Chapter 9
Real Estate Finance:
The Laws and Contracts
Real Estate
FIN 331
Fall 2013
Dr. David P. Echevarria
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1
General Characteristics of Real Estate
Contracts
A. Most real estate transactions involve debt financing
B. Most businesses prefer to have their cash in the bank
rather than tied up in real estate
C. Most investors leverage their investments in order to
increase their returns on equity
D. Mortgage debt financing is a major aspect of real
estate decisions
E. Mortgage lending is a major industry in United States
and many other countries
F. A mortgage loan creates documents: a note and a
mortgage or deed of trust
G. Debt financing also has tax advantages
Dr. David P. Echevarria
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2
The Note
A. Interest rates - Interest charges
1. Interest rates may be fixed or variable
2. Mortgages are amortized
a.
b.
c.
Payments consist of principal and interest
The principal portion increases over time
The interest portion decreases over time
Dr. David P. Echevarria
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3
The Note
B. Adjustable Rate Mortgages
1. Adjustable-rate mortgages generally use an index
2. The index might be U.S. Treasury constant maturity
rates (10-year) or the LIBOR
3. As the index changes the adjustable rates change
4. All adjustable-rate mortgages have floors and caps
a.
b.
A floor is the lowest rates can go
A cap Is the highest rates can go
5. Margin is the lenders markup above the index rate
6. Teaser rates: a reduced interest rate for a short
period of time
Dr. David P. Echevarria
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4
Interest Rate Volatility
Libor vs. 10-Yr Treasuries
Frequency: Weekly, Ending Wednesday
12.00
10.00
10-Year Treasury
Libor
8.00
6.00
4.00
2.00
0.00
Dr. David P. Echevarria
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5
Disclaimer from BBA Ltd
For your information, and for historic reference purposes only, a link to the previous BBA
LIBOR website (pre-regulation) can be found here (http://www.bbalibor.com/). Please note
that all information contained within the previous website shall from 2 April 2013 be
considered to be for historic reference purposes only and BBA, BBA Enterprises Ltd and
BBA LIBOR Ltd accept no responsibility for any reliance placed on any such information
from such point in time. To the extent permitted by applicable law, BBA, BBA Enterprises
Ltd and BBA LIBOR Ltd expressly disclaim all liability howsoever arising whether in
contract, tort or otherwise (including, but not limited to, liability for any negligent act or
omissions) to any person in respect of any claims or losses of any nature, arising directly
or indirectly from: (i) anything done or the consequences of anything done or omitted to
be done wholly or partly in reliance upon the whole or any part of the contents of this
website; and (ii) the use of any data or materials on this website or unauthorized access to
this website or otherwise. Information on this website is not offered as advice on any
particular matter and must not be treated as a substitute for specific advice. In particular,
information on this website does not constitute professional, financial or investment
advice and must not be used as a basis for making investment decisions and is in no way
intended, directly or indirectly, as an invitation or offer to buy, sell, hold, lend, subscribe
for, or otherwise deal in any legal or beneficial interest in any financial instrument.
Dr. David P. Echevarria
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6
The Note
A. Payments
1.
2.
3.
4.
5.
Payments are made at the end of the month
Loans may be fully or partially amortized
Loans may also have a balloon payment
Some loans may be interest only
Some loans may involve negative amortization in the
early years
6. Terms may be shortened by adding additional
principal to each payment
a.
b.
All “conforming” and FHA/VA loans
Home equity credit lines
Dr. David P. Echevarria
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7
The Note
1.
Loans with restricted right of prepayment
a.
b.
c.
d.
Subprime home loans
“Jumbo” home loans
Most income property mortgage loans
Lender may impose prepayment penalties
D. Other Terms
1.
Nonrecourse loan: No personal liability
a.
b.
2.
3.
Exculpatory clause: relieves one party if damages caused
during execution of the contract
Lender prohibited from charging back unpaid claims due to
borrower’s inability to pay.
Demand clause: Right of lender to require prepayment
Inclusion of mortgage clauses by reference
Dr. David P. Echevarria
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8
The Mortgage vs. Deed of trust
A. Mortgagor: Borrower
B. Mortgagee: Lender (holds deed to property)
C. Deed of Trust: Deed help by Trustee (not
bank)
D. Title vs. lien theory
1. Title theory: Mortgage a temporary transfer of
title
2. Lien theory: Mortgage is a lien
3. Historic difference was lender’s claim to rents
and possession in case of default
Dr. David P. Echevarria
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9
The Mortgage (Deed of trust)
D. Some Important Mortgage (DOT) Clauses
1.
2.
3.
4.
5.
6.
7.
Description of the property
Insurance clause
Escrow clause
Acceleration clause
Due-on-sale clause
Hazardous substances clause
Preservation and maintenance clause
Dr. David P. Echevarria
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10
Default
A. Failure to meet requirements of the note or mortgage
1.
2.
Technical default: Any violation of terms
Substantive default: Three missed payments (90 days)
1.
2.
3.
4.
5.
Counseling and consumer debt reorganization
Temporary reduction of payments
Assisted sale
Short sale
Deed in lieu of foreclosure
B. Non-Foreclosure Responses to Default
a.
b.
Advantages: quick, quiet, cheap
Disadvantages: other liens remain;
Dr. David P. Echevarria
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11
Default
C. Foreclosure
1. Legal process of terminating all claims of
ownership and all liens inferior to
foreclosing lien
2. Negatives
a.
b.
c.
d.
Risk of failing to notify a claimant
Presence of superior liens
Costly and time consuming
Distressed sale
3. Importance of lien priority
Dr. David P. Echevarria
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12
Default
4. Recourses of the defaulted mortgagor
a.
b.
Equity of redemption
Statutory right of redemption
5. Deficiency judgment: Judgment against mortgagor
for unrecovered balance
Example:
a. Net foreclosure auction price:
b. Remaining loan balance:
c. Deficiency :
$100,000
$120,000
$20,000
6. Judicial foreclosure vs. power of sale
a.
b.
Judicial foreclosure: Court-administered public auction
Power of sale: Public auction conducted by trustee or
mortgagee (preferred by lenders)
Dr. David P. Echevarria
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13
Bankruptcy Statistics
BankruptcyAction.com
There were 937,000 personal
bankruptcies filed in the year ended
December 31, 2014. So that means
that 937,000 people filed
bankruptcy. Right? Wrong!
The statistics include joint filings,
for example for husband and wife.
In accordance with a study reported
in September, 2001, Young, Old, and
in Between: Who Files for
Bankruptcy? By Dr. Teresa Sullivan,
Dr. Deborah Thorne and Professor
Elizabeth Warren 31.9 % of the
filings for the year ended December
31, 2001 were joint filings of
husband and wife.
To approximate the number of
people filing bankruptcy we must
increase the filings by 31.9% to get
1,236,000 people who filed
bankruptcy in the year ended
December 31, 2014.
Dr. David P. Echevarria
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14
Bankruptcy Stats
http://www.bankruptcyaction.com/USbankstats.htm
A. Bankruptcy Profiles
1.
2.
3.
4.
5.
6.
7.
8.
9.
Average age: 38;
44% of filers are couples;
30% are women filing alone;
26% are men filing alone;
Slightly better educated than the general population;
Two out of three have lost a job;
Half have experienced a serious health problem;
Fewer than 9% have not suffered a job loss, medical event
or divorce;
Highest bankruptcy rates: Tennessee, Utah, Georgia,
Alabama.
Dr. David P. Echevarria
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15
Bankruptcy
A. Three forms of bankruptcy
1. Chapter 7:
2. Chapter 11:
3. Chapter 13:
Liquidation
Court supervised “workout”
Wage-earner’s proceeding
B. No form of bankruptcy can set aside a
mortgage lien
C. Chapters 11 and 13 can result in delays
Dr. David P. Echevarria
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16
Bankruptcy Act
Important Changes to 2005 Rev.
A. law passed in 2005 prohibits some filers
with higher incomes from using Chapter
7 bankruptcy (liquidation) vs. Chapter 13
(repayment)
B. Before you can file for bankruptcy under
either Chapter 7 or Chapter 13, you must
complete credit counseling with an
agency approved by the United States
Trustee's office: www.usdoj.gov/ust
Bankruptcy Act
Important Changes to 2005 Rev.
C. How property is valued: at replacement cost
instead of at auction value, which means
more debtors are at risk of having their
property taken and sold by the trustee.
D. How long a filer must live in a state to use
that state's bankruptcy exemption laws
E. Chapter 13: repayment from disposal
income under numbers provided by IRS
rather than bankrupt’s budget info.
Bankruptcy
F. Out-of-Court Remedies;
1. Necessary conditions;
a. Debtor is good moral risk.
b. Debtor must show ability to make a recovery.
c. General economic conditions must be favorable.
2. Extension; postpone due date.
3. Composition; creditors agree to take less.
4. Assignment; Requires agreement as to liquidation
values, and priority.
North Carolina Bankruptcy Exemptions
NC Bankruptcy Exemptions
Dr. David P. Echevarria
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20
Regulation of Home Mortgage
Lending
A. Equal Credit Opportunity Act: no
discrimination (protected classes)
B. Federal Truth-in-Lending Act (TILA): full
disclosure
C. Real Estate Settlement Procedures Act
(RESPA): Standard HUD forms/requirements
D. Other laws
1. Home Ownership and Equity Protection Act
2. Home Mortgage Disclosure Act
3. Community Reinvestment Act
Dr. David P. Echevarria
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21
Regulation of Home mortgage
Lending
A. Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010
1. Given oversight and enforcement power for:
a.
b.
c.
d.
e.
f.
All federal consumer financial protection laws
Anti-discrimination laws in consumer finance
To restrict unfair, deceptive or abusive practices
Receive consumer complaints
Promote financial education
Power to monitor emerging consumer financial risks
2. Centralizes a multitude of regulators within one
agency for home mortgage lending
Dr. David P. Echevarria
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22
Homework Assignment
A. Key terms: Adjustable-Rate Mortgage,
Balloon Loan, Contract For Deed, Deed Of
Trust, Default, Foreclosure, Libor,
Negative Amortization, Nonrecourse
Loans, Recourse Loans, Short Sale, Term
To Maturity, LIBOR
B. Study Questions: 1, 4, 6 - parts a, b, c, d
Dr. David P. Echevarria
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23