Selling the home can account for passive losses, as well.
Passive losses can be stored up for that time and used to offset any gains from the sale.
Selling a Home and the Income Tax Implications
When owners sell a primary residence (one that they've lived in and used for at least two of the past five years) for more
than they paid for it, there may be income tax implications.
For example, if a property purchased for $215,000 appreciates to $380,000 in five years, the increase of $165,000 is
considered a capital gain on the sale.
Current tax laws allow taxpayers to apply a capital gains exclusion to at least a portion of the gain realized on the sale of a
primary residence.
Single taxpayers may be able to exclude $250,000 of the capital gain, and married taxpayers who are filing a joint tax
return may be able to exclude $500,000.
Rules for this exclusion:
Taxpayers must have lived in the property for two of the past five years, but they do not have to be living in the
property at the time of the sale.
Sellers can take the exclusion any number of times, but only once every two years.
When calculating the gain, taxpayers can deduct the original purchase price and the cost of capital improvements
from the gain.
Capital improvements include items such as major remodeling projects, adding a room, garage, or deck, and more.
Taxpayers should keep receipts for these improvements to document the cost when it's time to sell.
Taxpayers who don't qualify for the capital gains exclusion or whose gain exceeds the $250,000 or $500,000 limits will
pay a lower tax rate on the gain than on their regular income if they've held the property for more than one year and one
day.
A gain on the sale of property held for at least this length of time is called a long-term capital gain , and these
gains are taxed at a much lower rate than the rate on ordinary income.
Gains on property held for less than one year and one day are considered short-term capital gains , and they're
taxed at the taxpayer's ordinary income tax rate.
Reviewing Income Tax Implications When Selling an Investment Property
Calculating Adjusted Basis
Adjusted basis is how much money the investor has put into the property all together, including the purchase price,
closing costs, and improvements, less depreciation already taken.
Profit = purchase price + closing costs + capital improvements - depreciation already taken = adjusted basis.
For example, let's say an investor purchased an investment property for $250,000, and closing costs
were $5,000. The investor installed a second parking lot, a garage, and new balconies, which added
$100,000 in capital improvements. During the holding period, the investor took $20,000 depreciation on
the property. The property later sold for $475,000.
$250,000 + $5,000 + $100,000 capital improvements - $20,000 depreciation already taken = $335,000
(adjusted basis)
Calculating Capital Gains
Capital Gain - The amount of profit earned on an investment. Federal tax law classifies capital gains into either
short-term or long-term, based on how long the property is held by the investor before the sale.
Short-term Capital Gain - Property held less than one year
Long-term Capital Gain - Property held longer than one year
Sales price - adjusted basis = capital gains. For example, a property that sells for $475,000 with an adjusted
basis of $335,000 would result in a $140,000 capital gain:
$475,000 - $335,000 adjusted basis = $140,000 capital gains
From the $475,000, other costs related to the sale, such as brokerage fees, closing costs, surveys, etc., are
also deducted from the sales price.
Postponing Capital Gains Tax Through Installment Sale Deferment
Investors can postpone payment of capital gains tax when they sell a property with an installment contract where the
buyer pays for the property over a period of years.
Available for both commercial and residential properties with installment tax obligations at the end of the tax year of $5
million or less.
All About 1031 Tax-Deferred Exchanges
Under section 1031 of the Internal Revenue Code, the owner of real property can sell that property and then reinvest the
proceeds in a "like-kind" property to defer paying capital gains taxes.
Investors can reap significant tax benefits by taking advantage of the 1031 exchange.
A properly structured exchange can provide investors with the opportunity to defer all of their capital gains taxes.
A property must meet certain qualifications to be eligible for a 1031 exchange, such as:
The properties must be of like-kind.
The new property must come with the same or greater debt load than the original.
The transactions must involve a qualified intermediary, such as an attorney.
The new property must be purchased within 45 days of the closing of the original exchange.
The exchange must be disclosed to all parties.
Tax Shelters for Investors
Capital Gains Exclusion - up to $250,000 for singles, and $500,000 for married filing jointly); can be claimed once every
two years.
Tax-Free Financing - borrowed money isn't taxable, so refinancing allows investors to tap into equity in one property to
finance another. Capital gains aren't realized until the property is sold.
Pyramiding - refinancing or selling one property to finance another.
FIRPTA
Foreign Investment in Real Property Tax Act (FIRPTA)
Buyers who purchase property from non-U.S. citizens must withhold 15% of the gross purchase price for capital gains tax
and remit to the IRS.
Foreclosure Processes Study Sheet
STUDY SHEET
Types of Default
Acceleration Clause
An acceleration clause in a loan contract that allows the lender to foreclose on the outstanding balance of a loan if the
buyer defaults.
A single late payment doesn't automatically mean a loan has gone into default.
Types of Default
Delinquency
Property Taxes - Rare because property taxes are usually paid with the monthly mortgage payment
Liens - When payments are more than 30 days overdue, and federal tax liens that threaten the lender's position
Homeowners Insurance - When lapsed, it leaves the lender vulnerable to loss
Poor Property Management
Foreclosure
The process whereby the lienholder can sell the property at auction to recoup the funds due.
If the sale proceeds aren't sufficient to satisfy the lien, the lienholder can place a deficiency judgment against the property
owner for the outstanding balance.
Foreclosure Defenses
Right of Redemption - the homeowner simply pays the outstanding debt, plus interest and penalties, and other costs
incurred by the lender before the foreclosure occurs; ceases when the foreclosure sale is held.
Bankruptcy
Types of Foreclosure
Non-Judicial Foreclosure (aka "foreclosure by advertisement")
Requires the power-of-sale clause in the deed of trust, which gives the lender the right to sell the property if the
borrower defaults.
No court action is required
Judicial Foreclosure (aka "foreclosure by action")
If no power-of-sale clause is included in the deed of trust a lawsuit is required to foreclose on the property.
Redemption Periods - The time the borrower is given to pay off the debt and redeem the property from foreclosure
Equitable Redemption Period - Time between when the borrower receives notice that he/she is in default and when the
foreclosure sale is held.
Statutory Redemption Period - Time between the foreclosure sale and when the borrower must vacate the property;
generally six months, but may be extended to 12 months; the borrower can remain in the home, and the winning bidder
can't enter the property during this time.
Deed in Lieu of Foreclosure
Lender accepts the property deed instead of foreclosing.
Title is transferred to the lender, and borrower's debt is canceled.
Understanding Deficiency Judgments
Allow the lender to recover losses incurred in the foreclosure process.
Not all foreclosure processes allow deficiency judgments.
A blanket lien against all current and future property held by the borrower can be placed on the borrower's property until
the lender can recover all losses.
Distressed Property Types
Short Sales - A sale initiated by the seller facing default who owes more on the property than what it's worth; requires lender
approval, and can result in a deficiency judgment
Foreclosures - Foreclosure proceedings have been initiated by the lender due to borrower default, and the property is auctioned at
a foreclosure sale
REOs (Real Estate Owned) - A property which didn't sell at a foreclosure sale, and which the lender attempts to sell on the open
market.
Working with Distressed Properties
Both the seller and the lender must approve a short sale.
Cash payment is required at a foreclosure auction.
Know the lay of the land - how foreclosures work in your area, and any laws that could affect the property market.
Be first
Make the cleanest offer possible
Deal directly with property owners
Have cash ready
Don't overpay
Follow instructions and have paperwork ready - when dealing with short sales, be prepared to provide the lender with a
packet of documents
Strategies for Working with Buyers Interested in Distressed Properties
While waiting for lender approval, buyers should make sure financing is in order, and solicit bids
The purchase agreement between the buyer and seller is a binding contract, even though lender approval is required.
Buyers shouldn't pay out of pocket costs until the lender accepts their offer, or make multiple offers on short sale
properties unless prepared to purchase them all.
Junior liens can hold up a short sale because often there won't be enough funds to pay back all junior lien holders, which
can cause negotiation issues and time delays.
Sellers can accept multiple offers on short sales because all offers are accepted pending lender approval of the short sale,
which means the seller may retract acceptance any time before lender approval.
Gathering Data for Property Valuation
When you're valuing property, you'll gather data that will help you arrive at an opinion of value and then support that opinion.
What kind of data, and where does it come from?
Types of Data
You'll need to collect:
General data on the forces that influence property value, such as the social, environmental, governmental, and economic
features of the nation, region, city, and neighborhood.
Specific data about the subject site and its improvements, including a physical description and financial and legal factors.
Sources of Data
Primary data is anything compiled by the person conducting the valuation, and for that purpose. Collecting specific data
about a subject property and identifying comparable properties are examples of primary data used in a valuation.
Secondary data comes from reports or records developed for other purposes. For example, a published report on the
economic market's current state is secondary data, since it was published for another purpose. But the person conducting
the valuation may use it to support the opinion of value.
Data sources include people the valuator speaks to directly (sellers, buyers, brokers, etc.), records (deeds, title reports, maps,
financial statements, the MLS, etc.), and direct observation (visiting the subject property and comparables).
All data must be current, accurate, and reliable in order to arrive at a valid opinion of value.
Introduction To Estimating Closing Costs
Property transfer fees that aren't included in the sales price are known as closing costs . Typical closing costs include:
Charges for the mortgage loan
Appraisal and survey fees
Title insurance
Legal fees
Real estate professional fees/commissions
Prepayment of taxes and insurance
Other fees and taxes depending on the geographic region in which the transaction takes place.
Some states, counties, and municipalities require collection of transfer, mortgage, or other fees and taxes.
Buyer and seller closing costs depend on the practices in a given area, but there are some costs typically paid by buyers and
sellers regardless of location. Buyers are typically responsible for appraisal and credit report fees, inspections, mortgage recording
tax, title insurance, loan fees, recording fees, mortgage insurance, and tax reserves. A common estimate of a buyer's closing costs
is usually about 2% to 5% of the home's purchase price, according to Zillow.
Both the seller and the buyer, along with their attorneys or real estate professionals, should inspect the closing statement to make
sure that all transaction monies have been accounted for.
Buyers, especially if the transaction is financed, will bear most of closing expenses and will need to bring money to the closing,
usually in the form of a certified check or wired funds. Sellers in a regular transaction usually don't need to bring money to the
closing, but they'll want to know what they can expect to make-or net -from the sale. Sellers in a distressed sale transaction (a
short sale transaction, for example), may have expenses to pay at closing.
As a licensee, you have some tools at your disposal that can help both buyers and sellers estimate the financial impact of closing
the transaction.
Online Calculators
Most brokerage firms allow (and even encourage) licensees to prepare buyer's closing costs estimates or seller net sheets to help
clients estimate what a specific transaction will cost (for the buyer) or net (for the seller). Various online calculators are available,
or you can use a pre-printed form and manually calculate estimated closing costs or net profit.
If your brokerage firm allows presentation of these estimates, you may want to prepare a new estimate for each offer made or
received. Many licensees provide an estimate to sellers when helping to price the property. Walk your clients through preparation
of the estimate and provide them the tools to prepare their own estimates if they enjoy number-crunching.
Many title company and financial websites, including calculators that may be customized for each state.
Local Knowledge
Be sure your buyers and sellers know that they can't rely entirely on a national calculator, but many online calculators can be set
to recognize specific regions. Help buyers and sellers by being able to provide information about variable information related to
your region, including homeowner's insurance rates, property tax rates, regional fees and taxes, specialized insurance (such as
flood insurance, which isn't included in homeowner's policies), and specific inspection requirements.
Information Sources
Flood zone: Use the Federal Emergency Management Agency's (FEMA's) Flood Map Service Center site (https://msc.
fema.gov/portal/search) to search by address and check if your property is located within a floodplain.
Special taxing district: Usually the county tax assessor's site will list whether your property is subject to special taxes.
Property taxes: The county tax assessor's site will have this information, and many MLS systems include property tax
information. Always be sure to verify it, though.
Homeowners insurance rating: Certain properties in an area you serve may be assessed a higher homeowner's insurance
rating because of the potential for, distance from fire services, or other concerns. If your broker doesn't have this
information, consider contacting local insurance providers to find out.
Key Closing Documents
Overview
Although not required at every closing, the documents used at most closings are:
Document
Purpose
Deed
Is used to establish proof of ownership
Survey
Proves that no encroachments exist with the property
Chain of title
Establishes path and proof of ownership
Abstract of title
Provides a summary of the title history
Title insurance policy
Insures the policy owner against financial loss if the title to the real estate has defects
Deed
Is a legal document
Is used to establish proof of ownership
Assures the buyer that the seller has the right to sell the property
Is a new deed the seller's attorney prepares, normally based on the seller's old deed
Includes both parties' legal names and is typically signed by the seller (grantor) at closing
Survey
Proves that no encroachments exist with the property
Shows the measurements, boundaries, and area of the property
Usually paid by the buyer or seller
Source: http://www.rasmussenlandsurveyors.com/gallery/
Chain of Title
Establishes path and proof of ownership
Must be unbroken for the title to be good
Established through a search for successive conveyances of title, starting with the current deed and going back in time 4060 years (usually)
The buyer should not agree to close on a broken chain of title
Abstract of Title
Provides a summary of the title history
Contains a legal description of the property
Summarizes any records related to the title
An attorney:
Reviews the chain of title carefully to ensure it is unbroken and clear
Updates the abstract of title with an abstract continuation
Provides a written certificate of title opinion that the title is clear
Title Insurance Policy
Two types: one insures the policy owner against financial loss if the title to the real estate has defects, and the other
protects the lender from the same
Protects against title defects existing at the time of title transfer only
Issued only if title is acceptable (insurable title) and certificate of title opinion is provided by an attorney
Source: DocStoc.com, SAMPLE-ALTA-Title-Policy
Land Description
STUDY SHEET
Surveys and Plats
A legal description - is a description of the land that specifies the boundaries and location of a specific piece of real
property
Accurately describing the boundaries of property in a deed is extremely important. A street address is simply not
sufficient, so legal descriptions are employed for the purposes of pinpointing the properties involved in real estate
transactions. Legal descriptions leave no doubt about the boundaries of any property being conveyed.
A survey is a drawing or sketch of the property detailing the boundaries lines, and generally the structures
(improvements) within the boundaries. Legal descriptions are included as part of a survey.
A plat is an official map or plan of a parcel of land that's been or will be subdivided to show the boundaries of each
created lot. It includes a description of the land and everything that's on the land, such as improvements, boundary lines,
and roads.
Three Methods of Land Description
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Methods of land description include:
Metes and bounds, which use compass headings and directions
Lot and block, which provides plat references
Rectangular (government) survey system, which divides surveyed land into six-mile-square townships that are further
subdivided
Monument system, in which permanent land markers are used as points of beginning
Overview of Land Units and Measurements
Foot -12 inches
Yard -Three feet
Mile -5,280 feet
Square Yard - Nine square feet (three feet x three feet)
Acre -43,560 square feet
Section -One square mile; 5,280 feet on each side; 640 acres
Cubic Yard - three feet x three feet x three feet
Metes and Bounds
Metes are the direction and distance of a line forming the boundary of the property. To find the direction, a
compass was used indicating north, south, east, west as well as the degree of direction between 0 and 90.
Bounds refer to the physical features that define the boundaries of the land. Common terms used to reference
bounds might be the name of a tree, creek, owners of land bordering the property, and even piles of rocks.
The language and numbers used in a metes and bounds description are derived from a survey performed by a
licensed land surveyor.
A key consideration is the point of beginning . Unless it is easily identifiable, the rest of the description won't
be of much use to anyone, because everything is based off of that point. After identifying this point, the
surveyor sights the direction to the next point.
Lot and Block
The lot and block system is also called a plat reference system because it's a description by reference, plat,
or lot and block.
Lot and block systems are surveyed by first referencing either a rectangular government survey or a metes
and bounds description. Then the land is divided into lots with a numerical designation of a parcel. The block
refers to the name of the subdivision under which the map is recorded.
A licensed surveyor or engineer creates the lot and block system beginning with a subdivision plat. The
surveyor/engineer divides the land into numbered (or lettered) lots and blocks, including streets, access roads,
and other important features. All lot measurements and distances between points are included, making it a
very detailed map.
When approved, the plat map becomes part of the legal description.
A description by reference to a plat may refer to a plat map and lot number as part of a recorded subdivision.
The description will cite the plat book and page number in which the map is recorded so that any interested
party can look it up and determine the exact location and dimensions of the property.
Rectangular Government Survey System
The rectangular government survey system is also known as the Public Land Survey System (PLSS), because
it was originally used to survey federally owned blocks of land.
Only used in 30 western and southern states.
Divides land into townships, sections, and fractions of sections.
Townships consist of 36 one-mile-square (640 acres) sections.
A section consists of 640 acres.
The principal meridian north-south line that runs through the initial point is a true meridian.
The east-west lines of a survey are called township lines. The north-south lines are called range lines.
Loan Types and Structures
Before we get too far ahead of ourselves, let's make sure you understand a very important term that applies to mortgages:
amortization . This is the process of paying off a loan by making periodic payments on the principaland interest. Initially, most
of the payment will go toward interest, with ever-increasing amounts going toward the principal until the loan is paid off. For
instance, a 30-year, fixed-rate loan will be fully amortizedin 30 years. In contrast, a non-amortized loan is one where the
payments go only toward interest, not to the principal. In a non-amortized loan, the principal is paid off at the end of the loan term
as a lump sum.
Negative amortization occurs when a borrower's loan payment is actually less than the interest charged, meaning the loan's
outstanding balance increases. We see this with deferred interest loans and graduated payment mortgages.
Partially amortized loans are far more common with commercial loans versus residential loans. They set a fixed interest rate and
low payments for the first few years. After that, borrowers owe a balloon payment-a lump sum-when the loans mature.
Now let's look at some loan options.
Residential Mortgage Types
Fixed-Rate Loan
With this type of loan, the principal and interest payment remain the same over the life of the loan. Fixed-rate loans are the most
traditional loan product.
Graduated Payment Mortgage
A graduated payment mortgage has a fixed interest rate, but monthly payments gradually adjust (usually upward) based on a
predetermined schedule and amount. The initial payments are less than what would be a fully amortizing payment, which creates
negative amortization. However, this type of payment plan can make payments easier in the beginning when income may be
lower.
Growing Equity Mortgage
Like a graduated mortgage, this is a fixed-rate mortgage where interest rate remains the same, and the monthly payments increase
over time according to a set schedule. However, there's no negative amortization; the first payment is a fully amortizing payment.
As the payments increase, the amount that's larger than what would be a fully amortizing payment is applied directly to the
principal balance. This reduces the life of the term and increases the interest savings for the borrower.
Bridge Loans
Bridge or swing loans offer temporary (usually 90-day) funding until permanent financing can be obtained.
Alternative Mortgage Instrument (AMI)
An alternative mortgage instrument (AMI) is any type of mortgage other than a fixed-rate, fully amortizing mortgage loan. You
can imagine, then, that this is a fairly broad category. AMIs can differ in terms of interest rate structure, repayment options, and
other features. Some of the most common AMIs are adjustable rate mortgages.
Adjustable Rate Mortgage(ARM)
This is a loan where the interest rate is based on an economic index (e.g., the Consumer Price Index) and is adjusted on a
periodic basis, such as annually. The interest rate is calculated by adding a specified number of percentage points, called the
margin , to the associated index. The margin is constant throughout the life of the mortgage.
ARMs also have limits, or caps , on how much the interest rate can increase from the current rate when it's adjusted. The first
interest rate adjustment (for example, after the first year) has an initial capthat limits the amount the interest can go up at that
time. At subsequent adjustment dates, the periodic cap(also known as anniversary cap, subsequent cap, or period cap) limits the
amount the rate can adjust. There's also a lifetime cap, (aka aggregate cap) which is the maximum amount the interest rate can
increase from the initial rate through the life of the loan. The mortgage's interest cap structure is usually expressed in numbers as
something like 2/2/5 (the initial, periodic, and lifetime caps). Some ARMs can be converted to a fixed- rate loan depending upon
the conversion option.
Term Mortgage
This is a mortgage in which the periodic payments go to interest only, and the entire principal amount is due at the end of the term
as a balloon payment. Generally, the term period is very short---three to five years, for example---but they may be renewable.
Term mortgagesare frequently used of construction loans or junior mortgages.
Open-End Mortgage Loan
An open-end mortgage allows borrowers to increase the outstanding principal mortgage amount at a later date. That means
borrowers are able to borrow more money from their lender, although a set limit generally applies. Open-end mortgages are
similar to revolving credit.
Construction Loan
This is temporary financing for construction purposes. The developer will submit plans for a proposed project, and the lender will
make a loan based on the value of the appraisal of the property and the construction plans. The entire loan is not given at once;
disbursements are made at intervals as phases of construction are completed.
Upon completion, the lender makes a final inspection, closes the construction loan, and converts the loan into permanent, longterm financing. Construction loans involve risk for the lender (they are essentially loaning on land, air, and a promise to build)
and usually come with a higher rate.
Shared Appreciation Mortgage (SAM)
A shared appreciation mortgage (SAM) is a mortgage in which the borrower initially receives an interest rate that's less than the
current market rate. In exchange, the lender receives equity or a percentage of the appreciation in the property's market value.
Buydown Mortgage
With this loan, the buyer (or the seller or a third party) pays the buyer's lender a lump sum, usually stated as points, at closing to
either temporarily or permanently reduce the mortgage loan's interest rate.
Blanket Loan
Blanket loans are loans that cover two or more properties. As with other loans, the real estate is held as collateral; however the
individual pieces of the real estate may be sold without triggering a due on sales clause for the entire mortgage balance.
Package Loan
Package loans bundle real estate and personal items (such as the furniture in a house) together.
Seller Financing
Wrap-Around Mortgage
With this form of seller financing, the seller's mortgage remains in place, but the seller is receiving payments from the new buyer
and therefore is financing the purchase. The mortgage payments the buyer makes are expected to be more than the payments on
the seller's original loan, so the seller isn't paying out of pocket. It's generally a relatively short-term arrangement (perhaps five
years), made until the buyer is able to qualify for a conventional mortgage, and will then pay off the remaining principal to the
seller.
Purchase Money Mortgage
A form of seller financing in which a mortgage is given by the buyer to the seller toward the purchase price; buyers use this as
down payment financing.
Contract for Deed
Allows the seller to provide financing by providing credit to the buyer. The buyer makes payments directly to the seller, and legal
title remains with the seller.
Equity Loans
Home Equity Loan
This is a loan in which the borrower's equity in the primary residence is used as collateral to purchase a second home or an
investment property. If the primary home is owned free and clear, the home equity loan is a first mortgage. If not, it's a second or
junior mortgage. Rates on home equity loans tend to be higher than conventional loans, and their term rates are shorter.
Reverse Annuity Mortgage (RAM)
This loan is made using the equity in the property, but the homeowner continues living in the home while the lender makes
payments to the homeowner and gains corresponding ownership of the property over time. When the homeowner leaves the
home, the lender sells the property to pay back the amount of the loan and interest. This is designed for older homeowners who
want to use the equity in their homes as an income source.
Shared Equity Mortgage (SEM)
This is used most often in commercial lending. The borrower agrees to the lender's participation in the net income from the
commercial property or enterprise in order to obtain the loan. The lender may receive interest and a share of the owner's profits.
Math Skills
STUDY SHEET
Understanding Percentages
To change a percentage to a decimal, move the decimal point two places to the left (50% = 0.50).
To change a decimal to a percentage, move the decimal point two places to the right and add the percentage sign (0.50 = 50%).
Calculating Commissions
Commission = commission rate × sales price
Commission rate = commission ÷ sales price
Calculating Area and Length
Area of rectangle = length x width (6 x 4)
Area of square = side x side (4 x 4)
Area of triangle = ½ base length x height
To calculate the area of irregular shapes:
Divide the shape into squares, rectangles, and triangles.
Find the area of each separate shape.
Add the area of the shapes together.
Sales price ÷ area (square feet) = price per square foot
Potential home value = $ per sq. ft. x area (Price of comp home x potential home sq. ft.)
One acre = 43,560 sq. ft.
Hectare = 10,000 sq. meters (2.47 acres)
Front foot (frontage) is the length of property running along a street, highway, or water way.
Perimeter = the length/width of all sides added together (i.e., the perimeter of a 3x4 rectangular property = 3+3+4+4 = 14)
One mile = 5,280 feet
One acre = 43,560 square feet (four nuns driving 35 mph in a 60-mph zone)
One yard = three feet
One square yard = three feet × three feet
Square footage ÷ 43,560 = number of acres
Calculating Property Taxes
Assessed value = appraised value × assessment ratio
Property taxes = assessed value × rate
Property taxes = assessed value × mill rate ÷ 1,000
Pricing Properties
Identify comparables.
Adjust comparables up or down based on differences.
Calculating Net Operating Income
Effective gross income - operating expenses = net operating income
Calculating Capitalization Rates
Capitalization rate = R
Net operating income = NOI
Value = V
Capitalization rate = NOI ÷ value (R = NOI ÷V)
Gross Rent Multiplier and Gross Income Multiplier
Sales price ÷monthly gross income = gross rental income (GRM)
Sales price ÷ annual gross income from all sources = gross income multiplier (GIM)
Calculating Depreciation
Depreciation is a perceived decrease in value.
Investment properties are depreciated for income tax savings based on the initial sales price of the property, minus the
land value.
The depreciation schedule for a residential income-producing property is 27.5 years, and 39 years for non-residential
properties.
Annual depreciation rate = 1 ÷ number of years to depreciate (27.5 or 39)
Original value x depreciation rate = yearly deprecation. For example, a non-residential building valued at $800,000:
39.5 ÷ 1 = .026 depreciation rate
$800,000 x .026 = $20,800 yearly depreciation
Calculating Housing and Debt Ratios
Net income = gross income - taxes and expenses
Gross income, not net income, is used to calculate total and housing debt ratios.
The total ratio includes all recurring (or installment) debt that will last longer than 10 months, such as monthly mortgage,
car, credit, and loan payments.
The housing ratio includes monthly housing obligation (principal, interest, taxes, insurance) and HOA/condo association
fees.
Total debt ratio = (total of monthly debt obligations ÷ monthly gross income) x 100
Housing debt ratio = ([principal + interest + taxes + insurance + association fees] ÷ monthly gross income) x 100
Loan-to-Value Ratio and Equity
LTVR = loan amount ÷ sales price (convert the answer to a percentage)
Equity = appraised value - loan debt
Calculating Interest
Annual interest = loan balance × interest rate
Interest rate = annual interest ÷ loan balance
Monthly interest = yearly interest ÷ 12
Calculating Loan Discount Points
Loan amount × points = points amount
80/20 loan = financing 80%, putting down 20%
Calculating Amortization
Monthly principal and interest:
1. Using an amortization chart, find the point where the loan term and interest rate intersect, which is the "factor."
2. Divide the loan amount by 1,000 (the factor is for each $1,000 of loan balance).
3. Multiply the result by the factor.
Example: A $200,000 loan for 20 years at 3.5% interest:
20-year loan at 3.5% = 5.79960 factor
$200,000 ÷ 1,000 = $200
$200 x 5.79960 = $1,159.92 monthly principal and interest
Calculating Net to Seller
The net to seller formula calculates the amount the seller gets after commission is paid.
Percent to seller = 100% of sale price - commission %
Net to seller = sales price x (percent to seller)
Example: Home sale price is $150,000. The commission rate is 7%. The percent to seller is 93%, or 0.93 (100% ? 7%).
Multiply $150,000 by 0.93. The net to the seller is $139,500.
To calculate the sale price to net a specific amount, add the desired net amount to the outstanding loan amount, then
divide by the % to seller.
Closing Proration Practice
Calendar year = 365 days
Statutory year = 360 days
Calculate daily and/or monthly rate.
Determine number of days and/or whole months in the proration period.
Multiply the rate by the number of days/months in the proration period.
Transfer Tax and Recording Fees
Transfer tax is applied whenever real property is sold. It varies by state and is typically paid by the seller but is negotiable
between the parties.
A mortgage recording tax is a tax on the privilege of recording a mortgage on real property located within the state. Not
all states charge a mortgage recording tax, and the rate varies by state.
Calculating Per $100 divide by 100 (or move the decimal two places to the left). Example - $2.75 per $100 is 0.0275
Methods Appraisers Use to Measure
Depreciation
Age-life Method
Straight-line method or economic age-life method
The age-life method-the easiest way to measure depreciation-assumes that throughout the life of a structure, depreciation happens
at an even, steady rate. Using the age-life method, an appraiser estimates the accrued depreciation by comparing the structure's
effective age at the time it's appraised with the structure's total economic life.
Appraisers base depreciation estimates on a structure's effective age, rather than its actual age, because different structures are
built using materials and construction techniques of varying qualities. Different structures also receive varying degrees of
maintenance during their lifetimes, so even structures that are similar can and do depreciate at varying rates.
The loss in value for a structure can be assumed to be the ratio of its effective age to its total economic life.
Here is the formula for estimating depreciation using the age-life method:
Effective age ÷ Total economic life = Accrued depreciation
This formula leads to a decimal, which the appraiser can convert to a fraction, then apply to the structure's reproduction or
replacement cost (depending on which is applicable for the given structure) to arrive at the structure's estimated value.
Example
Building's reproduction cost: $300,000
Estimated economic life: 70 years
When the building's effective age is 35 years, what will its remaining value be?
1. Find accrued depreciation
Effective age ÷ total economic life = accrued depreciation
35 years ÷ 70 years = 0.5 (50%)
2. Apply depreciation rate to building's reproduction cost ($300,000)
$300,000 × 0.5 = $150,000
The remaining value is $150,000
Limitations of the Age-Life Method
While the age-life method is both easy to understand and easy to use, it cannot always be used, because it has some limitations.
These include the following:
It assumes that all buildings depreciate on a "straight-line" basis (the exact same amount every year of its economic life),
which isn't typically true. A building's depreciation fluctuates based on a neighborhood's economic cycles and market
conditions.
It doesn't take into account that deterioration falls into two categories-curable and incurable-and that if some parts of the
deterioration are fixed, it can slow down (or even reverse, to some degree) the deterioration.
It puts value loss from all causes into a single broad depreciation estimate.
Both "effective age" and "total economic life" are subjective terms, because "effective age" refers to a future time, it can
be difficult to predict.
Modified Effective Age-Life Method
There are variations of the age-life method of estimating accrued depreciation. One such variation, the modified effective age-life
method, addresses the aforementioned limitation regarding curable and incurable depreciation. In this method, the cost of curing
(fixing) all curable items of depreciation is estimated first. Here are steps an appraiser would take to use this method:
1. Estimate the cost of fixing all curable physical and functional depreciation.
2. Subtract that number from the reproduction cost.
3. Apply the age-life ratio to the remaining cost.
Most effective when a subject property has curable depreciation that's not usually found in the property sales within that subject
property's market.
Can be used when external obsolescence is found in the subject property, but not in the sales of other properties within that
subject market.
Observed Condition Method
Breakdown method
An appraiser estimates the property's loss in value for both curable and incurable items of depreciation.
Curable = Those that can be fixed easily and increase the appraised value
Incurable = Impossible, very difficult, or too expensive to fix in relation to their effect on the appraised value
Capitalized Value Method
Rent loss method
The appraiser calculates the loss in income, due to depreciation, by comparing the income that similar properties produce. Next,
the appraiser must apply an income approach (such as gross rent multiplier, gross income multiplier, capitalization rate, etc.) to
that income amount to determine its impact on the property's overall value. For the example below, we'll use GRM as the
multiplier.
To utilize this method, the appraiser must use comparable properties with and without the same defect to help the appraiser
determine the rental value difference caused solely by the defect.
Example
A single-family residence with three bedrooms and one bath rents for $950/month, while several comps with three bedrooms but
two bathrooms rents for $1,075/month.
$1,075 - $950 = $125 The monthly difference here that's directly attributable to the property having only one bedroom is $125 a
month.
$125 × 135 (the area's monthly gross rent multiplier) = $16,875 This amount is the loss in value to the subject property's
reproduction cost that can be attributed to this single item of incurable functional obsolescence.
Market Extraction Method (Abstraction Method)
Market/sales comparison method
The appraiser uses comparable properties' sales prices to figure out the value of a depreciated item. The appraiser must make sure
to have enough comparables to be able to figure out that specific item's value.* To determine the subject property's
depreciated value, the appraiser must take the following steps:
1. Selling price - land value = improvements' depreciated value
2. Reproduction cost - improvements' depreciated value = $ of
depreciation
3. $ of depreciation ÷ reproduction cost = depreciation rate
4. Depreciation rate ÷ age of the comparable = annual depreciation
rate
5. Repeat steps 1-4 on several comparables, then
average the annual depreciation rates: Sum of all the
rates ÷ number of comparables
6. Average annual depreciation rate × subject property age (in years)
= total depreciation
7. Total depreciation × reproduction cost = accrued depreciation of
subject property
8. Reproduction cost - accrued depreciation = depreciated value of
subject property
* Must have comparable sales of both improved properties and vacant sites. Requires that the estimate of reproduction cost for
subject property improvements is accurate.
Example
An appraiser is evaluating an industrial property that contains only a lot and an 10-year-old warehouse that would cost $500,000
to reproduce. The appraiser has located three comparable properties. The first comparable property is 13 years old and sold for
$400,000. Its appraised land value is $98,700. The reproduction cost of its improvements is $519,000. Assuming the two other
comparables have a similar depreciation rate, what is the depreciated value of the subject property?
1. $400,000 selling price - 98,700 land value = $301,300 depreciated value
2. $519,000 reproduction cost - 301,300 depreciated value = $217,700 depreciation dollar amount
3. $217,700 ÷ $519,000 (reproduction cost) = 0.42, or 42% (depreciation rate)
4. 0.42 ÷ 13yrs = 0.032, or 3.2% annual depreciation rate
5. Assume the other comparables have a similar depreciation rate, making 0.032 the average
6. 0.032 × 10yrs = 0.32 total depreciation
7. 0.32 × $500,000 = $160,000 accrued depreciation of subject property
8. $500,000 - 160,000 = $340,000 depreciated value of subject property
Property Valuation and Site Analysis
Your mission: Value a property. What's the first question to answer? Well, it might be "why" (so you know what type of value
you're looking for), but after that comes "where." Think how embarrassing to discover you've valued the wrong property! Once
you've identified the property, the site analysis provides a picture of the property's size and shape, its highest and best use, and the
specific and general factors that affect its value.
Identifying the Property
Most properties you're working with will have a street address. In addition, you'll need the property's legal description (and if it's
vacant land, that may be where you start). The legal descriptionprecisely describes the boundaries of the property.
A visual inspection is also part of identifying the property for an appraisal, but an appraiser doesn't verify property boundaries. If
the visual inspection reveals inaccuracies in the legal description-like when a structure exists where there isn't supposed to be onea survey should be recommended.
Highest and Best Use
Highest and best use analysis of a property identifies the legal and feasible use that would return its highest value. That doesn't
mean every parcel can have a multi-million-dollar mansion built on it. Highest and best use is based on four considerations:
Is it legally allowable (or permissible)?
Is it physically possible?
Is it financially feasible?
Is it the most profitable use of the site?
Legally Allowable: Zoning and Use Restrictions
That question about "is it legally allowable" has to do, in part, with zoning. Site analysis includes identifying the property's
specific zoning classification. If improvements exist on the site, you should determine whether those improvements are legal,
legal but non-conforming, or illegal use under current zoning regulations.
You'll also identify any easements, deed restrictions, or publicly held rights of waythat affect the site's use.
Important Features
The important features of a site include its size, location within the block, improvements, soil composition, and whether it's in a
special hazard area, such as a flood or earthquake zone. Evaluate if utilities, street improvements, and other amenities are
available. Consider all these factors in relation to what's typical of, and acceptable in, the market area.
Neighborhood
Site analysis includes a definition of the neighborhood where the subject property is located. While neighborhoods are sometimes
defined by natural boundaries-such as a river or lake- most often they're defined using man-made boundaries, like a highway, a
park, or even the city limits (if the subject property is on the edge of town). Identifying the neighborhood boundaries also helps
when performing a review of the current market for the area, including potential changes on the horizon.
Purpose of an Appraisal
Real estate appraisals are performed for many reasons, but most of the ones you'll encounter as a real estate professional will be
performed for the buyer's lender, who needs to determine the market valueof the property that will act as security for the buyer's
loan.
Definition of an Appraisal
Most appraisals must be performed by a qualified appraiser who is certified or licensed by the state. In most states, real estate
professionals aren't allowed to call their own property valuations "appraisals." The full definition of an appraisal for real estate is:
An opinion or estimate of a property's value found for a specific purpose, for a specific person, as of a specific date, and based on
proven facts. Only certified appraisers may evaluate properties for mortgage loan underwriting. The current threshold for
residential real estate transactions is $400,0000-in other words, residential properties that will be financed and are worth more
than $400,000 require a certified appraiser to perform the appraisal.
Market Value
There are different types of value, and an appraisal's purpose is to determine the type of value found. In most residential
transaction appraisals-where the purpose is to confirm for the lender that the property will serve as collateral for the amount of
money it's lending to the buyer-the appraiser is determining the market value . This is the price a willing buyer and seller will
most likely agree to for the property, given ordinary market conditions and an arm's-length transaction.
Let's parse some of those phrases:
Willing buyer and seller: Neither the buyer nor the seller is acting under duress, and they're also acting in their own best
interests.
Ordinary market conditions: The property receives decent exposure in the open market, and the buyer is paying cash or
financing the transaction (not trading a boat for a house or any other unusual circumstances).
Arm's length transaction: The buyer and seller aren't family members and don't have any other existing relationship that
could influence the price.
Market Value vs. Sales Price
Sales price is the pricefor which a property will actually sell. Market value and sales price may end up being the same; they
should at least be pretty darn close, if the sales conditions are normal.
However, many things can cause the sales price to be more or less than the market value an appraiser finds. A mother might give
her son a great deal when he buys her house. If a seller is facing foreclosure, she might take a lower offer to get rid of the
property. On the other hand, perhaps there's a buyer who has a unique reason to really want that particular property and is willing
to pay far more than market value to nab it. An appraiser can't predict these things in a sale but can only make a determination of
value based on known facts and presumed conditions.
Real Estate Mortgage Markets
STUDY SHEET
References
Prelicensing Course Syllabus: Pages 67-68
North Carolina Real Estate Principles & Practices, Chapter 11, pages 376-382
Mortgage Market
The Federal Reserve System (Fed)
Two federal reserve districts, which are each served by a district federal reserve bank.
National banks have to be part of the Fed and must purchase stock in the district banks.
Creates balanced and favorable economic conditions, avoiding both runaway inflation and serious deflation.
Regulates the flow of available funds and interest rates at each of its member banks.
Primary Mortgage Market
Where mortgage loans originate.
Packages loans and sells them to the secondary mortgage market.
Part of the mortgage market that borrowers see.
Lenders in the primary mortgage market make money by:
Collecting finance charges at closing, such as loan origination fees and/or discount points
Collecting interest payments from the borrower
Lenders can also make money by servicing loans for other lenders, billing them for:
Collecting mortgage payments
Processing tax and insurance payments
Preparing insurance and tax records
Banks that originate loans operate in the primary mortgage market.
They have the cash, which they loan to borrowers.
The players in the primary mortgage market are homebuyers (borrowers) and lenders (commercial banks, credit unions,
savings and loans, etc.).
Federal Housing Finance Agency (FHFA)
Oversees Fannie Mae and Freddie Mac and regulates the Federal Home Loan Bank.
Establishes limits on conforming loans (loans that meet Fannie Mae and Freddie Mac requirements).
Nonconforming loans do not meet all of Fannie Mae's or Freddie Mac's underwriting standards.
Secondary Mortgage Market
Secondary market players purchase loans from primary lenders and package and sell them to investors as mortgagebacked securities.
A secondary lender will service the loan for the consumer.
Government-Sponsored Enterprises (GSEs)
The U.S. Congress created private companies such as Fannie Mae, Freddie Mac, Farmer Mac, and the Federal Home
Loan Bank to make borrowing easier and more cost-effective.
Commonly, GSEs serve homeowners, farmers, and students.
Fannie Mae:
Buys conforming loans (mostly from commercial banks).
Packages loans into MBSs.
Sells shares of MBSs.
Freddie Mac
Buys conforming loans (mostly from thrifts).
Packages loans into MBSs.
Sells shares of MBSs.
Ginnie Mae
Guarantees MBSs that only contain loans insured or guaranteed by a U.S. government agency, which are issued by
private institutions.
Does not buy mortgages.
Does not issue MBSs.
Farmer Mac
Buys agricultural loans and loans from rural lenders.
Issues MBSs.
Reviewing the Closing Disclosure
One purpose of the Closing Disclosure is to itemize the amounts that the buyer and seller will pay as part of the transaction.
As a real estate licensee, however, you should be able to give your seller an estimate of sale costs. This is something you should
do early in the process, when an offer has been presented. This seller net sheetwill help the seller determine what the net proceeds
look like if the seller accepts the offer. The seller net sheet is only an estimate; closing fees, prorations, and other expenses may
impact the accuracy of the net sheet. The final closing statement is the one everyone signs and agrees to at closing. Even so,
adjustments are sometimes made after closing.
A Closing Disclosure includes the parties' debits and credits. A debitis a charge (an amount a party has to pay). A creditis an
amount that shows up as an amount in the party's favor-either an amount a party has already paid, an amount that must be
reimbursed, or an amount that is promised (e.g., the borrower's promised payment to the seller shows up as a credit for the seller).
Lenders must provide the Closing Disclosure a minimum of three days before closing. (Note that the requirements and forms may
be different for transactions that aren't financed.) This shows the buyer how much money to bring to closing and gives all parties
an opportunity to verify the disclosure's accuracy.
First, the buyer's debits are totaled, and any expenses and prorated amounts for items prepaid by the seller are added to the
purchase price. Subtracted from that amount are any credits for the buyer, such as the earnest money deposit that's already paid,
the balance of the loan the buyer is obtaining or assuming, and the seller's share of any prorated items that the buyer will pay in
the future.
Buyer's Closing Costs Determination
Debits:
Purchase price of property
Expenses
Prorated amounts for items the seller prepaid
Credits:
Earnest money deposit that's already paid
Balance of the loan the buyer is obtaining or assuming
Seller's share of any prorated items that the buyer will pay in the future
Seller's Closing Costs Determination
The seller's debits and credits are also totaled separately. The credits include the purchase price plus the buyer's share of any
prorated items that the seller has prepaid. The seller's debits include expenses, the seller's share of prorated items, and the payoff
of the seller's current mortgage loan or other lien.
Debits:
Expenses
Seller's share of prorated items
Payoff of the seller's current mortgage or other lien
Credits
Purchase price
Buyer's share of any prorated items the seller has prepaid
At the Closing Table
Closing occurs when all parties have fulfilled their obligations, the title company has completed the title search and issued
title insurance, the lender has disbursed loan funds, and necessary documents are executed.
Several contracts are consummated at the closing:
The lender and borrower close on the loan commitment.
The borrower and title company close on the title insurance contract.
Clients, licensees, and brokerage firms close on their respective compensation agreements.
The buyer and seller close on their respective agency agreements.
The various contracts executed at closing enable different actions by the parties:
Sales agreement permits the buyer to occupy the property.
Mortgage loan commitment requires the borrower repay funds as noted in the loan.
Title insurance contract results in delivery of the title policy upon premium payment.
Listing agreement secures compensation for the listing brokerage.
Brokerage agreement secures compensation between the seller's and buyer's brokerage firms.
Compensation agreement between the licensees and their firms secure compensation paid to each licensee.
How and Where Closings are Conducted
Closings may be held at the lender's office, the title company, or an attorney's office.
Closings may occur face-to-face (with all parties present) or in escrow (at different times/locations with a neutral third
party holding the funds).
The closing agent, sometimes called the settlement officer or agent, may be a closing attorney, lender's or title company's
representative, or buyer's or seller's broker.
Closing Agent Responsibilities
The closing agent is responsible for preparing for and conducting the closing meeting, and will perform or delegate many
closing tasks:
Properly manage any escrow funds.
Manage transaction documents and instructions from the parties.
Perform (or delegate the performance of) the title search.
Work with lenders and other necessary third parties to get required information.
Manage contract instructions, broker commissions, and title policy.
Prepare closing documents and conduct the closing meeting.
Record required documents.
Verify funding of the buyer's loan and arrange payoff of the seller's loan.
Distribute funds.
File 1099-S forms as necessary.
Broker Commission
Usually, a portion of the seller's proceeds is used to pay the broker's commission.
At or just after closing, the closing agent writes two commission checks-one for each brokerage (in a dual agency
transaction, it'd be one check to the sole brokerage, but check that dual agency is legal in your state).
Well in advance of closing, the licensees from each brokerage send a broker statement (or broker demand) to the
closing agent, stating how much commission is owed to each.
The brokerages deposit the commission checks to their respective general business accounts and then write checks from
those accounts to the licensees who represented the parties in the transaction for their fair share, according to their
compensation agreement (the broker will take his/her cut off the top).
Note that in some areas, or with some closing agents, one check will be cut to the listing firm, and the listing firm will
compensate the buyer brokerage firm. Either way, all licensee compensation is paid through the brokerage.
RESPA and the Closing Process
RESPA, the Real Estate Settlement and Procedures Act, ensures that borrowers receive proper disclosures
about to their federally related residential mortgage loan.
The required disclosures are referred to as TILA-RESPA Integrated Disclosures (TRID).
Applies to new first mortgages, refinancing, second mortgages, and home equity loans.
The Loan Estimate must be provided to borrowers within three days of loan application.
The Closing Disclosure must be provided to borrowers no fewer than three days prior to closing.
Closing Disclosures
The TRID required settlement statement is called the Closing Disclosure (CD) and identifies who pays what at
closing.
A debit is a charge that a party must pay.
A credit is a charge that a party has already paid, an amount that will be reimbursed, or an amount that is
promised.
Lenders must provide the CD a minimum of three days before closing.
Licensees may provide estimates of the seller's costs before closing on a seller net sheet.
Prorations
Shared expenses that either party owes at closing are prorated (divided between) the parties depending on when closing
occurs.
Typical prorations include:
Property taxes and HOA dues
Fuel (propane or oil tank)
Water and sewer charges
Rent
Security deposits
Interest
Prorated items will be either accrued or prepaid.
Usually, prorations are proportionate calculations that determine who actually owes an expense for a given period
of time based on ownership status-are computed by the parties' attorneys and the lender. These figures may need
to be adjusted at the closing if, for example, closing occurs on a different date than expected.
Accrued expenses go in the seller's debit column. They are expenses that the seller owes on the day of closing, but
that the buyer will eventually pay. The seller will give the buyer a credit for these items at closing.
Prepaid items go in the seller's credit column and the buyer's debit column.
The basic steps of proration include:
Determine whether the proration should be based on a calendar year (365 or 366 days) or a statutory year
(360 days).
Calculate the daily and/or monthly rate.
Determine the number of days and/or whole months in the proration period.
Multiply the rate times the number of days or months in the proration period.
In a calendar year proration, amounts due are calculated based on the number of days in the month or year.
Statutory prorations are based on 30 days per month or 360 days per year. Also called a "banker's calendar," this
proration method helps keep things clean and simple for loans and other expenses that span multiple years.
Closing Cost Estimation
Property transfer fees that aren't included in the sales price are called closing costs. These costs may include:
Loan fees
Appraisal and survey fees
Title insurance
Legal fees
Real estate commissions
Tax and insurance prepayments
Transfer fees
Lenders must give buyers a written estimate of closing costs within three days of the borrower's loan application.
Licensees may provide sellers with a seller net sheet to help them estimate what their net proceeds at closing will be.
Buyers will bear most of the closing costs and will need to bring money to the closing (certified check or wired funds).
Buyer closing costs usually range between 2% and 5%.
Sellers typically don't need to bring money to closing, because any expenses they owe are deducted from their net
proceeds.
Various online closing cost calculators are available.
The buyer's licensee, seller's licensee, the buyer, and the seller are responsible for verifying the closing statement figures
for accuracy.
Key Documents at Closing
Deed - used to establish proof of ownership
Survey - proves that no encroachments exist with the property
Chain of title - establishes path of ownership
Abstract of title - Provides a summary of the title history
Title insurance policy - Insures the policy owner against financial loss if the title to the real estate has defects
Closing Statement - records all the fees and costs to the buyer and seller related to the transaction.
How the Closing Statement Works
Also called a HUD-1 statement or settlement statement.
All parties must sign and agree to the closing statement at closing.
Identifies the costs and fees to the buyer and seller associated with the transaction.
Is provided ahead of time because it indicates to the buyer how much they must bring to the closing.
Includes each party's debits and credits.
Debits are expenses to the party.
Credits are money the party gets credit for (such as the buyer's earnest money deposit, and the purchase price that
the seller receives).
Specialty Practice Areas
STUDY SHEET
New Construction Sales
The sales process for new construction has many distinct differences over the sales process for existing structures. Here are a few
of the highlights.
New Construction
Usually a much longer timeline (6-13 months)
Can be less demanding
Builders have no emotional attachment
Seller's incentives usually tied to a specific lender
Must negotiate for free or reduced-price upgrades
Unlike existing structures, there's no need to:
Negotiate over earnest money deposits, post-inspection issues, or possession dates
Negotiate post-inspection repairs
Write a competitive offer
Analyze comparable sales to maximize chances of sufficient appraisal
New Construction Sales Responsibilities
Be prepared to advise your clients on:
Builders
Builder contracts
Upgrades and budget
Financing
Negotiate builder incentives
Verify construction reports
Attend walk-throughs
New Construction Financial Protections
For buyers:
Final payment checks made out to the builder and the buyer
Lender safeguards protect buyers too
For lenders:
Short-term construction loans
Pay out on draw schedule
Retainage - hold back 5-10% from payments until substantially complete
For builders:
Builder deposits
Preferred lenders
Mechanic's liens
New Construction Warranties
Are either administered by the builder or a third-party provider.
Typically cover workmanship and materials related to HVAC, plumbing, electrical, and structural issues.
Generally provide coverage for up to 10 years for major structural defects.
Don't usually cover appliances or components covered by manufacturers' warranties.
Disputes are typically resolved through mediation or arbitration.
Property Management as a Specialty
Property managers:
Set and adjust rent levels as necessary to keep pace with the market.
Market the property and collecting rent.
Find, qualify, and screen tenants.
Manage tenants (handling leases, complaints, emergencies, and evictions).
Maintain and repair properties (scheduling, overseeing, and paying invoices).
Perform accounting and bookkeeping functions .
Commercial property managers negotiate leases, and must be familiar with types of leases and landlord-tenant relations.
Getting Started in Commercial Real Estate
Commercial and residential real estate are very different. Licensees must avoid practicing outside their area of expertise and
should wait until they have experience with residential real estate transactions before venturing into commercial real estate.
Commercial real estate:
Is more physically complex than residential, and requires more specialized knowledge.
Focuses on ROI, rather than the wants and needs of the buyer/seller.
Bases value on income-producing ability, rather than the current market.
Commercial real estate transactions:
Are more complex.
Involve more decision makers.
Involve large transaction amounts and down payments.
Have long timelines (10 months isn't uncommon).
Involve many types of innovative financing.
The Basics of Site Valuation
STUDY SHEET
The Site Valuation Process
Sites are valued separately from buildings/structures for:
The cost approach
Assessments and property taxes
Condemnation appraisals
Income capitalization
Highest and best use
Identifying the Site
Legal description
General data (geographic and economic features of the area)
Specific data (site and improvements)
Additional data
A plot plan
Once on site, the appraiser performs a visual inspection, and identifies structures and improvements and does a rough
sketch of the shape and location.
Legal descriptions provide a less ambiguous and more complete description of a property than a street address.
If a visual inspection reveals inaccuracies in the the legal description, an appraise should recommend a professional
survey.
A professional survey clearly defines the property, and reveals potential concerns about property boundaries.
Highest and Best Use
An appraiser considers legal permissibility, physical possibility, financial feasibility, and economic profitability when
performing a highest and best use analysis.
Highest and best use is all about profit maximization.
The important features of a site include its size, location within the block, utilities, improvements, soil composition, and
whether it's in a special hazard zone, like a flood or earthquake zone.
Environmental Concerns
The presence of endangered species and wetlands are both environmental concerns that can impact the use of land and the
appraisal value, and should be noted on the appraisal report.
Environmental concerns such as underground storage tanks, groundwater contamination, waste disposal sites, and other
similar factors can impact a property's appraisal value.
The Brownfields Law provides funds to assess and clean up the many thousands of brownfields that are believed to exist
nationally.
Methods of Site Valuation
The sales comparison method of appraisal compares sales data of comparable properties and adjusts for differences to
arrive at a market value for the subject property.
The allocation method is sometimes used when the value for the land portion of an improved property must be
determined. It provides a broad, rule-of-thumb indicator.
The abstraction method (aka "the extraction method"), used to determine value when there's little or no comparable sales
data, like in rural areas.
The subdivision development method is used to provide a value for each lot in a residential subdivision.
The ground lease capitalization method converts the amount of yearly income the land will produce into a value using a
capitalization rate.
Key Terms
Site: Land that's either prepared for building, or that already contains a building (but where the site and its building are
being valued separately).
Survey: A professional on-site measurement of lot lines, dimensions, and elements of a property.
Brownfield: An abandoned or otherwise unused commercial or industrial site with suspected contaminants.
The CMA vs. the Appraisal
Comparative Market Analysis
A comparative market analysis (CMA) is an opinion of price arrived at by evaluating the property, its location within the
market, its condition, competing properties for sale, recent sales, and current buying tastes and trends. A CMA may also include a
look at expired listings to find the "let's not go there" price point. Here are some additional details regarding CMAs:
Prepared by a real estate agent.
Prepared for the seller or buyer.
Comparable propertysales are used to determine value, including properties currently on the market, sold recently, and
expired listings.
The level of detail is basic to moderate.
Price is an approximate range.
The cost is free or minimal.
Appraisal
An appraisalis a detailed analysis of market conditions, the property itself, comparableswithin close proximity to the subject
property, recent sales and listings, land value, construction costs-everything a lender wants to know to value the property as
collateral for a loan. Here are additional details about appraisals:
Prepared by a certified appraiser (with a few exceptions in some states).
Prepared for a lender, buyer, or seller.
Multiple methods are used to determine value, particularly sales comparison and cost. Appraisers also use the income
approach for income-producing properties.
The appraisal is very detailed.
Price is a fixed number.
The cost is $400 or more, depending on the size of the property.
The Residential Loan Process
When applying for a loan to purchase a property, consumers can expect to go through the following steps:
Loan pre-qualification or pre-approval
Loan application
Loan processing
Underwriting analysis
Loan approval/disapproval
Let's look at what takes place during each step.
Loan Pre-Qualification or Pre-Approval
Before prospective buyers go house hunting, they should first get an idea of how much house they can afford. There's no sense
looking at $500,000 houses if they only qualify for $300,000, right? Buyers can take one of two approaches to do this:
Loan pre-qualification: The buyer provides information to a lender about income, assets, debt, and how much money is
available for a down payment. The lender uses these numbers to provide the buyer with a pre-qualification letter that
estimates the amount for which the buyer might qualify but doesn't verify any of the information. This letter helps the
buyer understand what price range to shop in, and there's usually no cost to the buyer.
Loan pre-approval: The buyer actually applies for a loan with a lender. The information about income, assets, debt, and
money available for a down payment is accompanied by some supporting documentation. The buyer might also be
required to pay an application fee at this point. The lender will verify the buyer-provided information, determine the
buyer's ability to finance, and decide what that magic number might be. While there's no guarantee at this point that the
buyer will receive final approval for the loan, a loan pre-approval is generally viewed more favorably than a prequalification because of the verification of buyer-provided information. It's a good way to show a seller that the buyer's
offer is viable. However, until a property has been identified, or the buyer's financial condition is such that the lender can
easily pre-approve a loan, pre-approval is rare.
Loan Application
Once an offer on a home is made and accepted, it's time for the buyer to work with the lender (or mortgage broker) to select a
loan. The buyer completes an application and provides required supporting documentation to the lender.
The Loan Estimate
The Real Estate Settlement Procedures Act(RESPA) requires lenders to provide borrowers with a Loan Estimate of fees that will
be due at closing. The Loan Estimateis designed to provide disclosures that will be helpful to consumers in understanding the key
features, costs, and risks of the loan for which they're applying. The Loan Estimate must be provided to consumers no later than
three business days after they submit a loan application. If the borrowers don't inform the lender that they want to proceed with
the loan, the estimate will expire after 10 business days. Savvy consumers will shop around and receive estimates from more than
one lender in order to compare the offered terms. If any terms or conditions of the loan change prior to funding, a revised Loan
Estimate must be provided to the consumer. Items that would prompt revision include:
An adjustable-rate loan changes to a fixed-rate loan (and vice versa).
The amount of the down payment changes.
The property appraisal necessitates additional funds.
A credit score changes, resulting in changes to the interest rate, additional reserves being required, or an additional down
payment being required.
The lender is unable to verify certain income sources.
The interest rate, or points required to maintain the interest rate, change.
Because all lenders are required to provide the exact same Loan Estimate form, borrowers are easily able to compare loan costs
between different lenders. Real estate professionals and borrowers should pay particular attention to negotiable items or those that
borrowers can compare, such as origination fees and discount points, assumption and title insurance costs, as well as mortgage
broker, application, notary, document preparation, and rate lockfees.
Loan Processing
The loan processor verifies that the correct information and documentation have been received based on the loan requirements.
This will typically include documents related to the buyer, such as bank statements, pay stubs, and W-2 forms, as well as
information related to the property, such as the appraisaland title report. This part of the process may take from one to several
weeks, but a lot depends on the lender, the loan, the buyer's financial circumstances, and the buyer's prompt attention to requests
for additional documents.
Underwriting Analysis
When all of the required paperwork, referred to as the loan package , is complete and validated, the loan application goes to the
underwriter for analysis. Here, the borrower's ability to repay the loan, the value of the property, the type of property, and the loanto-value ratioare analyzed. The underwriter then makes a recommendation regarding whether the loan should be approved or
denied. A typical timeframe for this part of the process is three to five days.
Loan Approval/Disapproval
A loan committee reviews the analysis and the recommendation from the underwriter to provide a final approval or disapproval.
The approval may be conditional based on receipt of additional documentation from the consumer. If approved, the borrower will
receive required disclosures and papers detailing the final terms of the loan. These must be approved and signed before closing
and funding the loan. If denied, the lender must supply a written explanation outlining the reason the loan isn't approved.
The Three Approaches to Appraised Value
Appraisers may use one, two, or all three approaches to value when appraising a property. The approach most applicable to the
assignment is given the most weight when reconciling. This is known as "weighted averaging."
Approaches to Value
Approach
Description
Best Used
Sales comparison
Compares the subject property to recent sales of
similar properties.
Residential single-family homes
Cost
The cost of property improvements is added to the
land's value.
Unique properties or when finding
replacement value
Income
capitalization
Calculates the potential future income to determine
present value.
Income properties
Valuation Concepts
STUDY SHEET
The Comparative Market Analysis vs. the Appraisal
Comparative market analysis (CMA)
Prepared by a licensee for a seller or buyer.
Uses comparable sales to determine probable sale/leasing price, NOT value or worth.
Isn't an appraisal. Only a licensed or certified appraiser may perform an appraisal.
Appraisal
Prepared by a certified appraiser for a lender, buyer, or seller.
Uses multiple methods to determine value or worth of a property.
Very detailed.
Purpose of an Appraisal
Appraisal: An opinion or estimate of a property's value found for a specific purpose, for a specific person, as of a
specific date, and based on proven facts.
Often used for residential lending to determine market value and confirm that the property will serve as collateral.
Market value: The price for which a willing buyer and seller will most likely agree for a property, given ordinary market
conditions and an arm's length transaction.
Sales price: The price for which the property actually sells. Sales price and market value may be the same, but sales price
can also be more or less than appraised or market value.
Defining Value, Price, and Cost
Value in real estate comes in many forms.
Market value is the price for which you'd expect the property to sell after suitable exposure to the market, assuming there
are no exceptional factors in the transaction.
Price is the actual amount a buyer pays for a property.
Cost refers to all of the expenses required to develop or replace a property.
DUST
Four significant factors influence value:
Demand - How attractive or move-in ready is the property, how many buyers are there?
Utility - How usable is the property in it's current condition?
Scarcity - Related to demand; the fewer properties on the market, the greater the scarcity, and the higher the demand.
Demand pushes price upward.
Transferability - Relates to how easily the seller can transfer the property. Factors such as deed restrictions, clouds on the
title, and tenants can make conveyance more difficult and reduce property value.
Basic Principles of Value
Change: Real estate values are subject to constantly changing conditions, so appraisals from earlier periods must be reanalyzed based on current market conditions.
Anticipation: The value of a property today is the current value of the total anticipated future benefits.
Conformity: A property's value is determined in part by how well it conforms to its surrounding area.
Progression: The value of a property may increase due to the increase in value of surrounding properties.
Regression: A property may experience a decline in value due to the decline in value of neighboring properties.
Contribution: The value of any given change to the property is dependent on how it contributes to the value of the
property as a whole.
Plottage: Joining adjacent parcels will increase the overall value of the property beyond what they would be worth if sold
separately.
Competition: A property's value is determined in part based on what else is available (related to supply and demand).
Substitution: A reasonable person will not pay more for a property if a comparable one can be had for less.
Highest and best use: A property's most profitable use that is legal and economically feasible (and legal and possible).
Supply and demand: The amount of available housing (supply) and the number of buyers who want to purchase the
housing (demand) influence the price and value of a property. When supply is higher than demand, price goes down.
When demand is higher than supply, price goes up.
Various Types of Value
Assessed Value - Price placed on a home by a municipality to calculate property taxes
Depreciated Value - Calculated to for income tax purposes
Investment Value - Return on investment (ROI), and capitalization rates are two methods used to calculate investment
value.
Market Value - Price agreed to by the buyer and seller
Plottage Value - Assemblage of two or more adjoining parcels of land causes an increase in the parcel's value
Estate Tax Value - Value of a deceased person's property set by federal and/or state authorities
Insurance Value - Cost of replacing a damaged or destroyed structure; land value is not considered
Loan Value - Value established for the purpose of making a loan
Salvage Value - Value expressed when a structure must be moved to another location
List Price - Amount for which an owner offers to sell a property; typically found in an MLS listing
Rental Value - Value based on the right of use for a set period of time
Defining Value, Price, and Cost
Value, price, and cost are related, but have different meanings.
Value - Comes in many forms; licensees typically work with market value, but appraisers and lenders are often interested
in other types
Price - Actual amount a buyer pays for a property; may or may not be the same as market value
Cost - Refers to the expenses required to develop a piece of property such as labor, materials, fees, taxes, interest, etc;
costs may be direct (materials and labor), or indirect (fees and administrative costs)
Influencers of Property Value
Specific influences on property value are the improvements that exist, the construction, and available comparables.
Appraisers look at general influencers of value, which are categorized as:
Geographic: The climate, terrain, and environmental hazards, such as the potential for earthquakes, floods, and
tornadoes
Physical: The presence of schools, parks, shops, and roads
Economic: Changes in the local and national economy, and the availability of good-paying jobs and financing
Social: Changes in population levels and social attitudes
Governmental: Laws, policies, and zoning regulations
Valuation Process and Approaches
STUDY SHEET
The Valuation Process
Step one: State the problem.
Step two: List the data needed and where to find it.
Step three: Gather the data.
Step four: Determine the property's highest and best use.
Step five: Estimate the value of the land.
Step six: Estimate property value using three approaches to value.
Step seven: Reconcile the data.
Sales Comparison Approach to Value
Used for residential single-family homes.
Uses a process of comparison with similar properties that have a known sale price to determine a subject property's
market value.
The principle of substitution : The value of a property is equal to the value of an equivalent substitute property.
The process
Analyze the subject property to identify its characteristics, particularly those that are in demand in the current
market.
Identify comparable properties that have been recently sold.
Compare the comparables to the subject property and make adjustments to the sales price of the comparables
where they are different.
Use the data to arrive at an opinion of value for the subject property on the date of appraisal.
Two categories of comparison
Elements of comparison: Analyze comparables' locational/physical property characteristics and transaction
differences. They explain why different prices are paid for comparables.
Units of comparison: Allow the comparison to be standardized. Units may be price per square foot, per apartment
unit, per acre, etc.
Elements of comparison
Financing terms and cash equivalency: Builders often offer this for new construction or as seller concessions in
resale transactions.
Conditions of sale: Was it an arm's length transaction? Were personal items included or fixtures excluded?
Market conditions at time of contract and closing.
Location: Underwriters assume appraisers understand the local marketplace, and will accept comparables that
exceed distance, time, or other guidelines if the appraiser supports the decision with a written, detailed explanation
that demonstrates that local expertise.
Physical characteristics : This includes the site, view, construction quality, amenities, size, etc.
Highest and best use
Is it legally allowable (or permissible)?
Is it physically possible?
Is it financially feasible?
Is it the most profitable use of the site?
Types of data
General data on the forces that influence property value, such as the social, environmental, governmental, and
economic features of the nation, region, city, and neighborhood.
Specific data about the subject site and its improvements, including a physical description and financial and legal
factors.
Sources of data
Primary data is anything compiled by the person conducting the valuation, and for that purpose. Collecting
specific data about a subject property and identifying comparable properties are examples of primary data used in
a valuation.
Secondary data comes from reports or records developed for other purposes. For example, a published report on
the economic market's current state is secondary data, since it was published for another purpose. But the person
conducting the valuation may use it to support the opinion of value.
A comparative market analysis gathers information from:
Sold and expired listings
Active listings
Market indicators
Price levels
Vacancy rates
Sales volume
Inventory rates
New building permits
Days on market
Cost Approach to Value
Used for:
New construction of both residential and commercial property
Unique properties, such as highly energy-efficient houses, residential acreage with excess land, and high-dollar
houses with many amenities
Special-purpose commercial uses, such as hospitals, some manufacturing plants, hotels, and other single-purpose
properties
Three types of depreciation
Physical depreciation is a loss in value caused by deterioration in physical condition.
Functional obsolescence is a loss in value caused by defects in design, such as a poor floor plan or atypical or
inconvenient sizes/types of rooms.
External depreciation or "economic obsolescence" is a loss in value caused by an undesirable or hazardous
influence offsite. Examples are heavily trafficked areas, industrial odors, or airport noise.
Curable and incurable depreciation
Curable depreciation refers to an item that can be repaired or replaced, and where the cost to cure the item is
less than or the same as the anticipated increase in the property's value after the item is cured.
Incurable depreciation includes items not practical to correct. Examples are a furnace or a roof that hasn't
reached the end of its economic life.
Determining indicated value: Value is determined by estimating the reproduction cost of the new improvement and
subtracting the amount of depreciation from all causes described above. Then, the appraiser adds an estimate of the site
value as if it were vacant and available to be developed to its highest and best use.
Determining cost
Use published indexes and tables to source the data, such as Marshall & Swift Tables™.
The new cost is then adjusted by its loss in value due to depreciation from all causes.
An accurate site value is required as a separate figure. (The sales comparison approach is used most commonly to
estimate this value.)
Site value: In residential appraisals, the assessed value of the site is frequently used.
Reproduction and replacement costs
Reproduction cost: The construction costs at the current price to exactly reproduce the property.
Replacement cost: The construction costs at current prices to replace a property. It won't be an exact duplicate,
but serves the same purpose or function as the original.
Four methods to finding the reproduction cost of a structure
Index method : With this method, the appraiser applies a factor that represents the construction costs, up to the
appraisal date, to the subject building's original cost.
Square-foot method: With this method, the appraiser multiplies the cost per square foot of a recently constructed
comparable structure by the number of square feet in the subject building. Generally, appraisers use this method to
estimate construction costs.
Unit-in-place method: With this method, the appraiser multiplies the cost per unit of measure of each component
part of the subject property's structure (for example, the material, overhead, labor, and builder's profit) by the
number of units of that component part in the subject. The total component cost is the cost of a new structure.
(Generally, component parts are provided in square feet, but some parts, like plumbing fixtures, are provided as
complete units.)
Quantity survey method: With this method, the appraiser adds the itemized costs-including direct and indirect
expenses-of building or installing all of a new structure's component parts.
Methods of measuring depreciation
Age-live Method
Observed Condition Method
Physical deterioration
Functional deterioration
External obsolescence
Capitalized Value Method
Market Extraction Method (Abstraction Method)
Income Approach to Value
Income approach techniques
Gross rent multiplier: A figure used as a multiplier of gross monthly rent of a property; used to estimate
property value for properties of one to four units.
Gross income multiplier: A figure used as a multiplier of gross annual income of a property; used to estimate
property value for properties of five-plus units.
Direct capitalization: Converts a single year's expected income (or an annual average) into a market value.
Yield capitalization: Analyzes cash flows for multiple future years.
Gross rent multiplier (GRM) and gross income multiplier (GIM): Properties are classified in one of two ways, and
each uses a corresponding multiplier to determine value.
Single-family homes and two-to-four-family units are considered residential and use the GRM.
Properties with more than four units are considered commercial properties and use the GIM.
The GRM is calculated by dividing the sale price by the gross monthly rent.
One to four units: Sales price ÷ monthly gross rent = gross rent multiplier
Five or more units: Sales price ÷ annual gross income = gross income multiplier
Applying the formulas
Gather rental comparables of similar properties from the MLS or other local sources (up to 10 comparables).
Estimate the GRM or GIM by comparing the gross rent (or income) received and the sales prices of comparable
properties.
Example of GIM: Comp 1 has 10 units and a rental income of $10,000 per year. It sold for $100,000. The
GIM is 10X ($100,000 / $10,000).
Example of GRM: A single-family property that sold for $150,000 and has a monthly income of $2,000
would have a GRM of 75X ($150,000 / $2,000).
Reconciliation
A common way to reconcile the appraisal values is through a weighted average. With this, the appraiser assigns specific
percentages to each approach to arrive at a final estimate of value.
CMA Basics
A CMA is not an appraisal and shouldn't be referred to as one. Only licensed appraisers can perform appraisals.
A CMA is an opinion of a property's market price range, and is used to help the seller establish a probable listing or lease
price.
It's a licensee's duty to perform CMAs competently.
When completing a CMA, a quick sale of comparable properties usually indicates the market for similar homes is good.
Expired listings can tell a licensee the price at which a property won't sell, and knowing the prices at which similar
properties didn't sell can help a licensee show sellers what might be an unreasonable sales price expectation.
A CMA should use comparable properties that have sold in the last three to six months.
CMA steps:
Collect data on the subject property.
Collect comparable data using the MLS or a similar database.
Make adjustments to the comparable property for differences between the comparable property and the subject
property.
Present the CMA to the seller.
North Carolina BPOS and CMAs
The terms "BPO" and "CMA" are used interchangeably in North Carolina.
A BPO/CMA can't be used for appraisal or financing purposes.
Competency is key in preparing a BPO/CMA, and preparing a BPO/CMA incompetently is grounds for disciplinary
action.
North Carolina BPOs/CMAs can't be used to value properties, only to estimate a sale or lease price, and can't be used for
financing or appraisal purposes.
A no-fee CMA:
Is performed when there is a brokerage agreement in place as part of regular brokerage services.
Can be prepared by licensees with provisional licensure.
Is NOT required to conform to North Carolina Administrative Code (21 NCAC 58A.2201-2202) or North
Carolina General Statutes (N.C.G.S § 93A-83).
A for-fee CMA:
Is performed for a fee outside of a brokerage agreement.
Requires at least a non-provisional real estate broker's license.
Must conform to both North Carolina Administrative Code (21 NCAC 58A.2201-2202) and North Carolina
General Statutes (N.C.G.S § 93A-83).
Must be presented in writing
Must use standard methodology, and provide objective opinions on selling/listing price.
Can't include an automated valuation model.
North Carolina licensees are required to personally inspect the inside and outside of each property for which they prepare
a BPO/CMA. Even when waived by the homeowner, the real estate commission recommends both an interior and exterior
inspection, which will result in a more accurate sales price estimate.
Developing a CMA for a Customer
To develop a CMA, a licensee compares the subject property with other properties in the area. It's also known as a
competitive market analysis.
The CMA uses the sales comparison approach to estimate a property's market price range.
A properly prepared CMA will offer a real estate professional's informed price opinion, but it's not an appraisal and
shouldn't be referred to as one.
The CMA also uses data from expired listings, pending sales, and active listings, as well as knowledge of the local market
to arrive at a suggested list price for the subject property.
A well-prepared CMA is a keystone to a successful listing presentation.
The CMA process includes gathering data on the subject property, doing research on comparable properties, and then
adjusting the comparable sales prices up or down based on how they compare to the property in question.
Gather data on the subject property by researching:
The property
The neighborhood
Property improvements
Research comparable properties by
Using at least three comparable properties that are valid examples
Using comparable sales that are no more than one year old (preferably three to six months old)
Adjust for differences
Always adjust the comparable property, not the subject property.
If the comparable property is inferior to the subject property, add the difference in the amount to the sales price of
the comp.
If the comparable property has better features, subtract the appropriate amount from the comp's sales price.
Estimating a listing price
Give the seller a range of possible listing prices to consider, based on your market research.
Closing Process Agent's Responsibilities
Checklist
As an agent for the seller or buyer, you will be very busy prior to closing ensuring that your client is ready. Review the items
below to verify that you are doing everything possible to prepare your client for a successful closing.
All deadlines have been met.
All contingencies have been cleared.
All paperwork has been fully executed and delivered.
Final walk-through has been conducted and any issues resolved.
The property is left in substantially the same condition.
No items have been removed that should have remained.
No items have remained that should have been removed.
Trash and debris have been cleared away.
The property has been cleaned for move-in.
Any last-minute repairs have been done to the buyer's satisfaction.
Client knows what documentation to bring to the closing.
Client has been fully briefed on what happens during closing, who will attend, and who will lead the presentation.
Client knows where and when closing is being held.
Mortgage Markets and Financing Alternatives
STUDY SHEET
Mortgage Definition
A mortgage is a legally binding document that creates a lien (security interest) on a price of property, and gives the
mortgagee (lender) the right to foreclose on the property if the mortgagor (borrower) defaults.
A promissory note is a a document wherein the borrower promises to repay funds borrowed under a certain set of terms.
Promissory notes typically include repayment terms, length of the loan, late fees, prepayment penalties, and a description
of the circumstances that constitute loan default. Promissory notes are negotiable instruments.
Residential Mortgage Types
There are multiple types of loans and loan sources, including residential, short-term, refinancing and equity related, owner
financing, and commercial
Balloon loans (partially amortized) are paid as an interest-only or partially amortized loans with a lump-sum payment
that's usually due at the end of the loan term.
Amortized loans are paid in regular installments of principal and interest.
Adjustable-rate mortgages (ARMs) are loans in which the interest rate fluctuates based on the economic index, such as the
Consumer Price Index.
With a fixed-rate loan the principal and interest remain the same through the life of the loan.
Bridge or swing loans offer temporary (usually 90-day) funding until permanent financing can be obtained.
Growing equity mortgages are fixed-rate mortgages in which the interest rate remains the same, and the monthly
payments increase over time according to a set schedule.
Home equity loans are made based on the equity an owner has in a home; can be first mortgage (if the home is fully
owned) or a second mortgage.
A budget mortgage requires payments that include PITI (principal, interest, taxes, and insurance) in each (usually
monthly) payment, and are typically amortized.
Term or straight-term loans are those in which the borrower only pays interest for a set term, then pays off the loan in a
lump sum or through another loan.
The different types of seller financing include:
Wrap-around mortgage: The seller receives payments from a new buyer, and is therefore financing the purchase.
Purchase money mortgage: A form of seller financing in which a mortgage is given by the buyer to the seller
toward the purchase price; buyers use this as down payment financing.
Contract for deed: Allows the seller to provide financing by providing credit to the buyer. The buyer makes
payments directly to the seller, and legal title remains with the seller.
Construction Loans - Used for construction purposes
Shared Appreciation Mortgage (SAM) - The borrower initially receives an interest rate that's less than the current market
rate, and in return, the lender receives equity or a percentage of the appreciation in the property's market value.
The Mortgage vs. The Deed of Trust
Mortgage
Gives mortgagees the right to foreclose on property in case of default.
In lien theory states, the borrower holds the title, and the lender holds the lien
In title theory states, the lender holds the title, which makes it easier to foreclose on the mortgage.
Foreclosure: In title theory states, foreclosure is usually non-judicial; in lien states, foreclosures use the judicial method.
Deed of Trust
Parties: trustor/borrower, beneficiary/lender, and trustee
The property deed is held by a third-party trustee (attorney or title company) until the loan is paid in full. Once fully paid,
the trustee issues and records a reconveyance deed.
The trustee holds legal title on behalf of the beneficiary until there is a default on the debt or the loan is paid off in full.
A release clause directs trustee to execute a deed of reconveyance, which conveys the title to the trustor.
A deed of trust is used to secure the loan.
The lender (beneficiary) receives the promissory note from the borrower (trustor).
Promissory Notes
The note is a promise the borrower makes to repay a certain sum of money to the lender or note holder under specified
terms
Promissory notes should include the date, principal, interest rate, discount points, loan term, fees involved, late fees, prepayment penalties, default circumstances and process, as well as the signature of borrowers (including spouse or partner
responsible for repayment).
A negotiable instrument is one in which the holder may transfer the right to receive payments to a third party, and that
third party may enforce the promissory note.
Non-negotiable instrument must include a clause noting that it's non-negotiable and transfer isn't permitted.
A pre-payment penalty is a charge to the borrower for the early repayment of a loan.
Interest is the amount a lender charges for the use of its money.
Mortgage Clauses
Defeasance clause: Discharges the lien when the mortgage is paid in full.
Acceleration clause: Makes the entire debt due immediately if there's borrower default.
Due on sale clause: Borrower must repay loan when transferring ownership to another.
Pre-payment penalty clause: An amount the lender charges for interest lost when a borrower sells or pays off a loan early
Mortgagee rights include the ability to foreclose on property if mortgagor defaults, possess property (after foreclosure) if
mortgagee is purchaser at sale, and assign or transfer the mortgage.
Mortgagor rights include the ability to possess property during mortgage term, take advantage of the right of redemption
prior to foreclosure, and receive title and release of lien upon paying mortgage in full.
Mortgagor duties include paying the debt and real estate taxes, maintaining adequate insurance, and keeping property in
good repair.
Lien Theory vs. Title Theory
Title Theory
The lender holds the title to the property and owns the house until the borrower pays off the loan.
Because the lender already holds the title to the property, it's much easier for the lender to foreclose on
the property, and a non-judicial foreclosure is most often used.
Most title theory states use the deed of trust as a standard financial instrument.
Lien Theory
The lender holds a lien on the property, but the borrower holds the title and owns the house.
The mortgages places the lien on the property.
Most lien theory states use a mortgage as the standard financial instrument.
Comparing Conventional Loans to Government Loans
Conventional Loans
No government involvement
No limits on loan amounts unless the loan is conforming
Conforming loans meet Fannie Mae and Freddie Mac guidelines.
Government Loans
Federal Housing Administration (FHA)-insured
U.S. Department of Veterans Affairs (VA)-guaranteed
U.S. Department of Agriculture (USDA) offers state and local programs
PMI and MIP
Private mortgage insurance (PMI) is required for conventional mortgages where the borrower doesn't have 20% to put
down.
A mortgage insurance premium (MIP) is a fee related to FHA-insured loans, and is paid up front at closing and annually
for the life of the loan.
USDA Rural Housing Service Program
Provides funding for low-to moderate-income individuals in rural areas.
Provides loans and grants to help individuals make alterations to their homes to make them handicap accessible.
Provides funding for community facilities like hospitals and schools
USDA Farm Service Agency (FSA)
Provides two types of help to farmers and ranchers:
FSA direct loan funding - to buy farmland, construct buildings and repair buildings, and make improvements.
FSA guaranteed loans - provide lenders with a guarantee of up to 95% of the loss of principal and interest on a loan.
Farmers and ranchers apply to an agricultural lender, which then arranges for the guarantee
Rural Development Loans
Loans for family farms and rural housing
Operated through the USDA's Rural Development Housing and Community Facilities Program
Can be made for as much as 100% of the purchase price, and set for 33 years (38 for very low-income
borrowers)
Down Payment Assistance Programs
Many state, county, and city governments offer down payment assistance to qualified buyers, and some programs can be
layered together.
Not all down payment assistance programs are for first-time home buyers.
Buyers must meet eligibility requirements that include household income thresholds, credit score minimums, property
location, and use of the property as a primary residence.
Department of Veterans Affairs (VA) - provides many housing-related programs to military personnel, veterans, and
eligible surviving spouses.
Federal Housing Administration (FHA) - offers down payment grants and down payment assistance programs by state.
U.S. Department of Housing and Urban Development (HUD) - provides grants to state and local organizations through
various programs.
Residential Lending and Federal Regulations
STUDY SHEET
The Residential Loan Process
Pre-qualification or pre-approval, loan application, loan processing, underwriting, and an approval/denial decision
Loan pre-approval or pre-qualification can improve the chance of offer acceptance.
Loan pre-qualification: Buyer reports income, assets, debt, and available down payment to the lender and receives a prequalification letter that estimates a loan amount, without verification; usually no cost.
Loan pre-approval: Buyer applies for a loan with a lender, documenting income, assets, debt, and down payment; lender
verifies and determines buyer's ability to finance.
Loan application: Buyer completes and submits to the lender with supporting documentation.
Loan processing: Lender collects documentation about borrower's income and credit, as well as the property.
Underwriting: Underwriter analyzes borrower's completed loan package and recommends loan approval or denial.
Lender Criteria for Granting a Loan
The loan application (usually made with the Uniform Residential Loan Application) gathers details about the loan type,
property, and the borrower's qualifications, including:
Income
Assets and liabilities
Employment history
Credit
The lender will verify the buyer's qualifications through verification of deposit (or bank statements), employment (or pay
stubs), and credit reports.
Credit risk and income: Lenders analyze the borrower's income, tax returns, W-2s, pay stubs, and bank statements. Key
parts of the analysis are the monthly housing expense to income ration, and the total payment obligations to income ratio.
Employment history: A big consideration; steady and salaried income preferred.
Loan Qualifying Calculations
Total debt ratio = (total of monthly debt obligations ÷ monthly gross income) x 100
Housing ratio = ([principal + interest + taxes + insurance + association fees] ÷ monthly gross income) x 100
Loan-to-value ratio (LTV) = (amount financed ÷ property value) x 100
Loan Application Income Evaluation
How much borrowers earn, as well as the source of the income are considered.
Child support and alimony are factored in. In order for child support to be considered as income, there must be a
consistent track record of payments, and payments must be the result of a court order.
Total debt and total housing ratios are computed and must be within the lender's thresholds.
Qualifying Loan Thresholds for FHA, VA, and Conventional Loans
Conforming loans are those that those that meet Fannie Mae and Freddie Mac standards.
Nonconforming loans (aka "jumbo loans") exceed Fannie Mae and Freddie Mac standards
Conventional
No government involvement.
Down payment ranging from 3% to 20%.
No limits on loan amounts unless the loan is conforming.
PMI may be required for loans that are less than 80% of home value.
Borrowers must meet lender repayment standards (Fannie Mae and Freddie Mac for conforming loans).
FHA-Insured
Insures lender against borrower default.
Down payment as low as 3.5%.
Limits on loan amounts based on average home price in county.
Mortgage insurance premium (MIP) (up front at closing and annually for the life of the loan) required.
Standards for borrower credit are less stringent than for conventional loans.
VA-Guaranteed
Guarantees the loan for the lender, removing risk related to default
Down payment of 0% required, though borrower may make a down payment if desired.
No limits on loan amounts, but the amount the VA guarantees is limited.
Borrowers will usually be required to pay a one-time funding fee.
Available only to eligible active-duty military and veterans and their spouses; borrower must qualify for the loan.
Don't require down payments or mortgage insurance.
Loan Points: Origination Fees, Discount Points, and Buydowns
Loan Origination Fee
A percentage of the loan amount (usually 1%-3%) which is paid up front to cover the lender's cost of making the loan.
A 1% loan origination fee = 1% of the loan amount
Discount Points
Used to lower the interest rate on the loan.
Each point = 1% of the loan amount.
Buydown
A lump sum payment of interest to the lender at closing which buys down the interest rate to below the market rate.
Most buydowns are temporary.
Often used by buyers who can't qualify for a mortgage payment at the going rate, and who expect to increase their income by the
time the rate returns to the market rate.
Federal Lending Regulations
The federal government regulates mortgage lenders to make sure they operate ethically and fairly.
Equal Credit Opportunity Act
The Equal Credit Opportunity Act (ECOA) prevents lenders from discriminating against applicants based on
age (the legal age to sign a contract is 18), race, color, religion, sex, national origin, marital status, or public
assistance income.
The Consumer Financial Protection Bureau (CFPB) regulates the ECOA through Regulation B, which specifies
that applicants for credit be judged only on their creditworthiness (income, debts, credit history).
All individuals who participate in granting credit must follow the rules set forth in the act, including real estate
professionals who arrange financing.
The Truth in Lending Act (TILA)
Regulation Z: Mortgage lenders must follow TILA disclosure requirements for real estate advertisements, including
credit terms.
TILA: Requires lenders to make full disclosure of terms and conditions in any offers of credit when advertising trigger
loan terms, so as not to mislead consumers.
"Trigger" terms in ads that would require the full disclosure of all terms
Down payment
Payment amount
Number of payments
Interest rate (other than APR)
Lenders must use good faith efforts to determine whether the borrower can repay the loan.
Gramm Leach Bliley Privacy Act
Requires financial institutions to secure financial data and limit how the information is shared.
Dodd Frank Act
Created the Consumer Financial Protection Bureau (CFPB), whose mission is consumer protection in the financial sector.
Real Estate Settlement Procedures Act (RESPA)
Requires lenders to give consumers specific documents or information at designated times during the mortgage
transaction.
USA Patriot Act
Requires financial institutions to collect information about the identity of borrowers.
ans have information about all settlement costs.
Requires lenders to give borrowers TILA-RESPA disclosures (TRID), which are made up of two separate documents:
The Loan Estimate form, which lists charges the buyer will likely pay at settlement time. This form must be
provided within three days of receiving the loan application.
The Closing Disclosure, which provides information about all costs that will be settled at closing. This disclosure
must be provided at least three business days before closing.
Licensees should advise buyers to compare the Loan Estimate and the Closing Disclosure for any major changes that
impact closing and monthly loan payments.
TRID
Stands for TILA RESPA Integrated Disclosure rules.
Dictates the information lenders must provide to borrowers and when.
Regulates the fees that can be charged.
All mortgage lenders must follow TRID rules when providing a loan estimate for most consumer mortgages.
Doesn't apply to HELOCs, mortgages secured by manufactured homes, reverse mortgages, or mortgages secured by
dwellings not attached to land.
Dodd-Frank Act - Consumer Financial Protection Bureau is responsible for RESPA and TILA.
Implements TILA-RESPA Integrated Disclosures (TRID).
TRID may increase the likelihood of closing delays, because certain changes related to the cost of the loan trigger a new
three-day waiting period (borrowers must receive the disclosure three days before closing).
Licensees should be able to explain the contents of both the Loan Estimate and Closing Disclosure to clients.
Mortgage Fraud
Property flipping - a home is bought and the value is artificially inflated, and the home is sold in a short period of time.
Inflated appraisals - an appraiser illegally inflates property value in a report to a lender.
Silent second - a buyer accepts a second mortgage without disclosing it to the original lender; often used when a buyer
can't afford a down payment on a home.
Straw buyer - another person's name and credit information is used to obtain a loan.
Equity skimming - an investor receives title to a property, doesn't make mortgage payments, and rents the home out until
foreclosure occurs.
False identity - a borrower uses a stolen or fictitious identity to obtain a loan.
Undisclosed buyer rebate - a party provides funds that aren't included in the settlement statement.
Predatory Lending Practices
Predatory lenders take advantage of consumers by:
Encouraging debt
Making loans to unqualified borrowers (a consumer who can't really afford the loan)
Flipping loans (refinancing over and over, which allows the lender to charge fees each time)
Not disclosing all fees related to the loan
Not disclosing the true nature of the loan obligation
Including toxic loan features (e.g., terms exceeding 30 years, negative amortization, usurious interest rates)
The Cost Approach: Reproduction and
Replacement Costs
Reproduction and Replacement Costs
When it's time to conduct a cost approach valuation, the appraiser begins by estimating a new building's construction cost, at
current prices, that's either physically or functionally identical to the subject property. At this point in the process, the building's
physical condition and its outside factors-and their impact on the property's value-aren't considered.
Based on several factors, the appraiser will figure out the construction cost either for the reproduction or replacement of the
structure being appraised. Although the terms 'reproduction' and 'replacement' sound similar, they're quite different. Let's take a
look at these terms now. The e conomic or useful life is the period of time for which a structure can be used for the
purpose for which it was originally intended.
Reproduction Cost
Reproduction cost is the cost to construct a subject property's exact duplicate at current costs (as of the appraisal date). When
estimating reproduction costs for a building, appraisers must look at the cost of locating and using the same materials, made using
the same techniques, and incorporating the same design and style, as when the subject property was constructed.
When appraising newer properties, it's pretty easy to estimate reproduction costs, because the appraiser basically conducts a cost
analysis with similar structures of the same or nearly the same age. But the older the property is, the less feasible it is to determine
reproduction costs. For decades-old properties, it's difficult, if not impossible, to find the same designs, materials, and
construction techniques used to build the original property.
Because of this, and because sometimes properties don't have an economically viable reproduction cost, the appraiser has an
alternative: calculating the structure's replacement cost instead.
Replacement Cost
Replacement cost is the current cost to construct a building with the same usefulness as the subject building. The replacement
building should be approximately the same size, have the same number and sizes of rooms, and be able to be used in basically the
same way as the subject building.
When determining a structure's replacement cost, the appraiser doesn't need to consider the exact type of materials or
workmanship that went into making the subject property unique, because it's expected that current workmanship standards (and
modern materials) will be used in the new building. Even though this is expected, the appraiser must note as an appraisal
condition that it's impossible to create an exact duplicate of the subject property in today's marketplace.
One situation in which a replacement cost might be calculated is in an older home's appraisal. Due to the detail and quality of
craftsmanship in older homes, and the lack of availability of materials used when the house was originally built, the appraiser
estimates the cost of producing similar features within the house. For example, a particular architectural feature may be available
today, but that feature will likely be constructed with synthetic materials and won't be of the same quality as those in the subject
home.
Example
Courtney was determined to bring architectural features of her Craftsman home into her soon-to-be-built new home. She
asked her builder what it would take to recreate the old-growth timber archway in her current living room, featuring
multiple trims and a center medallion. "You can't afford it," he said simply, walking away.
Four Methods to Finding the Reproduction Cost of a Structure
An appraiser uses one of four basic methods to find the reproduction cost of a structure: index, square-foot, unit-in-place, and
quantity survey. Let's look at each of these now.
Index method: With this method, the appraiser applies a factor that represents the construction costs, up to the appraisal
date, to the subject building's original cost.
Square-foot method: With this method, the appraiser multiplies the cost per square foot of a recently constructed
comparable structure by the number of square feet in the subject building. Generally, appraisers use this method to
estimate construction costs. Appraisers use an updated cost manual, customized by geographic location, and published
by national companies like R.S. Means, Marshall & Swift, and E.W. Dodge Corporation, to find information on
building specs, construction costs, and more.
Unit-in-place method: With this method, the appraiser multiplies the cost per unit of measure of each component part of
the subject property's structure (for example, the material, overhead, labor, and builder's profit) by the number of units of
that component part in the subject. The total component cost is the cost of a new structure. (Generally, component parts
are provided in square feet, but some parts, like plumbing fixtures, are provided as complete units.)
Quantity survey method: With this method, the appraiser adds the itemized costs-including direct and indirect expensesof building or installing all of a new structure's component parts.
Let's look at the square-foot method for an example of how this number is calculated.
Square-Foot Method
Since the appraisal report forms prepared by Fannie Mae and Freddie Mac have become so common, the squarefoot method has become the go-to method of calculating reproduction costs for residential appraisals. With one such
appraisal form, the Uniform Residential Appraisal Report (URAR), the property's gross living area is multiplied by the
cost per square foot. (A property's gross living area takes the house's outside measurements and subtracts the nonliving areas from that.) Once the property's gross living area is multiplied by the cost per square foot, then that
number is added to the cost of the non-living areas and other improvements (a garage, deck, patio, etc.). And thenpresto!-you have the total estimated cost new of the improvements.
The formula used with the square-foot method looks something like this:
(Gross living area x cost per square foot) + cost of the non-living areas + cost of improvements =
reproduction cost new
Example
An appraiser is valuing a house with 1,600 square feet of living area, and the current construction cost is $70
per square foot. The non-living areas include a garage that is 500 square feet, with a construction cost of $24
per square foot; a deck valued at $1,400; and other site improvements (landscaping) that are valued at $2,500.
What is the reproduction cost of this property?
Let's look at our equation:
(1,600 x $70) + (500 x $24) + $1,400 + $2,500 = reproduction cost new
$112,000 + $12,000 + $3,900 = $127,900
These improvements have a present reproduction cost new of $127,900.