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Real estate Exam 3: The Legal Context

Terms in this set (18)

Two Documents used to create a loan
-the note
-Contract that establishes the financial obligation and the exact terms of the loan
-The Mortgage
-Contract by which the borrower grants the lender a security interest in the property.
Key Components of the Note
-Fixed Rate Mortgage
-Interest Rate is stated and does not change during the life of the loan.
-usually stated in the documentation.
-Adjustable rate mortgage
-Interest rate will change at some point during the life of the loan.
-Wide Variation with respect to how often the rate changes.
-Interest rates on some construction loans change every month.
-There is a 40 year loan where the interest rate changes only once after the 20 years.
- Compounding period
-Most mortgage loans employ monthly compounding in which the monthly interest rate is 1/12th of the annual rate.
How is the initial interest rate calculated
The annual rate of interest is calculated as the sum of the index rate plus a margin.

Index rate is a market determined rate that is beyond the control of either the borrower or the lender.

-The margin is the lenders markup and reflects the difference in risk between the index rate and the loan.

-Depending on the index rate the margin is usually between 200 and 300 basis points.
-100 basis points is the same as 1 percent point.
How often does the interest rate change?
-Frequency of change is stated in the note.
-New interest rate is the new value of the index rate plus the margin.

Longer lock = smaller interest rate savings.
shorter lock = larger interest rate savings.
Does the loan have a teaser rate?
-Teaser rate is an initial interest rate that is temporarily reduced to some values between index rate + margin.
-it is important to know the teaser rate because teaser rates can lead to large one time jumps in the loans interest rate and therefor payment when they expire and the rate adjusts to index + Margin.
Two types of payment caps.
Periodic caps: limit how much the payment and interest rate can change at any one time

Lifetime caps: limit how much the payments or interest rate can change in total during the life of the loan.

_ Caps normally apply to both upward and downward changes in rates and payments.
Right of Prepayment
1. the note may say nothing about prepayment. In this case it depends on the state that you are operating in.
-some states allow the lender to charge a prepayment penalty if the borrower seeks to pay off the loan early.
-others say the borrower has the right to prepay without penalty unless the note restricts them from doing so.
- Georgia forbids a prepayment penalty unless state in the contract.
2. the note may grant the borrower the right to prepay without penalty.
3. The note may allow the borrower to prepay so long as the pay a prepayment penalty.
Right of prepayment cont
-Most residential mortgages allow borrowers to prepay with out penalties.
Prepayment penalties are common for:
-Large residential mortgages (Called jumbo mortgages)
-Subprime mortgages: loans to borrowers with bad credit or inability to document income.
-Most commercial mortgages.
Types of prepayment penalities
1.percentage of the balance outstanding at the time of prepayment.
2.lockout provisions
3. Yield maintenance prepayment penalties
-Borrower must make lump sum payment to the lender equal to the present value of the interest income lost due to prepayment.
4. Defeasance prepayment penalties: Borrower must provide the lender with U.S. treasury securities that generate the same cash flow as the loan that is being repaid. In return the borrower is free to refinance or sell the property that has been securing the loan without having to pay off the existing loan.
-Most common for loans that are part of a commercial mortgage backed security pool.
Demand Clause
The demand clause allows the bank to call the loan and require immediate repayment of all outstanding principle even if the borrower is current with their payments.
-Usually tied to deterioration of the credit worthiness of the borrower.
Insurance Clause
Requires the borrower to insure the property at level determined by the lender.
Escrow clause
-Lender requires the borrower to include 1/12 of their anticipated property insurance premium and annual property taxes as part of their monthly payment.
-Lender is responsible for paying the premium and property taxes.
Accelatation clause
In the event of default, allows the lender to declare that all outstanding principle is immediately due.
-This is an important step in initiating the foreclosure process
Due on sale clause
-Requires the loan to be paid off if the property securing the loan is sold.
-Prevents loan assumptions where the buyer takes over responsibility for loan payments as part of the terms of sale.
Fully amortizing
Interest obligation is paid off every month and all principal is repaid by the end of the loans term
Partially amortizing
Interest obligation is paid off every month but there is still principal outstanding when the loan reach maturity.
-Common for commercial mortgages where there are separate and different loan and amortization terms. (10 year loan with 25 year amortization)
Nonamortizing
-interest obligation is paid off every month but the payment terms do not require any principal to be repaid.
-Entire principal balance is dues when the loan matures.
-know as interest only loans.
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