Understanding the Time Value of Money

In order to understand real estate financing, it is important that you understand the time value of money. Because of inf lation, a dollar today is generally worth less in the future. Thus, while real estate values may increase, an all-cash purchase may not be economically feasible, because the investor’s cash may be utilized in more effective ways. The cost of borrowing money is expressed in interest payments, usually a percent of the loan amount. Interest payments can be calculated in a variety of ways, the most common of which is simple interest. Simple interest is calculated by multiplying the loan amount by the interest rate, then dividing it up into period (12 months, 15 years, etc).

Example: A $100,000 loan at 12% simple interest is $12,000 per year, or $1,000 per month. To calculate monthly simple interest payments, take the loan amount (principal), multiply it by the interest rate, and then divide by 12. In this example, $100,000 °— .12 = $12,000 per year ÷ 12 = $1,000 per month.

Mortgage loans are generally not paid in simple interest but rather by amortization schedules (discussed in Chapter 4), calculated by amortization tables (see Appendix A). Amortization, derived from the Latin word “amorta” (death), is to pay down or “kill” a debt. Amortized payments remain the same throughout the life of the loan but are broken down into interest and principal. The payments made near the beginning of the loan are mostly interest, while the payments near the end are mostly principal. Lenders increase their return and reduce their risk by having most of the profit (interest) built into the front of the loan.

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What Is Foreclosure?

Foreclosure is the legal process of the mortgage holder taking the collateral for a promissory note in default. The process is slightly different from state to state, but there are basically two types of foreclosure: judicial and nonjudicial. In mortgage states, judicial foreclosure is used most often, whereas in deed of trust states, nonjudicial (called power of sale) foreclosure is used. Most states permit both types of proceedings, but it is common practice in most states to exclusively use one method or the other.

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The Deed of Trust

Some states (e.g., California) use a document called a “deed of trust” (AKA “trust deed”) rather than a mortgage. The deed of trust is a document in which the trustor (borrower) gives a deed to the neutral third party (trustee) to hold for the beneficiary (lender). A deed of trust is worded almost exactly the same as a mortgage, except for the names of the parties. Thus, the deed of trust and mortgage are essentially the same, other than the foreclosure process.

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The Mortgage in Detail

The security agreement executed by the borrower pledges the property as collateral for the note. Known by most as a “mortgage,” this document, when recorded (discussed below), creates a lien in favor of the lender. The mortgage agreement is generally a standardized form approved by FNMA. While the form of note is generally the same from state to state, the mortgage form differs slightly because the legal process of foreclosure (the lender’s right to proceed against the collateral) is different in each state. The mortgage document will state that upon default of the note, the lender can exercise its right to foreclose on the property. Foreclosure is the process of lenders exercising their legal right to proceed against the collateral for the loan (discussed later in this chapter). It also places other obligations upon the borrower, such as
• maintaining the property,
• paying property taxes, and
• keeping the property insured.

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Promissory Note in Detail

A note is an IOU or promise to pay; it is a legal obligation. A promissory note (also known as a “note” or “mortgage note”) spells out the amount of the loan, the interest to be paid, how and when payments are made, and what happens if the borrower defaults. The note may also contain disclosures and other provisions required by federal or state law.

Most lenders use a form of note that is approved by the Federal National Mortgage Association (FNMA, or Fannie Mae). A sample form of this note can be found in Appendix C. The note is signed (in legal terms, “executed”) by the borrower. The original note is held by the lender until the debt is paid in full, at which time the original note is returned to the borrower marked “paid in full.”

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What Is a Mortgage?

Most of us think of going to a bank to get a mortgage. Actually, you go to the bank to get a loan. Once you are approved for the loan, you sign a promissory note to the lender, which is a legal promise to pay. You also give the lender (not get) a mortgage as security for repayment of the note. A mortgage (also called a “deed of trust” in some states) is a security agreement under which the borrower pledges his or her property as collateral for payment. The mortgage document is recorded in the county property records, creating a lien on the property in favor of the lender. If the underlying obligation (the promissory note) is paid off, the lender must release the collateral (the mortgage). The release will remove the mortgage lien from the property. If you search the public records of a particular property, you will see many recorded mortgages that have been placed and released over the years.

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Mortgages by purpose

Mortgage forms vary in their payback provisions, terms of agreement, and the types of property used as security. Some are created to achieve specific purposes or to fit the need of the individual borrower. The types of mortgages classified according to purpose are as follows:

1. Purchase money mortgage
The distinguishing characteristic of a purchase money mortgage is that the title and the mortgage are conveyed in the same transaction. The loan involved could be from a third party, and it could be a first mortgage loan. However, typically the purchase money mortgage is a second mortgage given by the seller to the buyer to partially finance the purchase through installment payments. Purchase money mortgages are common in all types of real estate purchases. In the purchases of raw land in large quantities by a developer, the landowner may accept a partial cash payment q d take a mortgage for the remainder of the selling price. As the developer sells lots from the completed subdivision, the mortgage is paid off. In effect, the landowner is a partner with the developer through the use of a purchase money mortgage.

Purchase money mortgages are also common in transactions involving residential properties, such as when the buyer does not have a sufficient down payment. The remainder may be obtained by assuming an existing mortgage or giving the seller a new mortgage. Either way, the seller is willing to take a mortgage as part of the payment. Consider the following example to illustrate the use of a purchase money mortgage in residential properties. Seller A is asking $80,000 for a single-family residence. Buyer B likes the house but only has $10,000 for a down payment. The lending institution will only loan $64,000 on the house. To be able to sell the house, Seller A agrees to take a purchase money mortgage for $6,000 from Buyer B. In addition to taking this purchase money mortgage, Seller A is willing to accept a lower priority of claim if Buyer B should default, In this case, the lending institution has the fust claim because it has a first mortgage. The purchase money mortgage is a second mortgage.


2. Participation Mortgage
A participation mortgage is a loan agreement that provides for a lender to receive part of the income fiom an investment in addition to the interest payments. Participation mortgages became popular during periods of high interest rates and are used by lenders to increase their yields. The participation feature enables them to share in the expected success of income-producing properties. It also, protects the borrower fiom abnormally high payments, if income projections are not realized. The participation can be a specified percentage of gross or net income, a share of proceeds at sale, or both. The use of a closely related term, mortgage participation, occurs when the two or more lending institutions combine their funds to finance a real estate project. For example, a lender does not want the risk of a project of the magnitude for which an investor is seeking a loan. In this case the “primary” lender may call upon another lender to “participate: in this loan, thereby creating a participation. For example, an investor needs $100 million to purchase a large hotel complex. The lending institution to which the developer applies for a loan may not be able to lend that much money. By obtaining one or more “participants,” the original lender is able to obtain the money needed for the investor. In return, all lenders receive evidence of debt from the borrower, as well as an instrument pledging the property as security for each lender’s note.

3. Blanket mortgage
A blanket mortgage covers more than one parcel of land. Developers of subdivisions employ this type of mortgage, which permits small portions of the land (residential lots) to be paid off and released from the mortgage. This clause is known as a release clause, since the remainder of the land continues to be held as security for the loan. The percentage of the original mortgage that is released is usually smaller than the pro rata dollar amount. For example, the developer has a note for $100,000 on a subdivision with 20 lots. The lender will usually require more than lDOth of the mortgage dollar amount to be paid before one lot is released.

4. Reverse annuity mortgage
The reverse annuity mortgage was conceived as a way to enable older homeowners to liquidate and consume the equity “locked up” in their home. As the name suggests, in it’s simplest form the homeowner would receive a regular disbursement from the lender, secured by a mortgage. The regular disbursements and interest accruing against them accumulate eventually to some maximum loan balance. The major problem with this simple RAM is that the homeowner may outlive the time when the maximum loan is reached. While various solutions to this risk are being explored, there is yet to be a significant use of the RAM in the United States. Prudence requires that the loan be made to a homeowner late in life, and for a fairly small percentage of the property’s.

5. Package mortgage
A package mortgage allows home buyers to pledge household items of personal property, in addition to the real estate, as security for a loan. For instance, lending institutions may allow items such as ranges, refrigerators, dishwashers or air conditioners to serve as security, thereby allowing the home buyer to finance major appliances over the term of the loan at relatively low mortgage interest rates. This practice allows lenders to increase the amount of a loan with no added administrative costs and little additional risk. It allows buyers to purchase home appliances and other major items of equipment they may otherwise might not be able to afford.

6. Home equity credit line loan
By far the fastest growing form of mortgage loan in recent years has been the credit line home loan. It is a second mortgage loan that permits any number of draws or balance reductions, subject to a maximum of 75% to 80% of house value, including the first mortgage loan. The monthly payment typically is the greater of a fixed percentage of the current balance, usually 1 %% to 2%, or a modest dollar minimum. The interest rate is variable, usually prime (or another short term interest rate) plus one and a half to two percent. Draws against the mortgage usually are by check, though in some cases credit cards access the credit line.

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Mortgages by payment or yield variability (AMLs, GPMs and SAMs)

1. Adjustable mortgage loan (AML)
In 198 1 the Federal Home Loan Bank Board issued regulations incorporating both variable and renegotiable rate mortgages into adjustable mortgage loan regulations. “An adjustable mortgage loan (AML) permits adjustment of the interest rate, which may be implemented through changes in the payment amount, the outstanding principal loan balance, the loan term, or any combination of these variables.” (FHLBB Res. No. 8-12069 1981 .) As with VRMs and RRMS, interest rates must be decreased as the index decreases, and of course may be increased as the index rises. The lender may increase the loan term up to 40 years to cover interest rate increases (although such an extension is not an option that must be offered to borrowers). The interest rate may be tied to any index beyond the control of the lender and may be adjusted as often as monthly. Examples of indexes to which an AML may be tied are (1) the FI-LB District cost of funds to FSLIC-insured savings and loans; (2) the national average contract mortgage rate for the purchase of existing home; (3) the monthly average of weekly auction rates on three-month or six-month U.S. Treasury bills, and (4) the monthly average yield on U.S. Treasury securities adjusted to constant maturities of one, two, three or five years. All of these indexes are published in the Federal Reserve Bulletin. Notice of interest rate changes must be given to borrowers at least 30 days, but no more
than 45 days, prior to the change. Lenders may not charge a prepayment penalty or fee associated with interest rate changes. Within these regulations and guidelines, lenders may establish their own AML plans.
However, administrative costs, competition and secondary market requirements limit flexibility for most lenders’ in this regard. Frequent adjustments are costly. Competitors may limit the frequency and magnitude of adjustments. And secondary market lenders have established certain limitations for the AMLs they will purchase. For example, the Federal Housing Loan Mortgage Corporation will not purchase AMLs that allow rising balances or that have a subsidized payment (“buy down”) in the early months.

2. Graduated payment mortgage
In a graduated payment mortgage (GPM),th e payments begin at a lower level than in a comparable standard fixed payment mortgage. They gradually rise to an amount greater than the payment in the standard fixed payment mortgage. After the period for payment increases ends, the payments for the remaining term are fixed. In the early years of a GPM loan, interest accrues at a higher rate than is actually paid. The unpaid interest is added to the principal balance. This is called negative amortization because the remaining balance is increasing rather than decreasing

There are several plans for FHA-insured GPMs under Section 245 of the National Housing Act. The approved plans are:
Plan I: Payments rise 2.5% annually for five years.
Plan 11: Payments rise 5% annually for five years.
Plan 111: Payments rise 7.5% annually for five years.
Plan IV Payments rise 2% annually for 10 years.
Plan V Payments rise 3% annually for 10 years.

3. Shared appreciation mortgage
A shared appreciation mortgage (SAM) allows a lender to charge a below-market periodic interest rate by sharing in the property’s sale proceeds at time of sale or upon maturity of the loan. The payment to the lender upon maturity or sale is termed contingent deferred interest. The percentage share of the property’s appreciation the lender will receive is established in the loan agreement. While there have been numerous advocates of SAM home loans, no large-scale program has been implemented. One cause of this is home appreciation is geographically correlated with income and ethnichacial characteristics; therefore, the loan could be inherently discriminatory. A second cause is typical terms do not return a competitive yield to lenders. In income property lending, however, the SAM idea is used as one form of a “participation” mortgage loan.

Mortgages by method of payment

1. Straight (or straight-term mortgage)
A loan in which only interest payments are made periodically with the entire amount due at maturity is called a straight (or straight-term) loan. Although such loans are not used frequently to finance the purchase of single-family houses, they are used quite often in land transactions. In these situations, developers will be able to pay for the land after development and sale. In the interim, they pay interest only.

2. Standard fixed payment mortgage
A standard fHed payment mortgage (SFPM) is a fully amortized loan that is completely paid off by equal, periodic payments. This is the standard type of loan used to finance single-family homes today. It is also used sometimes for income-producing properties, although partially amortized loans are used often more frequently to finance these properties. Payments on fully amortized mortgages are usually required monthly. At maturity of the loan, the loan balance is zero.

3. Partially amortized mortgage
If a loan is not completely paid off by equal, periodic payments, but periodic payments are required, it is a partially amortized loan. In oper words, the loan will be partially paid off by periodic payments, but there will a remaining balance on the loan which must be paid off at maturity. This remaining balance on a partially amortized loan is called a’, balloon and is satisfied by a balloon payment.

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Government underwritten vs. conventional mortgages

Government underwritten loans are insured or guaranteed by an agency of the U.S. government. The Federal Housing Administration insures loans made by private lenders to qualified buyers of properties that meet minimum standards. The Veterans Affairs guarantees loans made by such lenders to veterans. A 1% user fee charge is made by the VA for a guarantee. The FHA charges a premium for loan insurance, as described below

1. FHA-insured mortgage
The Federal Housing Administration was created under the National Housing Act of 1934. Under this act the FHA was granted the authority to insure mortgage loans made by private lenders. It is important to understand that the FHA issues an insurance policy, whose premiums are paid by the borrower, which guarantees that the lenders will receive their money in the event the mortgagors fail to make their payments. There are several types of FHA mortgage programs including low-income housing, nursing homes, cooperative apartments and condominium apartments. The most common FHA program is for single-family homes as authorized by Title 1 1 , Section 203, of the National Housing Act. Under this program the borrower pays a one-time insurance premium based on several factors. This premium may be financed over the life of the loan if the skller pays the closing costs. The premiums for FHA insurance are deposited in the Mutual Mortgage Insurance Fund. The FHA reimburses a lender from this fund if a borrower defaults, the mortgagor’s interest has been foreclosed and the Secretary of HUD has taken title to the property. The FHA then must sell the property. Lenders will generally loan a higher percentage of the appraised value with an insured mortgage. There may be times when a potential home buyer does-not have a sufficient down payment to qualib for a conventional loan. In this case, an FHA-insured mortgage may be appropriate. However, the insurance premium is an added expense to the borrower.

2. VA-guaranteed mortgage
The Veterans Affairs (formerly the Veterans Administration) was created just after World War I1 as part of the Servicemen’s Readjustment Act and was authorized to guarantee a stated percentage of loans made to qualified veterans by qualified lenders. Although the Veterans Affairs does not normally make loans, in areas where here are no lending institutions, the VA will grant loans directly to veterans. Generally, the VA guarantees loans that are made by lending institutions to veterans. When a borrower defaults, the VA will pay up to 50% of the amount of the loan when5 the loan is $45,000 or less. For larger loans the VA will pay any loss up to a maximum of $22,500 plus 40 cents per additional dollar of the loan over $45,000, to a total loss limit of S36,OOO. Because VA loans are available up to 100% of the selling price, brokers are able to sell homes to veterans who otherwise could not afford to purchase a home. In this case the veteran is entitled to only one VA loan; however, in some cases the loan can be transferred to another eligible veteran, and the original borrower’s right to a loan is restored.


3. Conventional mortgage
In recent years, the percentage of FHA and VA mortgages has been decreasing. The majority of mortgages today are conventional. Conventional loans are preferred by lenders for two reasons. First, lenders have the flexibility to create loans that reflect their own requirements. This permits individualized programs that are in the best interest of both parties. Second, more paperwork and red tape are required for loans that are guaranteed or insured, and administrative costs are higher. Generally, a conventional mortgage requires a larger down payment than an FHA or VA mortgage. In the VA program, the borrower is not allowed to pay points on a new loan. However, the borrower may be required to pay points when refinancing or rolling over. (Points are a discount from the face amount of the loan which increases the yield to the lender.) In conventional and FHA mortgages, borrowers are allowed, and in many cases do, pay loan fees, user fees or discount points.

Mortgage Clauses

In every mortgage loan there are several clauses that state the rights of the mortgagor and the mortgagee during the tenn of the mortgage loan agreement. The various clauses (or provisions) that may be found in the debt agreement are as follows:

A. Acceleration clause
Lenders usually insist that the instrument contain an acceleration clause that makes the entire debt due in the event of default. This clause precludes the necessity for the lender to bring separate lawsuits against the same mortgagor for each late payment. This clause usually states that if any covenants are breached, including the obligation to pay the sums secured by the mortgage when due, then the full amount is due immediately. This declaration of full payment due is at the option of the lender.

B. Renegotiable rate clause
A renegotiable rate mortgage (RRM) is a series of short-term loans secured by a long-term mortgage. The short-term loans are automatically renewable at equal intervals of three to five years each. The mortgage term may not exceed 40 years. The monthly payments are made in equal installments. However, at the end of the life of each short-term loan, the interest rate may be changed. Changes are based on the movement of an index such as the Federal Home Loan Bank Board’s most recent monthly national average contract mortgage rate index. The interest rate is the only term-that may be altered. An interest rate.modification results in a change of the monthly payment. The new payment amount remains stable until the loan term has again expired.

C. Prepayment Clause
To prepay means to pay off the indebtedness before the end of the loan term. Under traditional common law, the mortgagor has no right to prepay a mortgage unless the right is explicitly provided by a prepayment clause. In some states statutory law has reversed this. Now, any note that is silent as to the right of the obligor to prepay the note in advance of the stated maturity date may be prepaid in 111 by the obligor or his successor in interest without penalty. In typical prepayment clauses a statement is made as to (1) whether there is a penalty for prepayment;

(2) whether extra payments directly reduce the principal upon which interest is computed or eliminates the last payment, and (3) whether the number and size of extra payments in any one year are restricted. Some lenders try to discourage a fast turnover of funds, which is costly to them, by imposing prepayment penalties during the early years. These penalties are usually stated as a percentage of the unpaid balance, and the percentage charge is usually reduced in later years of the mortgage term. Most savings and loan institutions have a prepayment clause in the note. Typically it states that the borrower has the right to prepay the outstanding principal amount in whole or in part and that the outstanding amount of the extra payment is applied against the principal amount. In addition, such clauses usually state that any extra payment does not extend or postpone the due date of subsequent monthly installments, or change the amount of the installments.

D. Variable rate clause
The variable rate mortgage (VRM) ties the interest rate to some specified index of market interest rates. As market rates fluctuate, either the periodic (usually monthly) payment or the loan’s maturity would increase or decrease depending on whether the rate went up or down. Until 1980, federally chartered savings and loans were precluded from increasing a loan’s monthly payments. However, financial deregulation during the early 1980s freed S&Ls from such restrictions, and they can now make many types of loans in which periodic payments may vary.

E. Defeasance clause
This clause “defeats” the right of the lender to foreclose on the property as long as the borrower lives up to the terms of the agreement. Thus, as long as the borrower makes periodic payments according to schedule and fulfills all other requirements, the lender may not sei& the property or have it sold.

F. Exculpatory clause
An exculpatory clause relieves the borrower of personal liability to repay the loan. Thus, if the borrower defaults; the lender can look only to the property foreclosure for recovery of the debt. In effect, the lender may not sue the borrower on the note or obtain a deficiency judgment, if sale of the property at foreclosure does not provide sufficient funds to cover the loan’s balance. Obviously, borrowers prefer to negotiate loans with exculpatory clauses, but lenders are usually unwilling to allow them. Probably the most frequent use of this clause is with investment property involving 1imited.partners. In order for limited partners to claim tax depreciation on the mortgaged portion of a property, the general partners must have no personal liability for the mortgaged loan. This means all partners are considered to be “at risk” for the mortgaged portion of the property, and that the limited partners can claim depreciation on the mortgaged portion. To achieve this arrangement, the mortgage will have an exculpatory clause to relieve the general partners of any personal liability.

G. Subordination clause
A lien holder may consent to place his or her interest in a property at a lower priority than another lien holder, through the use of a subordination clause. A subordination clause is often used when the seller of vacant land takes back a purchase money mortgage. In order to make the sale, the seller agrees to lower the priority of the lien to a position inferior to a construction or permanent loan. Sometimes land owners who lease their land will also subordinate their fee position to a construction or permanent loan obtained by the lessee.


H. Release clause
An acquisition and development loan obtained by a developer may be used to develop a number of building lots. Many such loan agreements contain clauses that allow the developer to release developed lots as security for the loan. In addition, a specified amount is paid back to the lender. Usually the amount that must be paid to obtain a release is greater than the proportionate amount of the loan allocated to the lot. For example, if a developer borrows $1 00,000 to develop 10 lots, the release amount might be $12,000 per 1&-$2,000 more than t& amount of loan per lot?.

I. Cognovit clause
This clause is considered to be a confession of judgment. If borrowers allow this clause to be included, they in effect give up their right to a day in court. It authorizes the lender’s attorney to obtain a judgment lien against the debtor’s real property. Without this clause, the lender must sue on the basis of the note and prove it to be in default.

J. Escalator clause
This clause allows the lender to increase the interest rate. Although an escalator clause in its most general sense could allow a lender to increase the rate for any reason, it is usually tied to an event or contingency. For example, if it is discovered that the mortgagor is an investor rather than an owner-occupant. Moreover, it could provide for the interest rate to escalate up to the legal maximum in the event of the borrower’s default. An escalator clause does not create a variable rate mortgage in which the interest rate is tied to a market index. Escalator clauses in which the interest rate change is at the discretion of the lender are very unpopular with borrowers. The potential for abuse and unfavorable public relations far outweighs any benefits.

K. Open end clause
Many institutions @articularly savings and loans) write loan agreements that allow a borrower to increase the amount of a loan after the loan balance has been paid down. The loan can usually be increased to the original amount borrowed. While closing costs and loan fees are avoided by using an open end provision, the lender usually reserves the right to adjust the interest rate if the current market rate is higher than the rate on the loan being opened.

L. Redemption clause
Prior to foreclosure, a borrower has the right to pay the amount owed, plus interest, in order to retain the property or interest in the property. This right is called the equity of redemption and is a matter of law, not negotiation. Nevertheless, the right is stated in most mortgages.


M. Due-on-sale clause
Traditional common law permits a buyer to purchase mortgaged property and preserve the existing mortgage unless the mortgage contains a clause to accelerate the loan upon sale. This dueon- sale clause is especially important to lenders in a world of volatile interest rates. Without it, buyers tend to preserve low interest rate mortgages as long as possible by purchasing second mortgage financing rather than refinancing the existing loan. The clauses discussed in this section are the principal variable provisions found in mortgages or notes. Other provisions that are sometimes used include equity participation and late payment clauses. Depending on the type of lender, each will usually have a standard form that outlines the rights of the lender and the borrower. All borrowers should carefully read these documents before signing. They may contain a clause that is detrimental to their particular needs. Fortunately for home mortgages, the influence of secondary mortgage market agencies has in recent years encouraged the widespread use of a standard home mortgage contract. This document, promulgated by the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal' National Mortgage Association (FNMA), is well crafted to protect the interest of both mortgagor and mortgagee in the fypical home loan situation.

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Mortgage Theory

A. Early mortgage history
In the early years, a mortgage - property pledged to secure a debt - was an actual assignment of that property to a lender. During the period of time that the mortgagor still owed the mortgagee part of the original loan, the lender had physical use of the land and was entitled to any rents or revenues generated from the land. Thus, in the ‘earlier forms of mortgages, title to the land pledged as security for a loan was truly transferred to the lender. Abuses on the part of lenders brought about more careful wording in the mortgage instruments. Slight delays in repaying the loan often resulted in “legal default,” with borrowers forfeiting any rights to the recovery of title to their land. An outgrowth of the early experiences of both lenders and borrowers is the current day distinction between the title theory and lien theory of mortgages.

B. Lien theory
Lien theory is a more modem approach to creating loan security and is used in most states. In lien theory states, the lender is considered to hold a lien, rather than title, against the property for security of the debt. A lien is the right to have property sold to satisfy a debt. In the event of default on the promissory note, foreclosure proceedings are initiated, and the title is conveyed from the borrower to the lender. The mortgage remains with the property until the debt is paid, even if ownership of the property changes.

C. Title Theory
Fewer than 20 states subscribe to this concept of mortgages. In states with title theory, a mortgage is assumed to represent an actual conveyance of title to the mortgagee, and the document is usually called a “mortgage deed.” This can be seen as very similar to the early mortgages in which the mortgagee owned legal title and could take possession or collect revenues from the property during the term of the loan. All of the title theory states have adopted one or several approaches to eliminating abuses in such mortgages. One altemative is to employ what is called intermediate title theory. Although this approach requires formal court action to rescind the borrower’s legal rights to the property, the mortgagee can assume possession of the property between the time of default and the sheriffs sale. While this system protects the lender against any property, it also protects the mortgagor from eviction without the legal process. Another approach requires that foreclosure proceedings must be held, as in lien theory states. This requirement makes these states’ mortgage laws equal in borrower protection to that of lien theory states’ requirements. The only difference is in the formal wording of the instrument.

D. Deeds of Trust
As mentioned earlier, the typical mortgage involves only two parties, the lender and the borrower. However, in a trust deed, also known as a deed of trust, the borrower conveys the land to a third party. The third party holds the land in trust for the benefit of the holder of the note. The primary reason some states use this form is that the deed of trust can be foreclosed easily and quickly by a trustee’s sale under a “power of sale” clause. In prescribed situations, court proceedings may be minimized or eliminated.

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Notes And Mortgages

The purchase of real estate can usually be regarded as a joint venture between an equity investor and a lending institution. Very few occasions arise where properties are bought for all cash. In most real estate transactions a lender provides a part of the financing, and the property is held as security for the debt. There are two instruments involved when a real estate transaction involves both debt and equity - the note and the mortgage.

A. Promissory note
A promissory note is a signed document acknowledging the existence of a debt and promising repayment. The chief function of the note is to make the borrower personally liable for payment of the debt. Once an individual has signed such a note, the t e n of the repayment schedule must be met regardless of the financial success of the property.

B. Mortgage
A mortgage is a pledge of security for the repayment of a debt. It is created by formal written agreement in which the person who signs a promissory note pledges the property being financed as security (or collateral) for the debt. Therefore, the mortgage itself is a lien - not evidence of a debt.

1. Parties to the mortgage
There arc two parties in each mortgage, the mortgagor and the mortgagee. The mortgagor is the borrower, or the one pledging the property as security for the debt incurred. The mortgagee is the lender, or the one to whom the property is pledged. In the process of borrowing money and pledging property as security, the borrower signs a note which is evidence of the debt. Without this evidence, no mortgage can exist. The mortgage is an instrument which creates an interest in property. This interest is a lien, or legal claim, on the mortgagor’s property until the debt is paid.

2. Mortgage requirements
Since a mortgage conveys an interest in real estate, it must be in writing. The actual wording of the document may conform to rather broad guidelines, but should contain essentially the same elements as the deed. The basic mortgage should contain the following elements:


a. The mortgagor’s legal name must appear. This implies that the mortgagor is of legal age for contracting.

b. The mortgagee’s name must also appear in the mortgage.

c. The mortgage must contain words of conveyance or granthg from the mortgagor to the mortgagee.

d. The instrument must contain a legal description of the mortgaged property that adequately identifies it..

e. Reference is usually made to the promissory note, in lieu of the amount of consideration that is found in a typical deed.

f. The mortgage must be signed by the mortgagor. Although it is not essential for mortgagees to sign documents, they usually do.

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