03 - Real Estate Finance

Finance
2-4
Contents
Chapter One: History of Finance & Lending ....15
Introduction ...................................................................................15
The Beginning ................................................................................16

Early Lending Practices.............................................................16
Mortgage Lending, Roman Era .................................................17
Mortgage Lending, German ......................................................18
Mortgage Lending, English .......................................................18
Mortgage Lending, United States..............................................20
The Great Depression ..................................................................22
Recovering from the Depression ..............................................24

Economic Growth ......................................................................25
Federal Governments Role in Real Estate Finance.............25

Mortgage Lending Laws ............................................................26
Last 20 Years of the 20th Century..............................................32

Advent of the 21st Century .........................................................36
Chapter Summary .........................................................................36
Chapter Quiz...................................................................................38
Chapter Two: Real Property .................................41

Introduction ...................................................................................41
Bundle of Rights ............................................................................41
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Real Property Types of Estates ..............................................42
Freehold Estates ........................................................................42
Less-than-Freehold Estates.......................................................44
Real Property vs. Personal Property........................................44
Real Property .................................................................................45

Land ...........................................................................................46
Permanently Attached to the Land ...........................................46
Appurtenant to the Land ...........................................................46
Anything Immovable by Law ....................................................46
Fixtures ............................................................................................47
Five Tests of a Fixture ...............................................................48
Trade Fixtures............................................................................49
Land Description Underwriting Guidelines ..........................49

U.S. Government Section and Township Survey ......................50
Recorded Lot, Block and Tract System .....................................50
Metes and Bounds .....................................................................55
Chapter Summary .........................................................................55
Chapter Quiz...................................................................................56
Chapter Three: Land Titles and Estates ............59

Introduction ...................................................................................59
Land Title ........................................................................................59
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System of Recording.....................................................................61
Elements of Recording ................................................................61
Public Notice and Its Outcome..................................................62
Priorities in Recording ..............................................................62
Ownership of Real Property.......................................................63

Separate Ownership ..................................................................64
Concurrent Ownership ..............................................................64
Limitations on Real Property: Encumbrances......................69

Money Encumbrances (Liens....................................................70
Homestead Exemption ................................................................76

Obligations Unaffected by Homestead Declaration .................77
Contents of the Homestead Declaration ...................................79
Effect of Recording and Its Termination ..................................79
Federal Homestead Act of 1862 ................................................79
Assuring Marketability of Title..................................................79
Title Insurance...............................................................................80
Chapter Summary .........................................................................82
Chapter Quiz...................................................................................84
Chapter Four: Instruments of Finance..............87

Introduction ...................................................................................87
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How a Loan Works........................................................................87
Promissory Note............................................................................89
Negotiable Instrument ..............................................................90
Types of Notes ...........................................................................90
Adjustable Rate Mortgages (ARMs...........................................92

Characteristics of ARMs ............................................................93
Holder in Due Course ................................................................98
Conflict in the Terms of a Note and Trust Deed .......................98
Property Transfers by the Borrower .......................................99

Assuming a Loan .......................................................................99
Subject To the Existing Loan..................................................100
Clauses in Financing Instruments............................................100

Acceleration Clause ...................................................................100
Alienation Clause.......................................................................100
Assumption Clause ....................................................................101
Subject To Clause ...................................................................101
Subordination Clause ................................................................101
Prepayment Clause ....................................................................101
Or More Clause.......................................................................102
Junior Trust Deed .........................................................................102

Outside Financing .....................................................................102
Seller Financing .........................................................................103
Balloon Payment Loans.............................................................105
Other Loans Secured by Trust Deeds or Mortgages ............106

Home Equity Loans ...................................................................106
Home Equity Line of Credit (HELOC) ...................................... 107
Package Loan .............................................................................111
Blanket Loan... ......111
Open-End Loan .........................................................................111
Swing Loan ................................................................................112
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Wrap-Around Loan ...................................................................112
Unsecured Loans...........................................................................114
Alternative Financing ..................................................................114

Pledged Savings Account Mortgage ..........................................115
Graduated Payment Mortgage ..................................................115
Shared Appreciation Mortgage .................................................116
Rollover Mortgage .....................................................................116
Reverse Annuity Mortgage ........................................................116
Contract of Sale..........................................................................117
Chapter Summary .........................................................................117
Chapter Quiz...................................................................................118
Chapter Five: Trust Deeds and Mortgages........121

Introduction ...................................................................................121
Trust Deed.......................................................................................122
Features of a Trust Deed .............................................................125
Trust Deed: Foreclosures............................................................128

Process of a Trustees Sale ........................................................128
Judicial Foreclosure ..................................................................134
Trust Deed: Benefits.....................................................................135
Mortgages........................................................................................135
Mortgage Features ........................................................................137
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Mortgage Foreclosures ................................................................140
Non-Judicial Foreclosure ..........................................................140
Judicial Foreclosure ..................................................................141
Chapter Summary .........................................................................145
Chapter Quiz...................................................................................146
Chapter Six: Mortgage Lenders ...........................149
Introduction ...................................................................................149
Institutional Lenders ...................................................................150

Commercial Banks.....................................................................150
Thrifts ........................................................................................151
Savings and Loan Associations .................................................151
Non-Institutional Lenders..........................................................161
Mortgage Bankers and Brokers.................................................161
Private Money Investment ........................................................164
Non-Financial Institutions........................................................165
Chapter Summary .........................................................................165
Chapter Quiz...................................................................................168
Chapter Seven: The Mortgage Market ...............172

Introduction ...................................................................................172
The Federal Reserve Banking System (The Fed....................175

Primary Tools of the Fed ...........................................................176
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History of the Fed ......................................................................176
Structure of the Fed ...................................................................183
Furnishing Financial Service.....................................................186
The Mortgage Market...................................................................187

Primary Mortgage Market .........................................................187
Secondary Mortgage Market .....................................................188
Ancillary Services ......................................................................194
Real Property Loan Law ..............................................................196
Personal Property Secured Transactions...............................197
Chapter Summary .........................................................................198
Chapter Quiz...................................................................................200
Chapter Eight: Mortgage Insurance and

Governments Role in Finance.............................203
Introduction ...................................................................................203
Mortgage Default Insurance ......................................................203
Government Insurance................................................................204
Federal Housing Administration (FHA .................................... 205
Veterans Administration ...........................................................207
California Veterans Loans (CAL-VET .......................................211
Private Mortgage Insurance (PMI ............................................215

Benefits of PMI ..........................................................................215
New PMI Requirements ............................................................216
A Change in PMI Requirements................................................216
The Homeowners Protection of Act (HPA) of 1998..................216
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Cancelling or Terminating PMI.................................................217
Disclosures Required by the HPA .............................................218
Effect of Increases in Home Value ............................................220
Chapter Summary .........................................................................221
Chapter Quiz...................................................................................223
Chapter Nine: Real Estate as an Investment....226

Introduction ...................................................................................226
Reasons for Investing in Real Estate .......................................227

Types of ROI ..............................................................................228
The Investment Process ..............................................................235
Steps of Successful Investment .................................................235

Securing the Funds....................................................................240
Prioritize and Set Preferences ...................................................242
Steps of a Successful Purchase ..................................................258
Real Estate Analysis Tools ..........................................................259

Investment Tools .......................................................................259
Development Cycle in Practice..................................................273
Real Estate Investment Tactics .................................................274
Purchase Options.......................................................................288
Chapter Summary .........................................................................292
Chapter Quiz...................................................................................295
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Chapter Ten: Shopping for a Lender..................299
Introduction ...................................................................................299
Choosing a Lender ........................................................................300
How Loans are Originated..........................................................303

Retail Loan Origination.............................................................303
Borrowers Expectations.............................................................305
Wholesale Loan Origination......................................................305
Wholesale Lending as a Solution..............................................308
Chapter Summary .........................................................................309
Chapter Quiz...................................................................................311
Chapter Eleven: Appraisal ....................................315
Introduction ...................................................................................315
Definition of Appraisal ................................................................316

Fair Market Value......................................................................317
Defining the Price, Cost and Value............................................318
Four Elements of Value .............................................................319
Forces and Factors Influencing Value.......................................320
Basic Principles for Estimating Value .......................................323
The Appraisal Process..................................................................326

Three Approaches for Appraising Properties ...........................335
The Appraisal Report ................................................................349
Appraisal Licensing Standards..................................................350
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Chapter Summary .........................................................................351
Chapter Quiz...................................................................................354
Chapter Twelve: Processing Loans .....................358
Introduction ...................................................................................358
Loan Process Overview................................................................358

The Loan Procedure ..................................................................360
Loan Application Package .........................................................362
Steps for Obtaining a Real Estate Loan...................................364

Application.................................................................................365
Required Disclosures Upon a Loan

Application (RESPA) ....................................................................368
Special Information Booklet .....................................................369
Good Faith Estimate (GFE ........................................................370
Mortgage Servicing Disclosure Statement ................................370
Affiliated Business Arrangement (AfBA) Disclosure ................371
Truth in Lending Act .................................................................372
Annual Percentage Rate (APR) .................................................373
Loan Processing.........................................................................374
Underwriting .............................................................................375
FICO...........................................................................................377
Chapter Summary .........................................................................382
Chapter Quiz...................................................................................386
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Chapter Thirteen: Loan Underwriting and
Closing ........................................................................389
Introduction ...................................................................................389
Risk Analysis ..................................................................................389
Underwriting Guidelines ............................................................390

Loan-to-Value Ratio ..................................................................390
Loan Amount .............................................................................391
Down Payment ..........................................................................391
Income Ratio .............................................................................392
Employment ..............................................................................392
Credit History ............................................................................393
Appraisal....................................................................................394
Federal and State Disclosures and Notice of Rights ............395

Disclosures at Settlement/Closing ............................................395
Disclosures After Settlement .....................................................396
Loan Closing ..............................................................................397
Chapter Summary .........................................................................397
Chapter Quiz...................................................................................399
Chapter Fourteen: Loan Servicing......................403

Introduction ...................................................................................403
Mortgage Servicer .........................................................................403

Roles and Responsibilities ........................................................403
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Consumer Checklist......................................................................413
Chapter Summary .........................................................................414
Chapter Quiz...................................................................................416
Chapter Fifteen: Consumer Protection

Measures....................................................................420
Introduction ...................................................................................420
What Creditors Look For ............................................................421

Capacity .....................................................................................421
Character ...................................................................................421
Collateral....................................................................................421
Information Not for Use By Creditors ......................................422
Special Rules..............................................................................423
Denial of Credit Applications.....................................................428

Building a Good Credit History.................................................428
Maintaining Complete Records.................................................429
Negative Information ................................................................430
Outdated Information ...............................................................430
Filing a Complaint with Federal Agencies ................................431
Federal Consumer Protection Laws.........................................432
Equal Credit Opportunity Act (ECOA .......................................432
Remedies for Discrimination ....................................................434
Equal Credit Employment Act Regulation B .........................437
Real Estate Settlement Procedures Act (RESPA) ..................... 437
Truth in Lending Act (TILA ......................................................441
Home Mortgages ...........................................................................443

Disclosures.................................................................................444
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Home Ownership and Equity Protection Act (HOEPA ............445
State Laws .......................................................................................459
Chapter Summary .........................................................................460
Chapter Quiz...................................................................................462
Glossary......................................................................466
Index ...........................................................................505
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CHAPTER ONE
HISTORY OF FINANCE AND LENDING
INTRODUCTION
In almost all real estate transactions some kind of financing is involved. It
is very important for the developer, the contractor, the real estate broker,
and the property manager to understand the process of financing the
transfer of real estate, without which they may find themselves jobless. The
majority of sellers would be unable to sell, as most buyers would financially
not be in a position to pay cash, or could not borrow a large chunk of the
purchase price.
Known sources of funds comprise lending institutions such as thrifts,

commercial banks, and insurance companies. Other dependable sources are
non-institutional lenders, such as mortgage bankers, mortgage brokers,
private individuals, pension funds, mortgage trusts, and investment trusts.
Both the real estate licensee as well as the consumer must keep a watchful
eye on the changing credit sources and mortgage methods to stay
competitive in the business of real estate.
In the past century, lending institutions were under perpetual pressure to

adjust to the changing needs of consumers. As the economy swung and
stalled, mortgage lenders had to remain ever alert to the needs of the
people, if they wanted to survive. Due to the changes in the economy and
the special demands put upon the banking industry, alterations were made
in the lending practices. Thus, as the 20th century came to an end, drift and
gridlock were replaced with renewal and reform.
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Events of the 20th Century which influenced the Real Estate
and Lending Industry
- The Great Depression

- Increased demand for housing after World War II
- Energy crisis
- Growth in technologies
- Economic stress worldwide
- Capital shortfalls
- Growth in inflation with erratic drift in interest rates
- High levels of unemployment
- Tight money and credit for the private sector
- Increasing deficit spending and borrowing by the government
- Social spending
- OPEC
- Depression in major industries
- Savings and loan scandals
THE BEGINNING
Mortgage lending was complicated from the start. Problems that were
present between lenders and borrowers many centuries ago still exist today
in some form or the other. Gaining an understanding of the history of
borrowing and lending will help us to know the rich bequest we have
inherited and also shed light on how mortgage lending works these days.
EARLY LENDING PRACTICES
In ancient times, as it is today, wealth was measured by the possession of

land. Societies thrived and progressed due to the cultivation and
development of the land. In these early times, when individual wealth
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became obvious due to the growth of private ownership of land, a need
arose for laws that would regulate the ownership of real property and the
rights of landowners.
In some places, the main reason for the growth of governments and laws
was the desire to acquire land, how to use that land, and the necessity to
develop laws that would provide legitimacy to the transfer of land from one
entity to another. Agriculture was the basis of most cultures, as the land
was of immense value and began to be used as security for debts. Such early
mortgage borrowing transactions have been known to exist in the Middle
East (Iraq), Egypt, and in ancient Greece.
Mortgage Lending, Roman Era

In the times of the Roman Empire, i.e., from 753 B.C. to 476 A.D., the
owners of real property were permitted to participate in a highly developed
mortgage lending system. In those days, when money was borrowed by a
landowner, his property was transferred to the lender with an
understanding that the property would be re-conveyed once the borrower
repaid the debt. It is done in a similar way today, just that the laws now are
more defined and useful to the citizens. The old practices that in due course
became part of the law was quite similar to our current system. The lender
had the authority to foreclose or take ownership of the property being
used as a security if the borrower failed to repay the debt, but title and
possession remained with the borrower during the term of the loan.
After the fall of Rome in 476 A.D., the system of lending that was
dependent on strong government-enforced effective laws was not appealing
any more. The lenders were now unsure that the weakened central
authority would be able to charge unwilling borrowers with repayment of
their debts. Thus, mortgage lending lost some of its popularity.
Mortgage Lending, German Era

As the Roman authority was declining, the influence of German customs
ascended. The concept of gage -- a deposit made in assurance of the
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fulfillment of an agreement -- came to be accepted by the German law. A
borrower could offer an item of personal property as collateral for a loan, as
a live gage. On defaulting by the borrower, the lender kept the item. When
real property was kept as security for the loan (known as a dead gage), the
borrower kept the possession of the property until he did not default, after
which time the lender took over ownership of the property.
Mortgage Lending, English Era

It was the French who spread the use of the gage system in England. This
was after 1066 when England was invaded by William the Conqueror. The
French used mort (French for dead) gage, when real property was used
as collateral for a loan, or as a dead gage. The word mortgage was born.
At one point in time, in England and most of Europe, mortgage lending had
come to a standstill due to societys feudal nature. In those days, since the
king had control over all the property and possession rights were given to
the citizens in exchange for loyalty and military service to the king, the use
of property as security for a debt was not imaginable then. The property
was nevertheless used to secure the military obligation as demanded by the
king. Failure to perform this duty could lead the hesitant warrior to lose his
land. That land was then given to a more loyal citizen of the king.
During the ascension of the common law, and while the medieval society in
England was changing, mortgage lending was uncommon. This was so
because, before the serial husband Henry VIII changed the state religion in
the mid-16th Century, the Catholic Church proclaimed that charging interest
for loaning money was immoral, and thus illegal. This prohibition of
interest was based on the notion that it was natural law and also the events
in society or nature which appeared to be natural. Back then, agriculture
was considered to be natural so as to produce food for the people and
animals reproduced naturally. Money could not reproduce naturally and
therefore interest charging was considered to be unnatural and immoral.
Obviously, as there was no profit to be earned, the money remained in the
purses of would-be lenders.
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However, it was specified in the law that if the lender suffered harm for
making the loan, then charging interest could be defended. Harm could
also mean lost opportunity, thus allowing medieval lenders to make loans,
not for interest, rather for the right to possess and obtain the advantage of
ownership, if the borrower defaulted.
The procedure for borrowing money was like this: the lender would take
possession and title to a particular portion of the land belonging to the
borrower. The lender would be entitled to the entire rent and profits till the
time the debt was repaid. In case the balance debt was not repaid, the
lender would keep the title and possession of the property for good while
the borrower still owed the money.
Towards the end of the 16th Century in England when Elizabeth I ruled,
common law came to protect the rights of the citizens. The entire estates of
these people were detained by lenders upon non-repayment of debt for
which real property was kept as security. It was ruled by the courts then,
that taking possession of the entire property -- the value of which was far
more than the loan amount owed -- was unjust. The court now allowed the
borrowers to regain their property once the debt was repaid. The
borrowers right to regain his property after default was known as the
equitable right of redemption.
This concept of the medieval custom of equity of redemption is retained

today by all American states. Defaulting borrowers in this country are
allowed to reinstate a loan by clearing all delinquent payments, taxes, and
other fees by the time of the sale. According to some individual states law,
the borrower may pay off all delinquent payments in a predetermined time
frame and regain the ownership of the property even after the foreclosure
sale.
As the law become more lenient towards borrowers, allowing them to repay
their loan and redeem the property even after the debt became payable in
full or delinquent, mortgage lending almost came to a complete halt. In this
scenario, the lender was unaware as to when the borrower might repay the
debt and regain the property, which was until now in use and under
possession of the lender. Nonetheless, the lender could ask the court to set
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a certain time limit for the borrower, in which period the loan must be
repaid or the borrower would lose the right to redeem the property forever.
Mortgage Lending, United States

When the daring immigrants formed a new society out of the wilderness in
the 1690, known as the Massachusetts Bay Colony, there was a necessity to
set up a system that would sustain economic governance and growth.
Money in those days consisted of gold and silver coins from Spain, England
and other countries. The method of most economic exchanges was by way
of cash or barter system. Hardly any financing of real estate was done
during that period. In fact, there was no need for any mortgage loans in the
new country as most of the citizens were living on farms inherited from
their families.
In 1781, during the Revolutionary War, the Bank of North America was
chartered in Philadelphia by the Continental Congress. This was the first
commercial bank of the country which was chartered to support the war.
During this period the Congress adopted the dollar as the countrys
currency unit.
After the end of the Revolutionary War, the leaders of the new nation had a
voluminous task of nation building that would enhance economic growth
and also provide political and social stability. In 1789, Congress set up the
First Bank of the United States that approved the issuance of money. The
money was then called paper bank notes. The First Bank of the United
States also fulfilled its duties as the U.S. Treasurys fiscal agent and
performed the first central bank functions in the United States.
In the following years, banking in America was in a mess as the state-

chartered banks were each printing their own money of different shapes,
sizes and designs. As there was no federal oversight, the notes of the same
denomination had different values according to the backing of the currency
and the state where it was issued. In the absence of strictly-governed
federal and state banking laws, almost anyone was allowed to issue paper
notes from states to private banks to railroads to stores and even
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individuals. In those days, mortgage lending was very rare, and loans were
only made by individuals, not by financial institutions.
It was not possible for the mortgage lending business to become a vital part
of the economy until and unless people had sufficient money to deposit in
institutions as savings. Even back then, as currently, the lending business
depended on utilizing customers savings for making real estate loans. Up
until the first half of the 19th Century, most people were still living on farms
and had very little cash flow. People who were living in the cities and did
have disposable income were also not in the habit of saving money.
As the population moved West after the Civil War, agriculture was still the
major source of livelihood. However, now the people needed financing for
buying new farms for settling down in the distant areas of the country.
Thus, the farm mortgage business started to evolve.
This was the period when the mortgage companies that made real estate
loans to farmers immediately sold the loans to rich investors or institutions
such as insurance companies. In this time, a huge number of loans were
made by mortgage companies and thus began a business which led the
American economy into the 20th and 21st Centuries.
Mortgage companies started to give out loans to a few single-family home

owners by 1900. For lending institutions, these types of loans made a small
part of their business but as people started moving towards the cities and
earned more money for buying homes, residential lending grew in volume.
There is a reduced risk for lenders when the loans are made on a basis of a
particular acceptable ratio of the loan to the value of the property. Also, for
minimizing the loss of investment, the lender should be able to acquire
possession of the property (in a set time frame) that is used as collateral.
In the beginning, lenders were not sure as to what would form a risk for
them or their investors as the business was relatively new without a history;
therefore the loan-to-value ratio was kept at around 50%. For instance, if
the value of the home was $20,000, the loan would be for $10,000. The
interest-only payments were payable twice a year, while the original
borrowed amount would become due in three to five years. The fee of the
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lender originating the loan would be between one to three points (one point
= 1%) of the borrowed amount. It would hardly be possible for the borrower
to pay the balance loan amount by the due date, but it was possible to
renew the loan by paying a 1% renewal fee.
During the 20th Century, lending institutions increased their lending

capacities thus developing new lending markets. Thrift institutions such as
saving banks, savings and loans companies began spreading across the
country and towards the west, where the population was directed.
THE GREAT DEPRESSION

In the decade starting in 1920, there was an impetuous fervor and a
widespread expectation that this was a lasting period of good times. Growth
and prosperity led everyone to believe that the soaring economy was here to
stay. Optimists of those times may be pardoned as they did not have the
support of history to guide them when making loans on properties that had
appreciated 25% to 50% per annum. Mortgage bankers were not guided by
the principle of maintaining their underwriting or loan approval standards
and that they must not over-appraise properties on the basis of their rapid
appreciation and inflation. The notion was that prices would keep going up
and protect against risky loans.
The lenders of the 1920s were the first of many who were stranded holding
loans on properties which, when the boom times ended, experienced drastic
drops in value greater than the amount loaned against them. History
repeated itself through the 20 th Century when booms ended in crashes.
Even then, as it is today, those in the real estate market were the first to
realize that the economy was failing. There was a drastic fall in the property
values by 1927 and by 1929 the real estate market was at its all-time low.
Soon the whole nation was facing a major economic downfall leading to the
Great Depression. The crash of the stock market and general financial
impotency plunged America into its worst economic crisis ever.
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Mortgage lenders were facing several predicaments. Due to epidemic
unemployment, they were unable to obtain their quarterly or bi-annual
interest payments on their mortgage loans from borrowers. It took 3-6
months for the lenders to realize that the mortgages were in trouble. By
then, the lender would already be in serious trouble as there was no cash
flow since no one was paying back the loan installments. The institutional
lenders had one option left, to sell their real estate and mortgage holdings
at compromised prices and bear huge losses.
Property owners lost their properties to foreclosures as they were neither

able to make the necessary payments nor refinance after their 5-year loans
became payable. Foreclosing on the borrowers was not meanness by the
lenders but a matter of survival for them just as it was for the borrowers.
The only two possibilities were to either pay off the loan or give their
property to the bank so the bank would sell it and get the cash. The
unavoidable mortgage defaults occurred at an alarming speed, causing the
real estate market to decline immensely by 1935.
The customers no longer trusted the financial institutions, and started to

withdraw their money deposits from the banks causing a failure of many
types of financial institutions. This outflow of money from banks, called
disintermediation, and the rampant foreclosures further worsened the cash
flow issue for the mortgage lenders. This led the mortgage lenders to
forsake the customers they had and shut down their businesses.
The Midwest, which has dry prairies and poor weather conditions, was the
worst hit by this economic crisis, where a large number of the people lost
their farms or homes to foreclosure. With an increase in the number of
defaults, it became all the more necessary to bring a moratorium on
foreclosures.
Some of the lenders also offered forbearance by not demanding the

mortgage payments from the borrowers for as long as two years. More than
26 states had passed legislation declaring a moratorium on most
foreclosures by 1933.
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The moratoria did bring some relief for families that were worried about
losing their homes, while the federal government started the process of
bringing the economy back on track.
RECOVERING FROM THE DEPRESSION
By early 1930 the economic crash had become the Great Depression, and
the federal government realized the need for a legislation that would help
stabilize and rebuild the real estate market. With the desire of reversing the
negative loan and default cycle and boosting the sluggish economy the
federal government created the conforming and central lending programs.
The government was hopeful that with the recovery of the real estate
market, the general economy would also revive. That is exactly what
happened then and continued to happen in a similar fashion every time a
recession occurred throughout the 20th Century.
Commercial banks were the first institutions that benefitted from the
federal interest in lending. In 1932, the Reconstruction Finance
Corporation (RFC) was formed. These institutions provided liquidity to
commercial banks and brought them back in business by making loans
once again.
The Federal Home Loan Bank (FHLB) was the second program that was
introduced by the federal government. The FHLB set up a central credit
authority for home financing and its main function was to serve savings and
loan institutions.
Then in 1933 came the Home Owners Loan Act (HOLA). Federal charters
were given to savings and loans, while the Home Owners Loan Corporation
(HOLC) was formed to offer refinancing or purchasing for the defaulted
mortgages of families in financial crisis.
The creation of the Federal Housing Authority was done in 1934; its
purpose was to develop the foundation for a national mortgage market. The
FHA is widely recognized for insuring the first long-term, fully-amortized
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mortgages. The Federal Savings and Loan Insurance Corporation (FSLIC)
and the Federal Deposit Insurance Corporation (FDIC) were also
established during this period. This aim of these institutions was to
encourage savers to start depositing their savings in the banks again.
ECONOMIC GROWTH
At the time of the Great Depression and until World War II ended, people
used to build their own homes, inherited them, or rented them. Up to then,
homes for families were not available on a large scale, but as five million
soldiers returned from the war, there arose a great need for housing. The
federal government passed the Servicemens Readjustment Act in 1944, to
meet this particular requirement. This Act permitted former servicemen
and women to purchase homes without any down payments and also
provided a government guaranty for financing the loan amount.
From 1945 to 1955 there was a tremendous demand for housing, leading to
the biggest increase in home building in Americas history. Mortgage
lending now started to flourish because of the availability of long-term
loans, restored cash flow of mortgage lenders, realistic housing plans of the
government, and the growing demand for housing. The legislators made a
national promise that every possible step would be taken to ensure that
each American should own a home. Large numbers of homes were built by
developers and people could buy them easily for the first time in Americas
history.
FEDERAL GOVERNMENT S ROLE IN REAL ESTATE

FINANCE
In 1965, the Department of Housing and Urban Development (HUD) was

formed by combining various federal housing authorities. Regulating real
estate and mortgage lending was one of the main roles that the HUD was to
perform. In the following years, the mortgage lending regulations and the
25
new legislation made the federal government realize that the growth and
prosperity of the country was dependent on the growth and prosperity of
the real estate and lending business.
The federal government took a very important step towards regulating the
real estate and mortgage market by passing the Housing and Urban
Development Act in 1968. The federal government held the right of
subsidizing interest rates. This new approach of the federal government did
become a cause for apprehension about the fiscal and political impact of
such an obligation.
Two federal agencies were formed to engage in real estate financing: The
Federal Housing Administration (FHA) and the Veterans Administration
(VA). These agencies supported people in buying homes they would never
be able to buy without government intervention. The involvement of
government in finance programs and the economic growth encouraged
builders and developers to remain upbeat.
As the Constitution promises equality and fairness to all Americans, and as

citizens expect protection, the federal government has been considerate
about the interests of the consumers in regard to real estate financing. First
of the numerous laws that set new guidelines for residential lending was the
Consumer Protection Act of 1968. To safeguard consumers against fraud,
legislation that requires certain disclosures at crucial stages of a loan has
been passed since the Consumer Protection Act was enacted.
Most citizens have been in a position to buy a home due to the legislative
actions of the federal government. The possibility of getting credit and loan
facilities has fulfilled many average income families dream of becoming a
homeowner. The federal laws that have affected mortgage lending in the
20th Century are listed below:
MORTGAGE LENDING LAWS
Federal Reserve Act of 1913
26
This act set up the Federal Reserve System and gave authority to federally-
chartered commercial banks to make real estate loans.
Federal Farm Loan Act of 1916

This act supported in forming the Federal Land Bank Associations as units
of the Federal land Bank System, which had the authority of selling bonds
and generating funds for loans to farmers.
Reconstruction Finance Act of 1932

This act created the Reconstruction Finance Corporation, with providing
liquidity to commercial banks its primary aim.
Federal Home Loan Bank Act of 1932

This act set up the Federal Home Loan Bank Board and 12 regional banks
that were to furnish central credit facilities for home finance institutions
(which were members of the FHLB).
Home Owners Loan Act of 1932

There were two outcomes that originated from this act: (a) Creation of the
Home Owners Loan Corporation with authority to buy defaulted home
mortgages and to refinance as many as judiciously viable, and (b) Giving
lending authority for federally-chartered savings and loan associations.
National Housing Act of 1934

This act gave authority for the creation of the Federal Housing
Administration and Federal Savings and Loan Insurance Corporation.
National Mortgage Association of Washington of 1938

This was a government agency later renamed the Federal National
Mortgage Association. This association had the authority to provide
secondary mortgage market support for FHA mortgages.
Servicemens Readjustment Act of 1944

This act was set up within the Veterans Administration as a mortgage
guarantee program for veterans who qualified for it.
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Housing Act of 1949
It was stated in this act that it was the national housing goal to provide a
decent home and suitable living environment for every American family. It
also reinforced past lending programs of the Farmers Home
Administration.
Consolidated Farmers Home Administration of 1961

This office gave authority to the agency to make mortgage loans to non-
farmers in rural areas.
Housing and Urban Development Act of 1965

This act amalgamated several federal housing agencies into a new
Department of Housing and Urban Development with increased authority.
Interest Rate Adjustment Act of 1966

This act authorized the fixing of maximum savings rates and the formation
of a differential between the savings rates of commercial banks and thrift
institutions.
Fair Housing Act of 1968

This act forbade discrimination based on race, color, religion, and national
origin in real estate sales and mortgage lending.
Interstate Land Sales Full Disclosure Act of 1968

This act provided for the full and complete disclosure of all facts in regards
to interstate sale of real estate.
Consumer Credit Protection Act of 1968

The Truth in Lending (Title I) authorized the Federal Reserve Board to
frame regulations (Reg Z) that required advanced disclosure of the type of
finance charges, their amounts and also an estimate of the annual
percentage rate.
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Housing and Urban Development Act of 1968
Through this act, the current Federal National Mortgage Association
(FNMA) was shifted under private management and given the authority to
continue to support secondary mortgage market. A new government agency
was created by this act, the Government National Mortgage Association
(GNMA), and given the authority to continue to assist the FNMA and
guarantee mortgage-backed securities.
National Environmental Policy Act of 1969

This act needed an Environmental Impact Statement to be prepared for the
council on Environmental Quality so as to determine the impact of the real
estate development on the environment.
Emergency Home Finance Act of 1970

This act formed the Federal Home Loan Mortgage Corporation (FHLMC)
with the intention of providing secondary mortgage assistance for
conventional mortgages made by thrift institutions. Through this act,
Fannie Mae was given authority for purchasing conventional mortgages.
Flood Disaster Protection Act of 1974

This act, effective in 1975, disallowed making mortgage loans in a flood
hazard area if flood insurance had not been purchased.
Real Estate Settlement Procedures Act of 1974

This act and the amendments in it, needed mortgage lenders to give the
mortgage borrowers an advance disclosure of loan settlement charges and
costs. It even prohibited any illegal payments to anyone for referring
business. An amendment to this act was made in 1976 that required lenders
to furnish the applicants with a Good Faith Estimate of Settlement Costs
and a HUD booklet. Before or at the time of the settlement, a Uniform
Settlement Statement (HUD-I) needs to be provided to the borrower. An
amendment in 1993 permitted RESPA to supplement financing.
29
Home Mortgage Disclosure Act (HMDA) of 1975
This act and the amendments in it, required most mortgage lenders to
disclose their geographic distribution of loans in a metropolitan statistical
area. The idea was to confirm the lending patterns of the lenders.
Fair Lending Practices Regulations of 1978

As per the FHLB regulations, members were required to develop written
underwriting standards, maintain a loan registry, furnish loans in spite of
the age of the home or condition of the neighborhood, and advertise in all
segments of the community.
Community Reinvestment Act of 1978

As per this act the FSLIC-insured institutions had to endorse a community
reinvestment statement, which would depict the community in which they
intend to invest; post a CRA notice; and keep a public comment file.
Housing and Community Development Amendments of 1979

This amendment exempted FHA-insured mortgages from the usury ceilings
by the state and the county.
Depository Institutions Deregulation and Monetary Control Act

of 1980
Through this act, Congress prolonged the savings interest rate control and
one quarter of 1% differential of thrift institutions for six years. This act also
prolonged the federal ban of state usury ceilings on some mortgages. This
act also simplified the truth-in-lending standards and eased lending
restrictions which included geographical limitations, loan-to-value ratios,
and treatment of one-family loans over specified dollar amounts.
Omnibus Reconciliation Act of 1980
30
This act put a limit on the issuance of tax-exempt housing mortgage
revenue bonds.
Garn-St. Germain Depository Institutions Act of 1982

This act assumed state due-on-sale loan restrictions, validated the phasing
out of interest rate differential by January 1, 1984, arranged FSLIC and
FDIC assistance for institutions with inadequate net worth, and permitted
saving and loans to make consumer, commercial, and agricultural loans.
Deficit Reduction Act of 1984

This act prolonged the tax exemption for qualified mortgage subsidy bonds
and also made new reporting processes for mortgage interest.
Tax Reform Act of 1986

This act brought down the top corporate tax rate from 46% to 34%, brought
down the taxable income bad debt deduction from 40% to 8%, provided for
3-year carry-backs, and 15-year carry-forwards for net operating losses of
savings institutions.
Competitive Equality Banking Act of 1987

This act gave a start to the FSLIC $10.8 billion recapitalization program,
savings Bank Life Insurance was kept intact, and flexibility was given to
thrifts for creating different types of holding companies.
Housing and Community Development Act of 1987

This act required a notice of availability of counseling to be given within 45
days of default on single-family primary residence.
Financial Institutions Reform, Recovery, and Enforcement Act

(FIRREA) of 1989
This act refurbished the regulatory framework by retiring the FHLBB and
FSLIC; formed the Office of Thrift Supervision (OTS) under the Treasury
31
Department; strengthened the FDIC to supervise the safety and stability of
financial institutions, the Savings Institutions Insurance Fund, and the
Bank Insurance Fund; formed the Resolution Trust Corporation (RTC) to
sell off failed savings and loans; and set up new capital standards for thrifts.
RESPA Amendment of 1992

Through this amendment RESPA coverage was extended to subordinate
financing.
HMDA Amendment of 1992

This amendment required the mortgage companies and other non-
depository institutions to abide by the HMDA.
The last 30 odd years of the 20th Century was a golden period for real estate
construction and financing when more people benefited than ever before.
LAST 20 YEARS OF THE 20TH CENTURY

The 1980s was a period of economic upheaval for the United States. The
economy was in a disastrous condition with a major recession, inflation at a
sky-high level, and a stock market crash that was actually worse than 1929.
The savings and loan industry was facing ruin before the taxpayers came to
its rescue. Aside from this, on a positive note, the Dow Jones average hit a
record high, more and more mortgage-backed securities were being used,
along with different kinds of mortgage instruments, and more sources of
required mortgage money were now available. It was a difficult phase for
the economy but brought about many changes that were required. Due to
the changes made, the mortgage lending market and the mortgage lenders
responded more responsibly towards the needs of the borrowers.
The 1980s
32
Up until the 80s, the Federal Reserve was managing and regulating the
rates of interest and the money supply in an effort to control the inflation.
But by 1979, the Fed stopped regulating short-term interest rates and
attempted to check the uncontrollable growth in the money supply that was
the cause of inflation.
The idea was to put a limit on the amount of money in circulation thus
bringing down inflation and curbing the interest rates from going up. When
interest rates were raised by the Fed, money became expensive to borrow,
leading people to borrow less. As fewer funds were borrowed, there was less
money for spending. More money was required to buy less, this being the
outcome of inflation.
After rising suddenly, interest rates did go down ultimately; this was the
result of the change in policy by the Fed. In 1981, the prime rate, i.e. the
short-term rate that a bank charges to its most creditworthy customers,
increased to 21.5% which resulted in a bottleneck situation in banking and
especially the mortgage lending business. Very few people were now
applying for loans or thought of buying homes because they could not
qualify for home loans whose interest rates became as high as 17.5%.
Mortgage money became deficient and expensive because of high interest
rates, tight money, and stringent credit underwriting. Due to this situation
the real estate and building industry started to decline and became a cause
for the recession for the entire nation, with unemployment was now at
almost 10%.
Eventually, by mid-decade, inflation came under control, interest rates

started going down, and the nation once again became positive about the
economy. Developers started building homes and it was now possible for
families to buy them.
In 1987, the stock market escalated to an all-time high, but eventually its
radically faulty over-valuation of stock became reason for a disastrous
collapse that sent shock waves in the entire investor world. The combined
effect of a huge federal deficit during the last years of the decade and the
declining stock market was difficult for the recovering economy to
33
withstand. By the early 1990, the probability of a dismal recession was
again in the way of families wanting to buy homes.
Decline of Savings and Loans
For years, some savings and loans institutions were operating under a guise
of assumed integrity and restraint, hoping to disguise their deceitful
business dealings. Negative earnings, low capital, presumptive lending, and
poor management all were responsible for the failure of many saving and
loan associations and the bankruptcy of the Federal Savings and Loan
Insurance Corporation (FSLIC) which was the deposit insurance fund for
savings and loan associations.
Due to the skeptical business practices of the savings and loans

associations, the savings of individuals were sometimes used unwisely and
at other times unethically and deceitfully. The entire economy was in
danger because of the failure of the FSLIC, as many other businesses were
also involved in the complicated net of treason and fraud. People lost not
only their money but also their faith in the banking system.
As hundreds of savings and loans closed, the federal government attempted

to rescue the ailing banks by selling bonds to finance the bailout. In the
1989 legislation, the Financial Institutions Reform, Recovery, and
Enforcement Act (FIRREA) were given the authority for the bailout.
The 1990s
The economic scene in the 1990s was dominated by the profits that were
made via initial public offerings (IPOs), producing inconceivable wealth for
the ones who were able to influence the buying and selling. A sensational
rise in mutual funds, stock options and some brilliant investment plans all
led to the prosperity of individuals.
Now, we are in a position of making a more realistic evaluation of the

business cycle of the 1990s, i.e. the lethargic recovery at the start of the
decade, the stupendous technology boom, and the collapse of that boom
34
that led to the 2001 downturn. There was more to the decade than the
symbolic belief held about the star status of upper management of big
corporations and the mentality of newly rich stock holders that the profits
will never end.
A surprising and overlooked trend was taking place in this decade: there
was a significantly high rise in productivity as compared to the previous
decade or any time frame before that. It is remarkable that in the end, it
was the workers who gained more from the additional production and not
the investors. The perseverance of hard-working individuals predominated
long after the end of a brilliant but short period that made millionaires out
of some lucky investors.
Most of the American workers, especially in the less-paying, less-skillful

occupations, benefitted from the sensational wage growth during the 1990s.
As there was very low unemployment, most people had jobs with good
salaries. The 1990s proved to be the greatest period of wage growth at all
levels for top executives to lowest paid workers in the last 30 years.
There were many reasons why individuals were being paid more and were
getting better jobs. More opportunities in the educational field were
responsible for people acquiring new jobs in the technological field. Wages
were higher as unemployment was falling. New jobs were being created as
motivated investors were eager to provide financing for training and
devices for boosting productivity.
As the decade was coming to an end, a big percentage of corporate earnings

were being taken up by the labor costs. Even as the profits were growing
gradually, workers were becoming used to the prosperity and demanded
their fair share of the corporate pie.
At the start of the decade, it seemed as if the corporations, instead of the

workers were going to dominate in the productivity-labor costs conflict. As
the profits were rising, the wages were slowly but surely catching up behind
the corporate earnings. However, increase in salaries have generally been
behind productivity gains by some years. As the decade was going by,
35
compensation per hour and the benefits along with it, soared to surprising
levels.
The workers paychecks briskly made up for the slow-paced growth in the
early part of 1990s. As the 20th Century came to an end and the 21st Century
began, those individuals who had jobs that required less skill in a varied
range of occupations were prospering in a worker-dominated economy.
The newly acquired financial independence and the prosperity of workers

during the last part of the 20th Century led many a families to live their once
-impossible dream of owning their own home. This was indeed very good
for the growth of the real estate industry.
ADVENT OF THE 21ST CENTURY

American consumers continued their spending and borrowing spree even
as the economy was sinking into a recession in 2001. The economists were
worried that the consumers would not be able to recover from their debts.
As the country was plunging into recession, the citizens were in a happy
financial condition, particularly as compared with the other large
industrialized countries. On the basis of the latest available statistics across
countries (taken in year 2000), the financial net worth of all U.S.
households was 365% of total disposable personal income. In the Group of
Seven major economies, this was the highest ratio.
Due to this high level of financial net worth, comprising of stocks, bonds,
and bank accounts (except real estate), it was difficult to realize the tension
of the recession on the U.S. The new statistics from the Federal Reserve
revealed a drop of 8% in the financial net worth in 2001. This was again not
enough to arrive at a conclusion regarding the health of American economy.
Compared to other countries, the American consumers are not so debt-

laden. Compared to other advanced nations, Americans ratio of liabilities to
disposable income was third-lowest. (The prudent Japanese and Germans
had the highest liabilities ratio.) In terms of assets, Americans did benefit
36
from the long bull market, in spite of the tribulations of the last few years
and as opposed to the bear market destruction of half of Japanese
households net worth.
CHAPTER SUMMARY
Financing is required for almost every kind of real estate transaction.

Without it, real estate sales would not take place since most people
cannot pay for property in cash or borrow a large portion of the
purchase price.
Some familiar sources of funds including lending institutions such as

thrifts, commercial banks, and insurance companies, along with non-
institutional lenders, such as mortgage bankers, mortgage brokers,
private individuals, pension funds, mortgage trusts, and investment
trusts.
Early lending customs evolved throughout eras influenced by Roman,

German, and English financial practices. As the United States grew,
its financial institutions adapted to the changing needs of its citizens
moving from a strictly farm-based economy to a more diverse, urban
society.
Lenders in the 1920s were stuck holding loans on properties with

huge declines in value greater than the amount loaned against them.
The drastic fall in property values contributed to the stock market
crash in in 1929, plunging the nation into the major economic
downfall known as the Great Depression.
After World War II, the return of millions of soldiers to the civilian
workforce led to the largest increase in home building in American
history. The government set up new federal agencies, including the
Federal Housing Administration (FHA) and the Veterans
Administration (VA), to foster lending to the returning veterans.
37
Boom-bust-boom cycles have repeated themselves throughout the
end of the last century and the beginning of this one.
CHAPTER QUIZ
1. The word mortgage has its roots in French, but the nation where the
modern concept of mortgage loans first took hold was:
a) Rome
b) Germany
c) England
d) U.S.
2. In Elizabethan England, the right of the borrower to regain ownership

after default was called:
a) Equitable right of redemption

b) Deficiency judgment
c) Mortgage insurance
d) Statute of limitations
3. The loan-to-value ratio used by mortgage lenders in the early years of

the industry, around the year 1900, was:
a) 10%
b) 20%
c) 40%
d) 50%
4. In which year was a new society created, known as the Massachusetts

Bay Colony?
a) 1492
b) 1500
c) 1690
d) 1860
38
5. When did the Continental Congress charter the Bank of North
America the countrys first commercial bank?
a) When the Massachusetts Bay Colony was formed, in 1690

b) During the Revolutionary War, in 1781
c) During the Civil War, in 1862
d) During World War II, in 1944
6. Spurred by the Great Depression, which institution was created in

1932 to provide liquidity to commercial banks and put them back in
business for making loans?
a) The Reconstruction Finance Corporation (RFC)

b) Federal Home Loan Bank (FHLB)
c) Federal Housing Authority (FHA)
d) Federal Insurance Deposit Insurance Corporation (FIDC)
7. Which act established a system through which the federally-chartered

commercial banks were given authority to make real estate loans?
a) Federal Reserve Act, 1913

b) Federal Farm Loan Act, 1916
c) Reconstruction Finance Act, 1932
d) Federal Home Loan Bank Act, 1932
8. Disintermediation is__________.
a) Charging interest on loans

b) Depositing money in savings accounts
c) Large-scale withdrawals from savings accounts
d) Reviewing savings histories of the depositor
9. Which act limited the issuance of tax-exempt housing mortgage

revenue bonds?
a) Tax Reform Act, 1986

b) Depository Institutions Deregulation and Monetary Control Act,
1980
39
c) Omnibus Reconciliation Act, 1980
d) Community Reinvestment Act, 1978
10. The ____________ restructured the regulatory framework by

discarding the FHLBB and FSLIC, and also created the Office of Thrift
Supervision (OTS) under the Treasury Department.
a) Housing and Community Development Act, 1987

b) Garn-St. Germain Depository Institutions Act, 1982
c) Financial Institutions Reform, Recovery, and Enforcement Act
(FIRREA), 1989
d) Competitive Equality Banking Act, 1987
11. The Federal Home Loan Bank Act of 1932 established _____
regional banks.
a) Two
b) Five
c) 12
d) There were no regional banks established.
12. Both Fannie Mae and the FHA/VA have the authority to purchase
conventional mortgages.
a) True
b) False
Answer Key:
1. C 7. A
2. A 8. C
3. D 9. C
4. C 10. C
5. B 11. C
6. A 12. B
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CHAPTER TWO
REAL PROPERTY
INTRODUCTION
Ownership is a fundamental component when it comes to real estate.
Owning a property in our society is considered to be a basic right of every
citizen. This wasnt the case earlier. The laws of property ownership were
first presented in English common law. In eras gone by, all properties were
either owned by the king or an appointed noble. With time, people started
to feel the need for their rights of property ownership.
The discontentment among the people led to a change. In the end, each real
property owner attained certain rights along with property ownership.
BUNDLE OF RIGHTS
A number of rights together known as the Bundle of Rights comprises the
right to own, possess, use, enjoy, borrow against, and dispose of real
property.
REAL PROPERTY TYPES OF ESTATES

An ownership interest or claim a person has in real property is called an
estate. Estates are of two types: freehold and less-than-freehold. How much
of a claim exists is determined by the type of the estate. Estate type is
defined in terms of its time frame and the rights that come along with it.
41
FREEHOLD ESTATES
The word freehold was first used in medieval England. In those days, if the
land owner was not subject to the demands of the ruler and held his land
freely, he was said to be holding a freehold estate. The estate of this nature
continues for an indefinite time frame and it may belong to a homeowner or
a landlord. The bundle of rights is also included.
In present day context, a freehold estate is of two kinds: estates in fee and life
estates.
Estates in Fee
This form of ownership is the most complete one and is also called a fee
simple estate or a fee. As an owner of a fee simple estate is allowed to
dispose of his property in his lifetime or after his death by will, this type of
estate is also called an estate of inheritance.
This is generally the type of estate that is transferred in a regular real estate
transaction. A property that is sold or transferred without any conditions or
limitations on its use is known as an estate in fee simple absolute.
In case a seller demands qualifications or conditions, then the buyer is said

to be holding a fee simple qualified or fee simple defeasible estate. For
instance, a seller may want the property to be used for a particular purpose
such as a home for old people or a rehab center. The owner sells the
property with a condition that this requirement be fulfilled. If in case the
buyer does not fulfill the condition subsequent after the sale, then the seller
may regain the possession and title of the property. In a different example
of a condition subsequent, the seller may even impose special limitations on
the use of the property after the sale. A buyer may be disallowed the right to
run a day-care for children or use the property as a storage yard. If any of
these activities take place, the seller (or his heirs) may have the ownership
of the property reverted back.
There is a restriction called the condition precedent, which may be imposed

by the parties to a contract. In this situation, something has to occur before
42
the transaction is finalized and completed. For instance, a sale may take
place only on the condition that the buyer will obtain financing or qualify
for a VA or FHA loan.
Life Estates
In a life estate, there is a limited duration in which real property may be
held by a designated person. For example:
Martha grants a life estate to Kevin, provided that if Kevin dies, the
property shall revert back to Martha. Here Kevin is the life tenant or
the designated party who receives the life estate. An estate in
reversion is held by Martha.
Robin grants a life estate to Keith, provided that if Keith dies, the
property shall go to a third party, Cindy. The interest held by Cindy is
known as an estate in remainder.
Ricky grants a life estate to Tess for the life of Grace, provided that
the estate goes to Rose if Grace dies. Tess gets to enjoy the life estate
benefits for the time Grace is alive. On Graces death the estate goes
to Rose or her heirs. This is known as reserving a life estate.
As a life estate is a kind of freehold, or fee estate, the holder of a life estate
get all the rights that come along with fee ownership apart from disposing
of the estate by will. Note that a life estate is bound to a designated life, and
at the death of the party, the estate either goes to the person in reversion, or
the person in remainder, or their heirs.
Life estate holders are liable for paying taxes and maintaining the property.
They have the right to the rents collected and all the profits for the duration
of the life estate. Life estate holders may encumber the property or dispose
of it in ways other than by will. If an interest is created in the property by
the life estate holders, and it extends beyond the life of the person used to
measure the estate, it will become invalid at the death of the designated
person.
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LESS-THAN-FREEHOLD ESTATES
As we know by now, a freehold estate is the most complete form of

ownership with most rights included. Let us now discuss less-than-freehold
estate s . This estate is also called a leasehold estate or a lease. A leasehold
estate is held by renters or tenants.
Leasehold estates are personal property or chattel real that comes with a
right to use the property for a fixed time period. Renters (lessees) have a
right to possession and quiet enjoyment of the property. It implies that they
have the right to exclusive use of the rented property and a right to live
quietly without the invasion of their privacy. These rights are legally
secured rights, just like the rights of a landlord or lessor.
REAL PROPERTY VS. PERSONAL PROPERTY

Anything that can be owned is called a property. It could either be real or
personal. A property that is not real property is personal property. Money,
movable goods, and proof of debts as in a promissory note are personal
property. On the other hand real property is immovable and is normally
transferred or sold by a deed.
With the sale of real property, anything that is attached to it goes to the
buyer, unless it was otherwise arranged. Personal property, also known as
chattel, is movable and sold or transferred through a bill of sale. It is
possible to change real and personal property from one to the other. For
example, an air conditioner by itself is personal property, but once attached
to a wall by framing, it becomes real property.
REAL PROPERTY
Real property is land, anything permanently attached to it, anything
appurtenant to it or anything lawfully immovable.
44
LAND
Land comprises the soil and the rocks that stretch to the center of the earth.
The definition of land as real property includes airspace, mineral rights,
and water rights.
Airspace, to a reasonable height, is considered as real property. An

example of airspace is a high-rise condominium, which is also known as
vertical subdivision. This airspace may be sold as real property by an owner
or a developer.
Minerals may be owned as real property except if they are non-solid or

transient minerals like oil or gas. These may be owned only after being
taken from the ground, becoming the personal property of the one who
removes them.
Water rights that go with the land are considered as real property. The
law is very precise regarding the owners water rights because there are
many disputes regarding the use of percolating (underground) water and
surface water. Water is not supposed to be owned, dammed, or channeled
for the use of a single land owner. An owner is allowed to only take a fair
share of underground waters as per the doctrine of correlative user. An
owner whose property borders along a stream or a river has riparian rights
over that water and the owner is known as riparian owner.
The riparian owners may use the water to their advantage in a justified
amount and without excluding the adjoining owners. Owners whose land is
bordering a lake, known as a littoral owner, usually own to the average low
water mark or the edge of the lake. The ordinary high-tide mark is the
boundary line of the land touching the ocean.
The right of appropriation is applied, when the government diverts water

for public use.
PERMANENTLY ATTACHED TO THE LAND

Things that are permanently attached to the land are also considered as real
property and go along with the land to the owner. Swimming pools, out-
houses, fences or other such things that are attached permanently to the
45
land are owned as part of the property. Similarly, anything that is attached
to the land by its roots such as plants, trees, or shrubs is also part of the
property; so is a fixture that is permanently attached to a building.
Crops that are grown and cultivated yearly for sale -- for example, grapes
grown in a commercial orchard or grapefruits grown in a commercial grove
-- are an exception to this rule. These are personal property and known as
emblements, which may be owned by tenants as well as fee owners. Note
that although crops are personal property, the trees or plants on which they
grow are not.
APPURTENANT TO THE LAND
Appurtenance is anything that is used with the land for its benefit. The two
most common appurtenances to real property are easements and stock
rights in a mutual water company. A right-of-way through a parcel of land
is called an easement. An easement is automatically transferred with the
property when sold. The easement is said to be appurtenant to the
property.
Water users who have arranged to form a water company for their mutual
benefit own the stocks in the water company. The water company shares
are appurtenant to the land and transfers with the sale of the property.
ANYTHING IMMOVABLE BY LAW
Rooted trees or crops are supposed as immovable by law and should be sold
along with the property. If a seller sells a property, he has to do so along
with the peach grove on it. The seller may sell the crop grown from the tree
as personal property, but the tree is still real property and cannot be
excluded from the sale.
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FIXTURES
An item of real property that used to be personal property is called a
fixture. As an item gets permanently attached to real property it becomes a
fixture.
By now we know the characteristics of real property. Let us study what that
exactly means to a consumer. Assume yourself to be a prospective buyer. As
you enter a house, you immediately take a liking to the curtain frames
attached to the windows around the house. You offer to buy the house, your
offer gets accepted and the escrow, too, goes through smoothly. The seller
receives the money and you receive the deed to the house.
Upon reaching your new house, you discover that the windows are all
minus the curtain frames. The old owner then informs you the curtain
frames were made-to-order for him by a specialist and he was going to use
them in his new home. The window frames were never meant to go with the
sale of the house.
Now, if you are unaware about the difference between real property and
personal property, you would have thought that the curtain frames were
rightfully the sellers.
It is the duty of a real estate agent to make sure that the parties to a sales
contract are aware of what goes with the sale and what doesnt. In this case,
the listing agent should have confirmed with the seller if the curtain frames
were going to be a part of the sale or not, and notified the prospective buyer
accordingly.
The buyer was not wrong in assuming that the curtain frames were a part of
real property, as it was not excluded from the listing. It had become a
fixture, thus it should have been a part of the sale.
When making an offer on a property, there is a section in the offer-to-

purchase contract where the buyer may request any item of real or personal
property such as curtain frames, chandeliers, air conditioners, refrigerators,
or a fish tank. It is always a good practice for the buyer to put his intentions
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in writing for the seller to be informed and register his approval or
disapproval.
FIVE TESTS OF A FIXTURE

To deal with the disputes regarding real and personal property, the courts
have adopted a series of five tests which help buyers and sellers decide as to
who is right in event of a disagreement about what are fixtures:
Method of attachment
Adaptation
Relationship of the parties
Intent of the parties
Agreement of the parties
Method of Attachment
If the item in dispute is attached permanently attached, it is real property.
In case of the curtain frame, it was nailed to the walls, so it was a fixture
real property. If the seller wanted to take it with him, he should have
specifically mentioned it, otherwise it should go to the buyer with the sale
as something attached or affixed to the land.
Adaptation
Check if the item has been custom-made for the property. For example, is
the stove built in the counter, or are the drapes made-to-order for the
windows, or if the mirrors in the bathrooms are incised in the walls. In each
of the above examples, the items became fixtures; therefore now they are
real property and not personal property.
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Relationship of the Parties
In disputes regarding fixtures where no convincing evidence of the right of
one party is found, the court determines whether the parties are landlord
and tenant, buyer and seller, or lender and borrower. Then a decision
follows on the basis of the relationship of the parties in the dispute.
Intent of the Parties

This is deemed as the most important test of a fixture. An example: a tenant
gets some special lights fixed for his personal requirements in the ceiling of
his rented apartment, promising the landlord that he will remove them and
restore the ceiling to its original condition when he moves out of the
apartment. In this case the tenant was clear in his intention of keeping the
lights as his personal property. If all parties are informed, then a fixture
may remain personal property. However, it is important that intentions are
put in writing.
Agreement of the Parties

When the parties in dispute have a clear agreement about fixtures, the
courts then apply this test to find out who is in the right.
TRADE FIXTURES
Items of personal property that are used to conduct a business such as cash
registers, shelves, cabinets and cubicle partitions are known as trade
fixtures. The ownership of these items is retained by the tenants as
personal property when they move out of the premises. However, the
tenants are responsible for repairing the damages done by the fixing and
the removal of the trade fixtures.
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LAND DESCRIPTION UNDERWRITING GUIDELINES
New land was explored by the staunch individuals and families from the
wilderness which later became America. The families kept moving
westwards and developed the land they settled on. Soon enough a need for
a system for property description became inevitable.
A street address was not exact enough for identifying a particular property,
though it was good enough for social contacts and mail delivery.
Now, a legal description is a must for a deed to be recorded for transferring

title to a new owner. There are three common ways of describing property:
U.S. Government Section and Township Survey
Recorded Lot, Block, and Tract System
Metes and Bounds
U.S. GOVERNMENT SECTION AND TOWNSHIP SURVEY

By the end of the 19th Century, the U.S. government had established a
system of describing land for new territories, states, and other public lands.
The U.S. Government Section and Township Survey, which is also known as
the rectangular survey system, forms a grid of imaginary lines to locate
land. Meridians (the North-South longitude lines) and Base Lines (the
East-West latitude lines) intersect, forming an imaginary starting point
from which distances are measured.
California has three such starting points:
The Humboldt Base Line and Meridian Northwest California,
The Mt. Diablo Base Line and Meridian Northeastern and Central
California, and
The San Bernardino Base Line and Meridian Southern California.
Once a starting point was set up at the intersection of a selected principal

meridian and base line, imaginary lines (called range lines) were drawn by
the government surveyors. These range lines were drawn every six miles
east and west of the meridian to form columns called ranges. Each of the
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ranges was then numbered either east or west of the principal meridian. As
in, the first range east of the meridian was called Range 1 East (R1E), and
similarly, the first range west of the meridian was called Range 1 West
(R1W).
Likewise, imaginary township lines were drawn every six miles north and
south of the base line forming a row or a tier of townships. These rows were
then numbered as per their distance from the base line. As in the first row
of townships north of the base line was called Township 1 North (T1N), and
similarly, the first row of townships south of the base line was called
Township 1 South (T1S).
Hence, appears a grid of squares which are called townships. These are
each six miles by six miles; 36 square miles.
The location of each township is described in relation to the intersection of

the base line and meridian as explained above. An example would be, a
particular township that is located in the second tier north of the base line
and in the first range west of the meridian would be described as: T2N,
R1W (T = township, R = range), san Bernardino Base Line and Meridian.
To locate T2N, R1W. Count up (or north) from the intersection of the base
line and meridian two rows and then count to the left (or west) one row.
Refer to the diagram, below, showing that each section is one mile by one
mile and comprises 640 acres.
SECTION
640 Acres 1 MILE
1 MILE
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A section may be further divided into quarter sections comprising 160 acres
each. These quarter sections may be further divided into smaller parcels,
which can be identified through their compass direction, i.e. NE, SE, NW,
and SW.
QUARTER SECTION
NW 1/4 NE 1/4
160 Acres 160 Acres

1 MILE
SW1/4 SE 1/4
160 Acres 160 Acres
1 MILE
If you have this knowledge, you can locate any size parcel, large or small, by
just dividing the section. Make a note of this important number: 5280. This
is the number of linear feet in a mile, where linear means length and not
area.
The following diagram depicts how a section is to be divided and the way to
describe each parcel.
SECTION DIVISIONS
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Section 3 Section 2
40 40
Acres Acres 160
40 40 Acres
320 320 Acres
Acres
Acres Acres
160 160
Acres Acres
N
Section 10

W
S
E Section 11
80 80 160 160 160

Acres Acres Acres Acres Acres
2.5
40 10 10 40 10 2.5
160 Acres 10 10 160 Acres 10 10
Acres Acres
40 40 40 40
Acres Acres Acres Acres
Given, below, is the summation of the basic facts about the U.S.
Government Section and Township Survey, which can be referred to when
calculating land measurement.
Three Base Lines and Meridians in California
Humboldt Base Line and Meridian

Mt. Diablo Base Line and Meridian
San Bernardino Base Line and Meridian
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System for Locating Land
Meridians run north and south

Base Lines run east and west
Range Lines run north and south, parallel to the principal
meridian, every 6 miles
Township lines run east and west, parallel to the base line, every
six miles
Townships are six miles by six miles, 36 square miles
Sections are one mile by one mile, 36 in each township and
comprises 640 acres
5,280 feet = one mile
43,560 square feet = one acre
640 acres = one square mile
Four miles = distance around a section/square mile
RECORDED LOT, BLOCK, AND TRACT SYSTEM
There is another land description method which is the recorded lot, block,
and tract system. When dividing the parcels of land into lots, the developers
need to prepare and record a plat map. This is a requirement from the
California Subdivision Map Act.
The location and boundaries of individual new lots in the subdivision are
shown in this map. This must be recorded in the county recorders office.
This is by far the most simplified and convenient method of land
description.
Once the subdivision map has been recorded it becomes available to public
for their information. Identification of each lot in a subdivision is done by
number. So also is the block in which it is located. Thus, every lot and block
is in a referenced tract. Usually, one would find recorded map description
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of lands in counties which have planned communities and commercial
areas for growth.
METES AND BOUNDS
Metes and bounds is the third way of describing land. In this method, the
boundaries are delineated and the distance between landmarks or
monuments is measured to identify property. In the metes and bounds
method the dimensions of the property are measured by distance and
direction. With an odd-shaped land or land that cannot be described with
the use of either of the other two methods of land description, then the
metes and bounds method is used.
The word metes should remind you of measuring, while the word bounds
should remind you of boundaries. Normally a surveyor measures the
distances and provides a legal description.
This is how a metes and bounds method works: The description starts at a
distinguished point of beginning, the boundaries of the land are followed,
distances between the landmarks are measured, and then return back to the
starting point.
CHAPTER SUMMARY
A number of rights together known as the Bundle of Rights

comprises the right to own, possess, use, enjoy, borrow against, and
dispose of real property.
Estates are of two types: freehold and less-than-freehold.
Real property is land, anything permanently attached to it, anything

appurtenant to it or anything lawfully immovable.
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An item of real property that used to be personal property is called a
fixture. When an item gets permanently attached to real property, it
becomes a fixture.
Currently, a legal description is a must for a deed to be recorded for

transferring title to a new owner.
The U.S. Government Section and Township Survey also known as

the rectangular survey system -- forms a grid of imaginary lines to
locate land. Meridians (north-south longitude lines) and base lines
(east-west latitude lines) intersect, forming an imaginary starting
point from which distances are measured.
Another land description method is the recorded lot, block, and tract
system.
Metes and bounds, the third way to describe land, measures the
distance between landmarks or monuments to identify property.
CHAPTER QUIZ
1. Which of the following is included in the bundle of rights?
a) Possession right
b) Encumbrance right
c) Enjoyment right
d) All of the above
2. Which type of estate is also called an estate of inheritance?

a) Fee simple estate
b) Fee simple qualified
c) Life estate
d) Less-than-freehold estate
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3. A fee simple defeasible estate is also called a(n) ________.
a) Estate of inheritance
b) Fee simple qualified
c) Life estate
d) Less-than-freehold estate
4. The type of estate upon which a seller imposes conditions is called a:

a) Life estate
b) Less-than-freehold estate
c) Fee simple defeasible
d) Fee simple estate
5. Crops which are grown and cultivated every year for sale, such as
grapes or tomatoes, are called:
a) Agricultural property
b) Emblements
c) Plant property
d) None of the above
6. Which if the following is NOT true for a life estate holder?

a) May pay taxes and maintain the property
b) Interest of the life holder remains valid even after the death of the
designated person
c) May collect rents and keep all profits for duration of the life estate
d) May dispose of the estate in any way except by will
7. When real property is sold, anything permanently attached to it:

a) Goes with the seller
b) Is divided between both the buyer and the seller
c) Goes to the buyer
d) The broker decides to whom it goes
8. In the land locating system, what runs north and south?

a) Meridians
b) Base lines
c) Range lines
d) Township lines
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9. In the land locating system, what runs east and west?
a) Meridians
b) Base lines
c) Range lines
d) Township lines
10. Which land description method measures distances between

landmarks and monuments to identify property?
a) U.S. Government Section and Township Survey
b) Recorded Lot, Block, and Tract System
c) Metes and Bounds
d) Common address
11. The following are types of estates:

a) Freehold
b) Less-than-freehold
c) Both A & B
d) Neither A nor B
12. Six hundred and forty acres equals one square mile.
a) True
b) False
Answer Key:
1. D 7. C
2. A 8. A
3. B 9. B
4. C 10. C
5. B 11. C
6. B 12. A
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CHAPTER THREE
LAND TITLES AND ESTATES
INTRODUCTION
Consumers have always wanted to know how a property may be owned, the
kind of ownership that could be taken, the way of measuring the property,
what the duration of the ownership will be, and how much of the property
is owned.
In this chapter we shall study the basics regarding titles and estates. What
this chapter deals with will be of use to you when dealing in the transfer of
real property, regardless of whether you are a borrower, lender, or seller. To
commence, lets see who owned the land at first.
LAND TITLE
As studied in Chapter 1, ownership of land gained importance as a result of
the growing requirement of land coming from the agricultural societies.
Many wandering tribes realized the benefits of staying put on land rather
than undergoing the uncertainties of a nomadic life. Soon, these tribes
started to grow their own crops and vegetation and domesticated animals at
a permanent location. This created a longing for an exclusive right to the
use of that particular land.
With the growth of permanent civilization and peoples fondness towards

their personal production capabilities, every family was given the right to
use a part of the tribal land in exchange for loyally defending the
collectively owned property and/or the complete area held by the tribe.
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As society grew to become political states, important ownership traditions
took the form of laws. Ultimately, a king or tribal leader came forth to claim
all real property under their empire. The king expected loyalty from his
people and in return granted them the right to the possession and use of
particular parcels of his land. This right was called a feud. The inhabitants
who served and defended the king were called lords; they did not own the
property, only remained tenants for life (or as long as they served the king).
The land ownership of this nature was called feudalism.
The lords started giving the right to use certain portions of their lands to
the citizens and, in return, expected a share of the crops and the loyalty of
the citizens in safeguarding his estate. These citizens were called vassals
and they were the tenants of the lords. They did not have the right to sell or
will the land that was in their possession.
Soon, the allodial system took over the feudal system of land ownership.
Under this system, the citizens possessed more rights regarding real
property than ever before. Now, the people possessing the land were
allowed to convey their tenancy rights to anyone and also pass on their
interest to their heirs. The feudal system ended in England by 1650, while
in France it ended by 1789, after the French Revolution. Originally, the
lords became owners of the lands of the king and the ordinary peasants
were tenants. Afterwards, the farmers were allowed to purchase land or it
was gifted to them by the lord. The age-old dream of ordinary citizens of
owning real property was now becoming possible.
The first English settlers in America were given ownership of land that they
claimed was their own; however, titles to unclaimed lands remained with
the king. After the Revolution, the king had no power over American land.
The newly-formed nation that had adopted the allodial system of land
ownership began its journey towards economic growth.
SYSTEM OF RECORDING
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As the occupation of the vast lands of a new nation began, Americans
started to develop the borders and the endless plains into dynamic towns
and cities. Agriculture remained the main occupation of the people, though.
As with the development of ancient culture, the owning of land became a
symbol of wealth in the new America, too. In the quest for prosperity and
opulence and to maintain the continuity of acquired wealth, the people of
America were looking for a method of notifying others of their owned real
property. A need of a system arose in which property owners could make
known to the public of their claim or right to a particular parcel of land.
To safeguard their land ownership, Americans devised a policy of recording

evidence of title or interest. This system collected records at a convenient
and safe public place; this would give the purchaser of real property the full
information regarding the previous ownership and condition of the title. It
protected the public against secret conveyances and liens and provided for
a freely-transferable title to real property.
In all states, there is a law that provides for the recording of documents that
describes ownership interests in land and also its conveyances and
encumbrances. In all counties, there is a public recorders office that is in
charge of recording documents that deal in real property located in that
particular county. Once the recording has been done, the public is
considered legally notified of the ownership of the property.
ELEMENTS OF RECORDING
Regarding the recording acts of individual states, it is provided that, once

the acknowledgement has being signed before the notary or a public
official, any instrument or judgment affecting the title to, or possession of,
real property may be recorded. Recording allows the filing of documents
that affect title to real property, although it is not a requirement to do so.
The instrument to be recorded is copied into the proper index, and is filed
in alphabetical order, under the names of the parties. To be valid, the
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document needs to be recorded in the county where the real property is
located.
When a document is received by the recorder for filing, he first notes the
time and date of filing and the name of the person who requested the
recording. After copying the contents of the document into the record, the
original document is marked filed for record and stamped with the
appropriate date and time of recording, before returning it to the person
who requested it.
PUBLIC NOTICE AND ITS OUTCOME
There are two ways of giving a public notice. A constructive notice may be
conveyed by recording a document in the public records at the office of the
county recorder. Another way of giving a public notice is by occupying or
using the property in a way that serves to notify anyone interested that the
party in possession is the lawful owner. The one recording the deed first or
the one who first occupies the property holds legal title.
The recording process gives public or constructive notice of the details of

any instrument recorded to anyone who is interested in looking into the
records. The information filed at a recording is considered to be a public
notice. So also is possession, considered as constructive notice. Before
purchasing a property, the buyer must ensure that no one occupying the
property has a prior interest in the ownership. The buyer has a duty to
make proper enquiry regarding the property before buying it.
PRIORITIES IN RECORDING
We know now that recording laws are in place to protect the people against
fraud and to provide notification of property ownership. Liens and
encumbrances that might influence ownership can also be recorded. To
attain priority through recording, a buyer needs to be a good faith
purchaser, for a valuable remuneration, and record the deed first.
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Priority means the order in which deeds are recorded. The priority is
confirmed by the stamped date in the upper right-hand corner of the
document by the county recorder, regardless of whether the deed is a grant
deed, trust deed, evidence of a lien, or an encumbrance.
If more than one grant deed is recorded against a property, the first
recorded deed will be the valid one. In such cases where more than one
trust deed is recorded against a property, it is not indicated as to which one
is the first trust deed, which is second and so on. Therefore, anyone
inquiring about the priority of the deeds must refer to the time and date on
which the deed was recorded. The importance of time and date of recording
will be clearer as the chapter progresses.
However, certain instruments are not affected by the rule of the priority of
recording. Tax liens and lien take priority even if they are recorded after a
deed.
We shall study liens and encumbrances in detail later on, but it is worth
noting the impact of the laws of recording on this subject.
OWNERSHIP OF REAL PROPERTY
There is an owner of every property. The owner may be government,

private institution, or an individual. Title is a proof of the legality of the
possession of land by its owner. Real estate may be owned in two ways:
separate ownership and concurrent ownership.
SEPARATE OWNERSHIP
Property owned by one individual or entity is known as ownership in

severalty or sole and separate ownership. A corporation is a sole entity;
thus it holds a title in severalty.
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CONCURRENT OWNERSHIP
When two or more people or entities own a property at the same time it is
known as concurrent ownership or co-ownership. There are five types of
concurrent ownership:
Joint tenancy
Tenancy in common
Community property
Tenancy in entirety
Tenancy in partnership
Joint Tenancy
Joint tenancy applies when two or more parties own real property and they
have the right of survivorship. This means that if one of the co-owners die,
the surviving owner automatically becomes the sole owner of the property.
The deceaseds share does not go to his estate or to his heirs; it becomes the
co-tenants property and does so this is a huge benefit -- without
involving probate. The surviving joint tenant is not even liable to
creditors of the deceased who hold liens on the joint tenancy property.
For a joint tenancy, there is a requirement of four elements: time, title,

interest, and possession. If any element is missing, the joint tenancy is
dissolved.
The four elements of Joint Tenancy
Time: All parties have to become joint tenants at the same time.
Title: All parties have to take title on the same deed.
Interest: All parties should have an equal and undivided interest in

the property.
Possession: All parties have an equal right of possession (or an

undivided interest).
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Joint tenants may sell their interest, give it away, or borrow money against
it. They do not need the co-owners approval for it. A joint tenant cannot
bequeath his share in a will, due to the right of survivorship. However, if
there are no other surviving joint tenants then it may be possible to devise
(pass on real estate) the joint property.
Here are some examples:
1. Tom, Jack, Mary, and Bob are joint tenants. On the demise of Jack,
his interest automatically goes to Tom, Mary, and Bob who are the
surviving joint tenants. The three of them get equal one-third
interests.
2. Hugh and Paul are joint owners of a house. When Hugh dies, Paul
becomes the sole and separate owner of the house, without probate.
Because of the right of survivorship, the heirs of Hugh will not be
entitled to his share.
3. Clare, Lizzy, and Jane are co-owners of an apartment building.

Clare sells her share to Sally who is now a tenant in common with
Lizzy and Jane (There is no right to survivorship for Sally). So, if
Sally dies, her heirs will inherit her share of the property, but if Lizzy
or Jane die, the surviving co-owner will inherit the deceaseds share.
Tenancy in Common
A tenancy in common occurs when two or more owners of undivided
interest in a property have equal or unequal interest in it. Whenever there
are co-owners in a property and the form of ownership is not specified, then
the title is assumed to be a tenancy in common.
For tenants in common, there is just one requirement and that is the equal
right of possession or undivided interest. This means that each co-owner
has an equitable interest in the property (for example one-half interest, or
0ne-fourth interest) along with the right to use the entire property. One co-
owner cannot exclude another from the property nor can he claim any part
of the property for exclusive use.
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Features of Tenants in Common
Title may be taken at different times.
Title may be taken on separate deeds.
Co-owners may have unequal interests.
There is an undivided interest or equal right of possession.
A tenant in common may sell, encumber, or will his interest. An heir

becomes a tenant in common among other co-owners. A tenant in common
is liable to pay a proportional share of any expenses incurred on the
property; this includes expenses for repairs, loan repayments, taxes, and
insurance.
In an event of a disagreement between tenants in common regarding the
property, any of the co-owners may file a partition suit, so the court decides
the fate of the ownership rights of the tenants.
That property which is acquired by a husband and wife during a valid

marriage, apart from certain separate property is called community
property.
What accounts for a Separate Property?
Property that is owned before marriage.
Property acquired by either party during the marriage by way of gift

or inheritance.
Any income that is derived from separate property.
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In case the couple wants to maintain the status of their separate property,
they must see to it that they dont commingle it with their community
property. Separate property (for example, a building with a negative cash
flow) need not be supported with community property funds. Also the
income of either spouse may not be used to maintain separate property.
Any income, even wages from either spouse, is considered community
property.
Just one of the spouses cannot sell or encumber community property.

Either of the spouses may buy real or personal property without the others
consent. Each is bound by the contract made by them, unless of course the
new property is particularly purchased as separate property using funds
from a separate property account.
In California, married people have three options as to how they take title.
The first type is joint tenancy, in which the right of survivorship is
included, if one of the spouses dies. It may also include tax liability for the
surviving spouse. The second type is community property; this includes the
right of survivorship, while also incurring probate and its costs after a
spouse dies, The third type is community property with the right of
survivorship; this has the best features of all the three types. There is no
particular tax liability after the death of the spouse and also no probate with
its seemingly endless costs.
When the title taken is that of community property, either of the parties
have the right to will one-half of their community property. In the absence
of a will, on the death of one of the spouse, community property is inherited
by the surviving spouse.
Regarding the case of multiple marriages: After the death of a parent,

children of the first marriage no longer remain the natural heirs of the
property. If no will has been made and a subsequent spouse survives, then
the new spouse inherits any property owned or community property.
With separate property, the surviving spouse gets one-half and one child
gets one-half in the absence of a will. If there are more children, then the
surviving spouse gets one-third and the children get two-thirds.
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State recognition for Community Property Law: Nine states that use
the community property system to decide the interest of a husband and
wife in property acquired during marriage are: Arizona, California, Idaho,
Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Those
residents should be aware of some special rules that apply to community
property. Any property previously acquired while living in one of these
states might still be community property even today.
Tenancy by the Entirety

This legal concept came into being due to the idea that a husband and a
wife are an undividable legal entity. This is a type of concurrent ownership
and its two most important features are: In the event of the death of one
spouse, the surviving spouse becomes the sole owner of the property, and,
neither of the spouse has a disposable interest in the property during the
lifetime of the other. This means that to convey title to another party both
the spouses (if they are alive and married to one another) need to sign the
property conveyance. Tenancy by the entirety is similar to joint tenancy,
with the right to survivorship (except that joint tenants can convey title to
another party without the consent of the other joint tenant).
The Five Elements of Tenancy by the Entirety
Time: All parties have to become joint tenants at the same time.
Title: All parties have to take title on the same deed.
Interest: All parties should have an equal and undivided interest in the
property.
Possession: All parties have an equal right of possession (or an undivided

interest).
Unity of person: A husband and wife are a unity of person. Both parties
need to agree before conveying the property to another person.
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Tenancy in Partnership
Ownership by two or more people who form a partnership for conducting
business is called a tenancy in partnership. The property is to be held in the
name of the partnership and each party has an equal right of possession for
the partnership.
LIMITATIONS ON REAL PROPERTY: ENCUMBRANCES

An interest in real property that is held by someone who is not the owner of
the property is called an encumbrance. Anything affecting the title or use of
the property is an encumbrance. A property is encumbered when there are
legal liabilities against the title.
There are two types of encumbrances: Money encumbrances affect the title
of the property and non-money encumbrances impact the use of the
property. The encumbrances for which legal liabilities to pay are created are
called liens. Real property is used as security for the payment of a debt.
The most common types of liens are trust deeds and mortgages, mechanics
liens, tax liens, and special assessments, judgments and attachments. The
encumbrances that affect the use of property are easements, zoning
requirements, building restrictions, and encroachments.
MONEY ENCUMBRANCES (LIENS)
A lien is a liability to pay a voluntary or involuntary money encumbrance. A

voluntary lien refers to when an owner chooses to borrow money, using the
property as security for the loan.
An involuntary lien applies when the owner fails to pay property taxes or a
debt owed and a lien is created against his property without permission.
Property tax liens have priority over all prior security liens filed by private
individuals, as well as over federal and state tax liens. Property tax liens are
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also specific liens, applying only to the property with unpaid taxes, as
opposed to a general lien affecting all the property of the owner.
Trust Deeds and Mortgages

Trust deeds and mortgages are the two types of instruments that are used
in real estate financing to create voluntary, specific liens against real
property. This topic will be discussed in a later chapter.
Mechanics Liens
This lien is placed against a property by someone who has supplied labor,
or material used to improve real property and has not received payment A
contractor, subcontractor, a laborer on the job, materials supplier -- of
lumber, plumbing or roofing materials -- are eligible to file a mechanics
lien.
A mechanics lien needs to be verified and recorded. The recording laws are
very time-specific, though. The exact legal procedure has to be followed for
the mechanics lien to be valid. The following procedure needs to be
followed:
1. Preliminary notice: A written notice should be given to the owner

within a span of 20 days of first furnishing labor or materials for a job
by anyone who is eligible to file this lien. This document notifies the
owner that a lien may be placed on his property if the payments for
the completed job are not made.
2. Notice of Completion: Once the owner files a notice of completion

within 10 days after finishing construction, the original contractor has
60 days after the notice is filed (while others have 30 days after the
notice is filed) to record a mechanics lien.
3. No Notice of Completion: In case the owner has not filed a notice of

completion, then all claimants have 90 days from the day of
completion of work to record a mechanics lien.
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4. Foreclosure Action: After recording a mechanics lien the claimant
has 90 days to bring a foreclosure action for enforcing the lien. If
action of foreclosure is not taken then the lien will be terminated and
the claimant loses his foreclose right.
If unauthorized work is discovered on the property by the owner, he should

file a notice of non-responsibility. This notice needs to be recorded and
posted on the property to be valid and should mention that the owner is not
responsible for the work being done. This will release the owner from the
liability of the work done without permission. The notice should be filed
within 10 days after unauthorized work is discovered. If a tenant is ordering
the job, then the notice is usually posted with a commercial lease at the
commencement of a job.
To determine the starting time for a mechanics lien is very important. This
lien has priority over other liens filed after the commencement of labor or
delivery of materials. Thus, if there is foreclosure action, the mechanics
lien would be paid before any other liens that were recorded after work
started on the job. This includes the trust deeds or mortgages recorded
before the filing of the mechanics lien, but after the commencement of the
work.
Physical inspection of the property is done by the lender to make certain

that no materials have been delivered and no work has been done before
recording a construction loan to confirm the priority of their trust deed or
mortgage.
The example cited below shows the priority of the mechanics lien:
Commencement of work on May 1 Trust Deed recorded on May 5

Notice of completion recorded on August 1 Mechanics Lien recorded
on August 15.
Judgments and Attachments
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A process through which the court holds the property of a defendant until a
result of the lawsuit is known is called an attachment. An attachment liens
validity is three years, extendable in certain cases.
In a lawsuit, a judgment is the courts final confirmation of the rights of the

parties. A judgment does not necessarily create a lien. A summary of the
courts decision needs to be filed with the county recorder. The summary of
the courts decision is called an abstract of judgment. After the abstract is
filed, the judgment becomes a general lien on all property owned or
acquired by the judgment debtor for 10 years, in the county where the
judgment is filed.
Tax Liens and Special Assessments

Any unpaid government taxes, such as income or property taxes, become a
lien against the property. There are some special assessments that are
levied against property owners to pay for local improvements, such as
sewer maintenance, water projects, or street repairs. Special assessments
secure the payments for such projects, and these become liens against real
property. Property taxes and special assessments are specific liens while
other government taxes are general liens.
Lis Pendens
A recorded notice that indicates pending litigation affecting the title on a
property is called a lis pendens. This notice clouds the title, preventing the
sale or transfer of the property until it is removed.
Non-Money Encumbrances
A non-money encumbrance affects the use of property such as an easement,

a building restriction or an encroachment.
Easements
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An easement is the right to use the property of someone else for a specified
purpose. It is also sometimes called the right-of-way. Interest in an
easement is non-possessory. Thus, a holder of an easement can only use it
for the purpose intended for and cannot prevent anyone else from using it.
The right to enter a property by way of an easement is called ingress.
Leaving a property by way of an easement is called egress.
The party that gives the easement is called the servient tenement. It is
encumbered by the easement. The party that receives the benefits of the
easement is called the dominant tenement. An easement is appurtenant to
the dominant tenement.
As noted, the definition of real property includes anything appurtenant to

the land. Anything that is used for the benefit of the land is appurtenant to
it. An easement appurtenant by default goes with the sale of the dominant
tenement.
There are chances to have an easement that is not appurtenant to any

particular land. For example, a fisherman who does not own any land may
have an easement over the land of Winston for the purpose of reaching the
river where the fisherman goes to fish every day. Public utilities, too, have
easements that arent appurtenant to any particular parcel of land. These
are known as easements in gross. It is easy to confuse easements in gross
and a license. An easement may not be terminated discreetly (as noted in
the following section). A license, on the other hand, may be revoked at any
time.
An easement needs to be recorded so that its existence continues. The party

that benefits from the easement as a dominant tenement is the one that
should record the easement.
There are five ways to create an easement:
1. Express Grant: This is the most commonly used method of creating

an easement. The one who gives the easement or the servient
tenement grants the easement by deed or express agreement.
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2. Express Reservation: The seller of a parcel of land, who is also the
owner of the adjoining land, reserves the easement (right-of-way)
over the former property. This easement is created at the time of the
sale with a deed or express agreement.
3. Implied Grant or Reservation: Here the existence of an easement is

apparent and necessary when a property is conveyed, irrespective of
whether it is mentioned in the deed or not.
4. Necessity: This easement is created as the parcel of the land might be

completely land locked, without any access. It terminates
automatically when an alternate entry and exit point becomes
possible.
5. Prescription: This easement is created through continuous and

uninterrupted use by one particular party over a period of five years.
The use should be against the owners consent and has to be open and
notorious. The party wanting to attain the prescriptive easement
should have a legitimate claim to the use of the property.
Terminating or abolishing easements may be done in the following ways:
Express Release: Only the dominant tenement can release an

easement.
Legal Proceedings: The servient tenement can take a quiet title action
against the dominant tenement to terminate the easement.
Merger: The servient tenement and the dominant tenement are

joined together.
Non-use: When this becomes applicable to a prescriptive easement

for a five-year period, the easement is terminated.
Abandonment: Apparent and intentional surrender of the easement.
Destruction of the Servient Tenement: The easement is terminated

when the government takes the servient tenement for its use, like in
an eminent domain.
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Adverse Possession: By using it himself, the servient tenement may
prevent the dominant tenement from using the easement for a period
of five years, thus terminating the easement.
Restrictions
Restriction is another type of encumbrance. In this, a private owner, a
developer, or the government may place a limitation on the use of the
property. This restriction is generally placed on property to ascertain that
land use is uniform and stable within a particular area.
The grantor creates the restrictions in the deed at the time of the sale, or it
is created by the developer in the general plan of a subdivision.
In an event of a conflict arising between local minimum building

requirements and the subdivision regulations, the developer should comply
with the restriction that is more restrictive of the two.
There are private restrictions that are applied to a specific property or

development by a past or current owner. The government restrictions are
those that benefit the public in general; zoning, for example.
Restrictions are generally known as CC&Rs or Covenants, Conditions and

Restrictions. A promise to do or not do certain things is called a covenant.
Money damages are normally the penalty for a breach of a covenant. An
example of a covenant is that a property may be used for a specific purpose.
A condition is similar to a covenant, it is also a promise to do or not do

certain things (generally a limitation on the use of the property). In a
condition, the penalty for a breach is the return of the property back to the
grantor.
A restriction that is placed in a deed when conveying a property, upon

future use of it, is called a condition subsequent. The grantor may take back
the property if the condition subsequent is breached.
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When the occurrence of a certain condition or event is a requirement before
the title can be conveyed to the new owner, it is called a condition
precedent.
Encroachments
Placing permanent improvements on adjacent property owned by another
is known as an encroachment. Encroachments on adjacent land may limit
its use. An unauthorized encroachment can be removed within three years
by the owner.
HOMESTEAD EXEMPTION
In many states, personal residences have legal protection from the claims of
creditors because of the benefits of a homestead exemption. This is one of
the greatest advantages of a home investment.
A homestead exemption limits the amount of liability for some of the debts
against which a home can be used to satisfy a judgment. Although a
declared homestead will protect a home against certain types of creditors
(the claims of whom might be executed through judgment liens) some
aspects of real estate law are misunderstood by consumers.
Each state may have different declared homestead exemption laws. An

unlimited dollar value homestead exemption is provided by the states of
Kansas, Florida, Iowa, South Dakota, and Texas. In fact, Florida and Texas
are popularly known as debtor-friendly states on account of their
homestead exemptions. In Floridas homestead exemption, a U.S. Court of
Appeals has held that the exemption applies even when the owner acquires
or enlarges it with the intention of defrauding creditors.
States that have no dollar cap on their homestead exemption limit the
exemption to a certain area of land. This is much larger in rural areas. For
example, the exemption in Florida is limited to half an acre in the city and
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160 contiguous acres at other places. Practically, this limitation will hardly
ever be a factor.
On the other hand, Delaware, the District of Columbia, Maryland, New

Jersey, Pennsylvania, and Rhode Island do not provide any specific
homestead exemption.
Exemptions are offered between these extremes in most of the states.

However, the exemptions can be anywhere along this range. For example,
the exemption in Ohio is $5,000, in North Dakota $80,000, and in Nevada
it is $125,000.
The homestead exemption under the federal bankruptcy provisions is

$17,425. If a states homestead exemption is less than this amount, then the
consumer, who is considering a bankruptcy filing should opt to use the
federal exemption, provided the state law permits it. All other aspects
remain equal.
As the homestead exemption is taken to be a basic and important right in

most states, including Florida and Texas, it is authorized by the
constitution of the states. This restricts the states legislature from revising
or abolishing the exemption by statute.
Generally, uncontested liens such as mortgages cannot be terminated

inside or outside of bankruptcy, although they are attached to property
subject to an exemption. So, a homestead exemption eventually would
mean nothing if the property is heavily mortgaged.
In some states the homestead exemption has to be recorded at the county

recording office by the property owners. A homeowner may not be able to
use the exemption if he does not have it recorded. Some states require the
recording to take place before the bankruptcy is filed, while in other states,
recording must take place before a forced sale of a property. Recording the
exemption is optional in some states, and it does not matter if the recording
does not occur. However, if recording is allowed or required, it is better for
the homeowner to record the homestead exemption in any case.
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Following is the list of states that allow, or require a homestead exemption
to be recorded:
Alabama Iowa Nevada Washington
Arkansas Massachusetts South Dakota
California Michigan Texas
Florida Montana Utah
Idaho Nebraska Virginia
OBLIGATIONS UNAFFECTED BY HOMESTEAD DECLARATION
The homestead exemption amount has kept increasing. The validity of a

homestead exemption does not only depend on the recordation of the
homestead declaration, but also on other aspects such as actual occupancy
in the declared homestead property at the time of the recording of the
declaration and an actual interest in the property.
Homestead Declaration Protection
The homestead declaration does not protect the homestead from all forced sales.
The property may be subject to forced sales in case a judgment is attained:
Before the recording of the homestead declaration.
On loans secured by the encumbrances on the property executed by the

owner before the filing of the declaration for record.
On obligations secured by mechanics liens on the property.
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CONTENTS OF THE HOMESTEAD DECLARATION
A recorded homestead declaration has the following:
The name of the owner of the declared homestead. In case a husband

and wife both own an interest in the property chosen as their declared
homestead, then both their names may appear as declared homestead
owners.
The declared homesteads description.
A statement that mentions that the declared homestead is the

principal property of the declared homesteads owner (or the spouse
of such a person), and that the declared homestead owner (or the
spouse of such a person) resides in the declared homestead on the
date of the recordation of the homestead declaration.
EFFECT OF RECORDING AND ITS TERMINATION
Once a valid homestead declaration is filed in the county recorder where

the property is located, consisting of all the statements and details required
by the law, then the property becomes a homestead that is protected from
execution and forced sale, except if the statute provides otherwise. This
recorded homestead remains so till the time it is terminated by conveyance,
abandoned by a recorded instrument of abandonment, or sold at an
execution sale. There is no restriction or limitation set by the homestead
declaration on the right to convey or encumber the declared homestead.
FEDERAL HOMESTEAD ACT OF 1862
The declared homestead as explained above has no connection to the term

homesteading that is applied to filings on federal lands according to which
a person gained title to acreage by establishing residence or making
improvements on the land.
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The objective of the Federal Homestead Act of 1862 was to encourage
settlement of the country. In 1976, homesteading was discontinued on all
public lands, except in Alaska. This is because all the worthy agricultural
land had already been homesteaded or deeded. Congress soon realized that
the Homestead Act had outlasted its usefulness and passed the Federal
Land Policy and Management Act of 1976. This effectively repealed the old
law as it was applicable to all states except Alaska.
ASSURING MARKETABILITY OF TITLE

A marketable title is by no means a perfect title. Marketable only means
that the title is one that an individual would generally take as clear and free
from any possible challenge. For determining who actually owns what, one
can refer to the documentary record of ownership or the chain of title
available in the recorders office in the county where the property is located.
Abstractors used to investigate the status of title to property, prior to the

availability of the reliable histories of properties. They examined available
records and relevant documents, and prepared a summary called an
abstract of title. The abstract of title listed all the conveyances and other
facts concerning the property for the inspection by the prospective buyer or
lender. This was the original basis on which marketability of title was
established the abstract chain of title along with a legal advisors opinion.
These records were kept in a title plant and were provided to the interested
parties with a certificate of title. It stated that the property in question was
found to genuinely belong to the present owner, subject to noted
encumbrances. The guarantee of title was the next step that followed. In
this, the title insurance company furnished written assurances about the
title to real property, insuring against loss.
TITLE INSURANCE
Lastly, as per public demand, the title insurance companies started issuing
policies of title insurance. A major advantage of this was that the title
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insurance rendered protection against matters of record and a lot of non-
recorded types of risks, according to the types policy purchased.
In addition to matters of record, a standard policy of title insurance

protects against:
Off-record risks of forgery, impersonation, or a partys failure to be

legally competent to make a contract.
The probability that a deed of record was not actually delivered with
the intention to convey title.
The loss which may incur from a lien incurred from federal estate
taxes. These are effective without notice, at the death of an individual.
The expense incurred while defending the title.
A standard policy does NOT include protection against:
Defects in the title that is not disclosed to the title insurance

company but is known to the holder to exist at the date of the policy.
Easements and liens that are not discoverable through public

records.
Rights or claims of persons who are in physical possession of the

property, but their claims are not known through public records.
Rights or claims not known through public records but which could
be discovered when the property is physically inspected.
Reservations in patents or water rights.
Zoning ordinances.
Mining claims.
Many of the above mentioned risks may be covered by purchasing a policy

at an added price called an extended policy. The American Land Title
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Association offers an extended coverage policy to the owners, known as
A.L.T.A. This policy includes the same coverage as a standard policy, with
the below mentioned added coverage:
Unmarketability of title.
Reservations in patents.
Protection against claims of parties in physical possession of the

property, without recorded interests.
Lenders may purchase an A.L.T.A. policy, with the same extended policy,
for protection against loss of their investment in the property due to a
defect in the title.
Title insurance policies are now very commonly used all over California.
Policies are made in standardized forms prepared by the California Land
Title Association, the state trade organization of title companies.
All title insurers need to adopt and make publicly available a schedule of
fees and charges for title policies. Also, each title insurance company must
have on deposit a guarantee fund for the protection of title insurance policy
holders. The insurance commissioner is in charge of this fund.
CHAPTER SUMMARY
As society grew into political states, important ownership traditions

took the form of laws.
To safeguard the ownership of land by its people, Americans came up

with a policy of recording evidence of title or interest.
There are two ways of giving a public notice. A constructive notice

may be given by recording a document in the public records at the
office of the county recorder. Another way of giving such notice is by
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occupying or using the property in a way that notifies anyone
interested that the party in possession is the lawful owner.
Property owned by one individual or entity is known as ownership in

severalty or sole and separate ownership.
When two or more people or entities own a property at the same time,
it is known as concurrent ownership or co-ownership.
An interest in real property that is held by someone who is not the

owner of the property is called an encumbrance.
An easement is the right to use the property of someone else for a

specified purpose.
A homestead exemption limits the amount of liability for some of the

debts against which a home can be used to satisfy a judgment.
The title insurance companies started issuing policies of title

insurance. A major advantage of this was that the title insurance
rendered protection against matters of record as well as non-recorded
types of risks, according to the policy types purchased.
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CHAPTER QUIZ
1. When there is an easement appurtenant, the dominant tenement:
a) Is burdened by the easement
b) Can only be used for the purpose of ingress and egress
c) Receives the benefits of the easement
d) Cannot be sold
2. Unlike a license, an easement:

a) Runs with the land
b) Is not an encumbrance
c) Is considered a possessory interest in real property
d) Can be revoked by the owner of the servient tenement
3. Janets property includes an easement over Bettys parcel. Janets

property is the:
a) Dominant tenement
b) Servient tenement
c) Easement
d) Encroachment
4. A corporation takes title to real property as a:

a) Joint tenant
b) Severalty
c) Community property
d) Tenancy in common
5. Which of the following takes priority over a mortgage, even if that

mortgage was recorded first:
a) A deed of trust
b) A property tax lien
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c) A judgment lien
6. The four unities of title, time, interest, and possession are

necessary for a:
a) Joint tenancy
b) Tenancy in common
c) Mortgage
d) Partnership
7. Recording a lis pendens:

a) Does not affect the title
b) Clouds the title but does not affect the marketability
c) Clouds the title and affects the marketability
d) Affects the current owner but not a subsequent owner
8. Restrictions imposed by a past or current real property owner

affecting the propertys use are called:
a) CC&Rs
b) Trust deeds
c) Lis pendens
d) Liens
9. William, who is an owner of a ranch, gives Henry who owns no

property, a non-revocable right to cross his ranch to fish in the
adjoining river. Henry has a(an):
a) License
b) Easement in gross
c) Easement appurtenant
d) Easement by prescription
10. Deed restrictions are imposed on a property by:
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a) The legislature
b) The developer
c) Board of equalization
d) City council
11. Married persons can take title in the following way(s):
a) Joint tenancy
b) Community property
c) Community property with the right of survivorship
d) All of the above
12. An interest in real property that is held by someone who is not the
owner of the property is called an indirect interest.
a) True
b) False
Answer Key:
1. C 7. C
2. A 8. A
3. A 9. B
4. B 10. B
5. B 11. D
6. A 12. B
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CHAPTER FOUR
INSTRUMENTS OF FINANCE
INTRODUCTION
Most people would never be in the position of buying a house, if they had to
pay the total amount in cash. The price of an average single family home is
so high, making it an impossible dream without the realistic benefit of
financing.
Home buyers were enabled to procure a loan for the difference between the
sales price and the down payment by real estate lenders, thus allowing a
property to be bought and sold without requiring paying for an all-cash
sale.
A simple loan that was provided by a local bank, with an agreement that the
borrower would pay back all of it in a set time frame, is now a more
complicated matter. Buyers and sellers have to depend on experts to
understand all the available options for financing the purchase or sale of
the property.
HOW A LOAN WORKS
The borrower signs a promissory note when a loan is made. It is stated in

the note that a fixed amount of money has been borrowed, so the note
becomes proof of the debt.
When a loan is procured for the financing of real property, some type of
collateral (security) is normally required along with a promise to repay the
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money borrowed. The lender requires a substantial assurance apart from
the borrowers written promise that the money lent will be repaid. Usually,
the property that is being bought or borrowed against is used as collateral
or security for the debt. The lender feels that his loaned amount is secure if
he is assured of the property ownership in case the borrower defaults or
fails to repay the loan amount. The lender may then sell off the property to
get back the money given.
Based on the state in which the property that is being financed is located,
the promissory note is secured by either a trust deed or a mortgage. Once
the promissory note is signed, the borrower has to immediately execute a
trust deed or mortgage. This is the security that guarantees the repayment
of the loan. This process is known as hypothecation. It allows the borrower
to remain in possession of the property while it is being used to secure the
loan. The right of possession and ownership is lost if the borrower does not
make the payment as per the agreement. The trust deed and the note are
both held by the lender until the repayment of the loan.
In case of a trust deed, the lender is allowed to order the trustee to sell the
property as described in the deed, if there is a loan default by the borrower.
While in a mortgage, the lender himself may foreclose on the property of
the defaulter. We shall study more about trust deeds and mortgages in later
chapters.
Procuring a loan to buy a property means that the buyer is using the money
of the lender to finance the sale. This is called leverage. Using borrowed
capital for purchasing real property is a method that allows the buyer to use
some of his own money and a large amount of someone elses.
There are many reasons why leverage attracts both the property buyer and
the investor. For the property buyer, the main advantage is that he does not
have to accumulate the entire purchase amount himself in order to become
a home owner. The investor can use leverage to control many investments,
and not just one, each purchased with a small amount of personal funds
and a bigger chunk of the lenders money. The investor then earns a return
on each property, thus adding to the amount of profit on money invested.
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PROMISSORY NOTE
A written promise to pay back a fixed sum of money at specified terms and
at a time mutually decided is called a promissory note, or simply, a note.
Casually, it can also be called an I.O.U. The person borrowing the money or
making the note is the maker. The one who loans the money or holds the
note is the holder. A promissory note is a personal obligation of the
borrower and a proper contract in itself, between the borrower and the
lender.
As per the Uniform Commercial Code, a promissory note must meet some
specific requirements for it to be legally enforceable.
Promissory Note:
It is an unconditional written promise to pay a certain amount of money.
It is a promise made by two people who are legally able to enter into a
r contract.
It is signed by the maker (the borrower).
It is payable on demand or at a defined time.
It is paid to the bearer or to order.
It is voluntarily delivered by the borrower and accepted by the lender.
NEGOTIABLE INSTRUMENT
A written unconditional promise or order to pay a certain amount of money

at a defined time or on demand is called a negotiable instrument.
A promissory note is a negotiable instrument. An ordinary bank check is

the most common type of negotiable instrument. A check is an order to the
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bank to pay the money to the person named on the check. A promissory
note, too, is the same thing. Just like a check, a promissory note can also be
transferred by endorsement (signature). A correctly prepared check is just
like cash.
A document will be considered as a negotiable instrument, if it follows the

statutory definitions and has all the following elements:
It must be signed by a maker or drawer
An unconditional promise or order to pay a certain amount in money
Payable on demand or at a defined time
Payable to order or bearer
TYPES OF NOTES
It is possible that a promissory note stands alone as an unsecured loan or
note. It may even be secured by a trust deed or a mortgage. The promissory
note, nonetheless, is the primary instrument. In case of a conflict between
the terms of the note and the trust deed or mortgage, the terms of the note
will rule.
There are many types of promissory notes, all with different obligations
made distinct by the terms of the note. Some notes have a fixed interest rate
through the life of the loan, while others may have a movable interest rate
as well as changes in the payment over the life of the loan.
Fully Amortized Note

The most common type of loan with institutional lenders is the fully
amortized loan. In this type of loan, interest is charged on the principal
balance due (i.e., the original loan amount plus other loan costs that the
borrower decides to add rather than paying them at the time of funding the
loan) at the rate and term as agreed mutually by the lender and the
borrower. Once the interest for the term of the loan is calculated and added
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to the principal amount to get to the amount to be amortized, payment
amounts are then determined by dividing that amount (i.e. principal plus
interest) by the number of payments in the term of the loan. Payments are
made on a regular and periodic basis, of both the interest and principal to
pay off the debt completely by the end of the term.
A fixed-rate loan is the most common type of fully amortized note. These
are the types of loans that are available for 30 years, 20 years, 15 years, and
10 years. There are bi-monthly mortgages, too. These shorten the loan by
calling for half the monthly payment every two weeks. As there are 52
weeks in a year, 26 payments are made by the borrower.
Fully amortized fixed-rate loans have two specific features. First, the
interest rate remains fixed for the life of the loan. Second, the payments
remain the same for the life of the loan and are so structured that the loan
gets repaid by the end of its term. The 15-year loan and the 30-year loan are
the most common fixed rate loans.
In the initial amortization period, a large part of the monthly payment is

used for paying the interest. As the loan keeps getting paid off, the monthly
payments start becoming applied to the principal amount. A regular 30-
year fixed-rate loan would take 22.5 years of level payments to pay half of
the original loan amount.
Partially Amortized Installment Note
In a partially amortized installment note, regular and periodic payments

on the principal amount are required to be made. The interest that accrues
during the term of the loan, and other surplus unpaid principal is to be paid
at the end of the term. This type of note is generally used by private lenders.
Straight Note
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In a straight note only the interest is paid, or else no payment is made
during the term of the note. All the accrued amount, i.e., either just the
principal or the principal and the interest, is due and payable on a
particular date. This type of loan is not preferred by institutional lenders,
but it may be used by private lenders.
ADJUSTABLE RATE MORTGAGES (ARMS)

In an ARM, the interest rate is tied to a movable economic index. The
interest rate varies up and down over the term of the loan as per the money
market conditions and an agreed upon index.
A loan of this nature was first offered because of the big recession and
banking crisis that happened during the early 1980s. There are many types
of ARMs available these days, but the most basic adjustable loan is the one
that has an interest rate tied to a particular government economic index.
A borrower with an ARM may get various different offers of interest rates,
terms, payments, or adjustment periods from a lender. The foremost
interest rate is decided by the current rate of the chosen index. After that, a
margin (this could be from one to three percentage points) is added to the
initial interest rate to find out the actual beginning rate that the borrower
will have to pay. The margin is retained for the life of the loan and remains
constant. But the interest rate may change, as the chosen index changes as
per the economic conditions that affect it.
The payments of the borrowers remain the same for a fixed period of time.
This might be a period of six months or a year based on the agreement with
the lender. As the agreed-upon time approaches, the lender reviews the
loan to confirm if the index has changed (either upwards or downwards).
Then he calculates the new payment on the basis of the changed interest
rate plus the same margin. This will then be the new payment for the
borrower for the next six months or a year, until the loan is reviewed again.
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Usually a limit is set on how much the interest rate can change over one
year, plus there is also a lifetime cap (limit) on changes in interest rate. One
to 2% is the maximum annual increase, while the lifetime cap is not allowed
to go beyond five or six points above the starting rate.
CHARACTERISTICS OF ARMs
The following characteristics are common in all ARMs:
Introductory Rate: Many ARMs start with a low interest rate, as low as
5.0% below the market rate of a fixed loan. This starting rate stays the same
for as long as 10 years. According to the rules, the lower the start rate, the
shorter the time before the loans first adjustment can be made.
Index: The financial instrument, to which the ARM is tied to or adjusted

to, is called the index. Commonly used indices are the 1-Year Treasury
Security, LIBOR (London Interbank Offered Rate), the 11th District Cost of
Funds (COFI), Prime, and 6-Month Certificate of Deposit. On the basis of
financial market conditions, these indices move up or down.
Margin: One of the major features of ARMs is its margin. The margin is
added to the index to find out the interest rate that the borrower must pay.
The margin added to the index is known as the fully-indexed rate. For
example, if the current index value is 6.25% and the loan has a margin of
3%, the fully indexed rate is 9.25%. The loan margins range from 1.75% to
3.5%, depending on the index and the financed amount in relation to the
value of the property.
Interim Caps: Interim caps come with all adjustable rate loans. Some
ARMs have interest rate caps of six months or a year. Some loans have
interest rate caps of three years. At a time when interest rates in the market
are rising, interest rate caps are beneficial. It can also keep interest rates
higher than the fully indexed rate, if the interest rates start to fall.
Payment Caps: Instead of interest rate caps, some of the loans have
payment caps. In a rising interest rate market, these loans minimize
payment shocks, but may also cause deferred interest or negative
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amortization. The annual payment increases are generally capped by the
loans to around 7.5% of the previous payment.
Lifetime Caps: Most of the ARMs come with a maximum interest rate or
lifetime interest rate cap. The lifetime cap is different depending on the
company or the loan. Loans having low lifetime caps generally have higher
margins and vice versa. The loans having low margins usually have higher
lifetime caps.
ARM Index: There are different index options that are available to suit
individual needs and risk resistance with the various market instruments.
Purchases and refinances can both be applied to the ARMs, resulting in
different indices. A borrower can take full advantage of falling index rates if
he chooses an ARM with an index that reacts quickly to changing rates.
Meanwhile, an index that falls behind the market allows the borrower to
take advantage of lower rates even after the market rates have started to
shoot upward.
ARM Indices and Programs
6-Month Certificate of Deposit (CD) ARM:

Has maximum interest rate adjustment of 1% every six months.
The index of this ARM usually reacts quickly to changes in the market.
1-Year Treasury Spot ARM:

Has maximum interest rate adjustment of 2% every 12 months.
The index of this ARM usually reacts more slowly than the CD index, but quicker than the
Treasury Average Index.
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ARM Indices and Programs (contd.)
6-Month Treasury Average ARM:

Has maximum interest rate adjustment of 1% every 6 months.
The index of this ARM usually reacts more slowly in fluctuating markets, thus adjustments in
the ARM interest rate will fall behind some other market indicators.
12-Month Treasury Average ARM:

Has a maximum interest rate adjustment of 2% every 12 months.
The index of this ARM usually reacts more slowly in fluctuating markets, thus adjustments in
the ARM interest rate will fall behind some other market indicators.
LiborLondon Interbank Offered Rate

This is the rate on dollar-denominated deposits which is also called Eurodollars.
Eurodollars is traded between banks in London.
The index is quoted for 1 month, 3 months, 6 months and 1 year periods.
Libor is the base interest rate paid on deposits between banks in the Eurodollar market.
A Eurodollar is a dollar deposited in a bank of the country whose currency is not the dollar.
The Eurodollar market is as old as 40 years and a main element of the International financial
market. In terms of volume, London is the center of the Euromarket.
The Libor rate which is quoted in the Wall Street Journal is an average of rate quotes from
five major banks i.e. Bank of America, Barclays, Bank of Tokyo, Deutsche Bank, and Swiss
Bank.
COFI Cost of Funds Index

The 11th District Cost of Funds is more widespread in the West and the 1-Year Treasury
Security is more widespread in the East.
The slowly moving 11th District Cost of Funds is preferred by buyers while the 1-Year
Treasury Security is preferred by investors.
The monthly weighted average 11 th District is published by the Federal Home Loan Bank of
San Francisco since August 1981.
At present, more than one-half of the savings institutions loans that are made in California
are tied to the 11th District Cost of Funds (COF) index.
The Federal Home Loan Banks 11th District is composed of saving institutions in Arizona,
California, and Nevada.
Hybrid Note
Although most consumers would prefer the familiar types of loans, a new
type of loan called a hybrid mortgage may suit some borrowers. In this
type of loan, the interest rate is fixed for an opening period of three, five,
seven, or 10 years. Then the interest rate is tied to an economic index that
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adjusts every year. This mortgage has combined features of a fixed-rate
loan and the adjustable-rate loan, so it is called a hybrid mortgage.
A hybrid note may be preferred by the borrowers who plan to sell their
homes or pay off their loan within a few years. The initial interest rates on
these loans are generally lower than a fixed rate loan, but permit the
security, at least for the first years of fixed payments, of a fixed-rate loan.
The borrower can later on decide to either sell the property or refinance the
loan when it converts into an adjustable loan, particularly if the current
interest rates at that time are higher, and requires a higher monthly
payment. The borrower takes a chance with the hybrid loan in the
expectation that the interest rates will be lower when the interest rate
adjusts.
HOLDER IN DUE COURSE
We already know that notes are negotiable instruments that can easily be
transferred from one person to another. Nonetheless, the transferee or
buyer of the note should be confident in getting the money when the note is
paid.
A person who purchases an existing promissory note for value, and in good
faith, without notice that it is due for payment or that it has been
dishonored or claimed by another person, is called a holder in due course.
Holder in Due Course Takes a Negotiable Instrument if it is:

Complete and regular in appearance and form.
Without a notice that it is overdue, dishonored, or claimed by another person.
Purchased in good faith for valuable consideration.
The position of the holder in due course is favored in terms of the

instrument as the borrower cannot bring up certain personal defenses for
refusal to pay. Lack of consideration, setoff, and fraud are included as
personal defenses.
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This favorable position held by the holder in due course is a superior claim
than the original holder for the payment of the note. If a lawsuit becomes
inevitable for bringing payment on the note, the borrower cannot make any
of the following defenses to refuse payment to the holder in due course,
although the same defenses may be used against the original lender.
The following defenses cannot be used by the maker (borrower) of a note:
The maker cannot claim not received for what the payee promised in
return for the note.
The maker cannot claim that the debt was already paid. Although it
may have been paid, with no proof and the original payee having
transferred the note to a holder in due course, the original borrower
may still have to pay.
The maker cannot use fraud, in the original making of the note, as a
defense.
A setoff cannot be claimed by the maker; for instance, if $20,000 is

owed and the payee only owes $25,000 to the holder. The difference
cannot be used as a defense against paying the note.
The above mentioned defenses may be used against the original payee
(lender) but not against a holder in due course.
There are some defenses that may be used against anyone, a payee or a
holder in due course.
The following defenses are allowed against a payee as well as a holder in

due course:
Forgery, in case the maker did not actually sign the note.
Unrevealed material changes in the note.
If the maker is incompetent or a minor.
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If the note is connected to an illegal act or if the interest rate is
covetous.
Due to this partial treatment (the safety net) for a holder in due course,
people prefer to opt for these kinds of instruments without the necessity of
checking the credibility of the borrower or knowing the borrower.
CONFLICT IN THE TERMS OF A NOTE AND TRUST DEED
We know that a note is the evidence of a debt. A trust deed or mortgage is

the security for the debt nonetheless; it is still only an incident of the debt.
A trust deed or a mortgage needs a note to secure, while a note does not
require a trust deed or mortgage for a security. As mentioned before, in
case of a conflict in the terms of a note and the trust deed or mortgage used
as security, the terms of the note will rule. An unenforceable note cannot be
validated by the presence of a trust deed. But, if a note has an acceleration
clause (due on sale), the trust deed should mention it too for the clause to
be enforceable.
Security interest is the interest of a creditor (i.e., the lender) in the property
of a debtor (i.e., the borrower). The security interest allows some assets of a
borrower to be kept reserved so that it may be sold off by the creditor if in
case the borrower defaults on the loan.
The debt can be paid off using the proceeds from this sale. There is a
document called the security instrument which states the rights and duties
of the lenders and borrowers. Some of the states use the trust deed as the
primary instrument to secure loans, while other states use mortgages for
the same purpose.
The use of mortgages is similar to the purposes fulfilled by trust deeds; they
are used for securing real property loans. The term mortgage is commonly
used in California and also in other trust deed states, as in mortgage
company, mortgage broker, and mortgage payment -- here the term
mortgage actually implies a trust deed.
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PROPERTY TRANSFERS BY THE BORROWER
In some situations, an owner of a property might transfer the loan
responsibility to the buyer, when the property is sold off to another party. A
buyer may either assume the existing loan or then buy the property subject
to the existing loan.
ASSUMING A LOAN
A buyer may assume an existing loan when he purchases a real property.

Normally the lender gives his consent to the buyer for taking over the
primary liability for the loan. However, the original borrower is secondarily
liable for the loan in case of a default. This means that although the original
borrower is responsible secondarily, the loan assumption agreement does
not state that any actual repayment of the loan is expected from him. As per
the laws of the particular state, if there is no allowance for a deficiency
judgment, the credit of the borrower will be affected by the foreclosure but
he will not be required to pay off the loan. On default by the new owner, the
property is foreclosed by the lender. The current owner loses the ownership
of the property due to the foreclosure and the previous owners credit takes
a beating.
The seller or the original borrower can avert the responsibility of the loan
by urging the lender for a substitution of liability. Discharging the seller of
all liabilities for the repayment of the loan is called a novation.
In majority of the cases, a buyer assumes the existing loan with the consent
of the lender. The buyer might be prevented from assuming the loan if an
alienation clause is mentioned in the note, also called a due-on-sale clause.
SUBJECT TO THE EXISTING LOAN

A buyer may have purchased the property subject to the existing loan. In
this, the responsibility of the loan remains with the original borrower, but
the title is kept by the new buyer and payments also made by him. Here,
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too, the property remains as security for the loan. If there is a default, the
property is sold and the proceeds are used to pay off the loan. The original
borrower gets nothing from the proceeds. Yet again, the original borrowers
creditworthiness is negatively affected in case of a default. Some states
allow a deficiency judgment for the lender against the original borrower.
This would hold the original borrower responsible for the loan and he
would have to pay off to the lender for any loss suffered if the property is
sold for less than the loan amount.
The lender may not necessarily be informed if the buyer purchases a

property subject to an existing loan. The buyer starts making the
payments and the seller hopes that he does not default.
The subject to sales take place in conjunction with the economic and
market conditions. In a sellers real estate market (where there are more
buyers and less sellers), a property owner does not need to sell to his loan.
As opposed to a condition of a market where the money is tight, interest
rates are high and the buyers are few, a seller might become interested in
selling his property subject to his loan.
CLAUSES IN FINANCING INSTRUMENTS
Whenever a note is signed by a borrower in which he promises to repay an

amount, the lender always includes certain requirements in the note with
regards to the repayment. These are special clauses that are supposed to
protect the lender and his interests.
ACCELERATION CLAUSE
In an acceleration clause, a lender can call the entire note due if a specific
event occurs, such as a default in payment, taxes or insurance, or sale of
property.
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ALIENATION CLAUSE
An alienation clause which is also known as a due-on-sale clause is quite

similar to an acceleration clause. An entire note may be called due by the
lender, if there is a property ownership transfer from the original borrower
to another person. This clause keeps unqualified and unapproved buyers at
bay from taking over the loan. It is understandable that the lender fears a
default is likely, if there is no control over who is making the payments.
ASSUMPTION CLAUSE
In an assumption clause, the buyer is allowed to take responsibility for the

full payment of the loan. The lender is informed and gives his approval.
SUBJECT TO CLAUSE
In a subject to clause the buyer is allowed to take over a loan and make
payments, without the lenders knowledge and approval. The responsibility
of the loan remains with the original borrower.
SUBORDINATION CLAUSE
A subordination clause is used when the priority of a financial instrument

needs to be changed. As we know, the priority of a trust deed is determined
by the date it is recorded. If recorded earlier, the advantage will be greater.
If a subordination clause is included in a note and a trust deed, a new loan
that is recorded later assumes a higher priority, because of the
subordination clause. This clause is primarily used when land is bought
with an intention of constructing a home later, and will need financing. The
new financer would want to be in a prime position to secure his interest,
thus the trust deed would become subordinate to a new loan on the
building when the new loan was financed and recorded.
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PREPAYMENT CLAUSE
Sometimes, a trust deed comes with a prepayment clause if a borrower

pays off a loan before time. When making loans, the lenders calculate their
return over the loan term. In case a loan is paid off before its term, the
interest that the lender receives becomes less than expected; therefore, the
return on his investment is under threat. The borrower needs to balance
this by paying a penalty. A consumer may find this strange, but it is due to
banking standards.
In case of residential property, the penalty for prepayment cannot go

beyond six months interest. The borrower is allowed to prepay up to 20%
of the loan amount in any 12-month period and not have to pay a penalty.
Now, a prepayment penalty can be charged only on the amount in excess of
20% of the original loan amount. Other rules do apply for non-residential
property.
OR MORE CLAUSE
In an or more clause, a borrower is allowed to pay off a loan early, or make

bigger payments without penalty.
JUNIOR TRUST DEED

A junior trust deed is another way of financing a real property, either when
a sale is being done or afterwards. This is any loan that is recorded after the
first trust deed, secured by a second, third, or a following trust deed.
Sometimes in a sale, the first trust deed loan and the buyers down payment
added together are not enough to cover the purchase price of the property.
That is when additional money is required.
OUTSIDE FINANCING
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A buyer can acquire the necessary financing by getting a secondary loan
through an outside source, maybe a mortgage lender, or a private investor.
This is the same time when the buyer has also applied for a loan secured by
a first trust deed from a typical lender. A second or junior loan is made to
get through the financing.
If you remember, any loan that is made at the time of a sale and is a part of
the sale is called a purchase money loan. When the escrow comes to a close,
the loan from the first trust deed is financed and sent to the escrow holder,
who then sends it to the seller after he gets all the necessary loan
documents signed by the buyer.
The same applies to the second trust deed-secured new purchase money
loan. This loan, too, is similarly financed and the money is sent to the
escrow holder, who then gives it to the seller after obtaining all the loan
documents signed by the buyer. The escrow holder at this time asks the
buyer to bring the down payment too. Once the costs of the sale from the
first and the second loan are covered, the balance amount from the
proceeds is given to the seller at the close of the escrow.
SELLER FINANCING
The seller is another possible source for secondary financing of a sale. The
seller turns into a lender, agreeing to carry back or act as a banker, and
make a loan for the required amount, to the buyer. This loan is secured by
a trust deed favoring the seller, and recorded subsequent to the first trust
deed.
When a seller finances the sale of his property, it is called a purchase money
loan, too, just like a loan that is financed by an outside lender. If the first
loan provides a substantial amount to the seller, along with the buyers
down payment, then the seller might consider carrying a second trust deed
probably for income or to bring down tax liability by taking installment
payments.
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When the seller offers credit by way of a loan secured by a second deed of
trust, the note may be a straight note with interest-only payments or no
payments at all. It could also be an installment note with a balloon payment
in the end, or else a fully-amortized note with equal payments till the loan
is paid off completely. The buyer and the seller finalize the terms of the
loan. The escrow usually carries out the instructions of the buyer and seller
in regards to the seller financing.
A trust deed that a seller holds may be sold by him to an outside party; a
mortgage broker, generally. Although the mortgage broker will discount or
reduce the value of the note or trust deed, yet it is one way through which
the seller might get cash out of the trust deed that was carried back.
Heres an example:
Shaun and Mitchell were owners of an investment property. After

some years, they plan to sell the property on the market for
$400,000. They were expecting to get a full-price offer for their
property and then go their separate ways with the profits earned.
After a few months, they did receive a full-price offer. The buyer
agreed to make a down payment of $60,000 and procure a new first
loan for $300,000, while requesting Shaun and Mitchell to carry
$40,000 for two years as a second trust deed. The agent for the
owners suggested that they accept the sellers offer and sell the
second trust deed after the close of escrow. Although it would be
discounted, it was a good option for obtaining the maximum cash
out of their investment.
Now, if the second trust deed was sold at a discount of $7,000,

Shaun and Mitchell would end up with $33,000 ($40,000 minus
$7,000). Thus, the owners got the cash out of the sale, even if they
had to settle for less than what they initially expected due to the
discount. They accepted the advice of the agent and were satisfied
with the end result.
A seller-financed real estate transaction requires by law that the buyer and
the seller complete a Seller Financing Disclosure Statement. This gives
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both the seller and buyer all the necessary information needed to make an
informed decision regarding seller financing to complete the sale.
The disclosure can help the seller determine whether the buyer has the
capacity to pay off the loan by checking the buyers income and the buyers
credit history. The buyer finds out about existing loans and other details
like the due date and payments on existing loans (the senior loans than the
one in question).
BALLOON PAYMENT LOANS
Often, when a hard money lenders first trust deed loan is for $30,000 or
more, or a junior trust deed loan is for $20,000 or more, or when a seller
withdraws a junior purchase money note and trust deed, the necessary
monthly installment payments do not amortize the loan over the term. This
causes a large payment of principal and interest which is called a balloon
payment (it becomes due on the last payment). These balloon payment
loans are generally short term loans, about three to five years.
Considering consumer welfare, the law demands that the holder of a

balloon note that is secured by an owner-occupied building of one-to-four
units must give a warning of 90 to 150 days of the balloon payment due
date.
With reference to the hard money junior loans under $20,000 that are
negotiated by loan brokers in terms of less than three years, if the payments
are made in installments, then the final payment may not be more than
twice the smallest payment amount.
The law dealing with balloon payments is for all loans except purchase
money loans offered by a seller to aid a buyer finance a sale.
Hard Money Loan
Hard money is a loan that is made in return for cash, and not one made to finance
a particular property.
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OTHER LOANS SECURED BY TRUST DEEDS OR
MORTGAGES
HOME EQUITY LOAN
Another way of creating a junior loan is by a home equity loan. Supposing

there is sufficient equity, or the difference between the value of a home and
the money that is owed against it, a homeowner can apply for a cash loan
for any purpose.
Concerning loans, particularly junior loans, a lender adopts strict standards

for the amount of equity required in a property before making a loan. The
lender does this simply to get his money back within the stipulated time,
along with his expected return on the investment made. Special care should
be taken if the value of a subject property seems to decrease. The lender
must ascertain that the margin between the total amount owed and the
value of the property is sufficient. If a foreclosure action needs to be taken
against the property, it should be able to cover the money loaned by the
lender. The lender usually loans 75% - 90% of the property value, thus
keeping some leeway for loss.
Rodneys property was evaluated at $150,000 and a first trust

deed of $50,000 was recorded against it. Rodney required a
home equity loan for $45,000. The lender needs to determine
whether he should loan to Rodney. He adds the amount owed to
the amount required in the loan to find out the percentage that
would be encumbered by the existing first trust deed and the
required second trust deed. If the lender was to loan up to 80% of
the appraised value of the property, then would Rodney receive
his desired loan?
The priority of the loan depends on the other instruments that are recorded
before it, though it will be known as a hard money loan subject to state
laws. It will be secured by a deed of trust or mortgage against the property.
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Rodney does qualify for the loan as he has enough equity in the property.
HOME EQUITY LINE OF CREDIT (HELOC)
Many lenders are now offering home equity lines of credit. At a

comparatively lower interest rate, the borrower may use the equity in their
homes for procuring a sizeable amount of credit that may be used as
needed. Moreover, as per the tax law and depending on the specific
situation of the borrower, he may be allowed to deduct the interest as the
debt is secured by the property.
What is a home equity line of credit?
This is a type of revolving credit where a borrowers home serves as

collateral. Since a home is most consumers largest asset, most of them use
their home equity credit lines only for major necessities such as education,
medical bills, or home improvements and not for daily expenses.
There is a credit limit, i.e., a specific amount of money approved to a

borrower in a line of credit at one point of time.
The credit limit on a home equity loan is set by most lenders by taking a
percentage (usually it is between 75% - 90%) of the appraised value of the
home and subtracting the balance owed on the prevailing mortgage.
The lender, when determining the actual credit line of the borrower, will
also consider his capacity to repay. The lender can do so by taking a look at
the income, debts, and other financial obligations, including the credit
history of the borrower.
In the home equity plans, there is often a fixed time limit during which
money can be borrowed by a home owner; for example, 10 years. On the
completion of this period, the borrower may renew the credit line if the
plan permits. However, if the plan does not permit renewals, then the
borrower wont be able to borrow additional money on the expiration of the
term. In some plans, full payment of the outstanding balance has to occur,
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while other plans may allow a borrower to repay the balance amount over a
period of time.
On approval of the home equity plan, generally the borrower should be able
to borrow up to the credit limit whenever he wants. Usually, a borrower
might draw on the line by using special checks.
Some plans may allow borrowers to use credit cards or other means by
which he might borrow money and make purchases using the line.
Nonetheless, there may be limitations on the borrowers for the use of the
funds. According to some plans, the home owner may have to borrow a
minimum amount every time he draws on the line and also keep a
minimum amount balance. Some lenders may also require the borrower to
take an advance upfront when first setting up the credit line.
Interest Rate Charges and Plan Features:
A typical home equity plan consists of variable interest rates, not fixed
rates. The basis of a variable rate should be a publicly available index such
as the prime rate that is published in a leading daily newspaper, or a U.S.
Treasury bill rate. The interest rate changes following the fluctuations in
the index. For calculating the interest rate that the borrower has to pay, the
lenders mostly add a margin of one or two percentage points. This
represents the profit that the lender will make, based on the index value.
Since the cost of borrowing is directly tied to the index rate, it becomes
necessary to know what index and margin each lender uses, the frequency
of the change in index, and the rise of the index in the past.
At times a temporarily discounted rate for home equity lines is advertised

by the lenders. This rate is exceptionally low and usually lasts for a short
introductory period.
Variable rate plans that are secured by a home should have a cap or a
ceiling on how high the interest rate can go up over the life of the plan.
There is a limit set on how much the payment may increase in some
variable-rate plans, as well as on how low the interest rate may fall if there
is a drop in interest rates.
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A borrower may be allowed by some lenders to change a variable rate to a
fixed interest rate during the life of the plan, or a borrower may change all
or a part of the line to a fixed-term installment loan.
Under certain circumstances, agreements would normally allow the lender

to freeze or reduce a credit line. For instance, some variable-rate plans
would disallow a borrower from getting additional funds during the period
when the interest rate reaches the cap.
Costs for Acquiring a Home Equity Line:
Much of the costs in setting up a home equity line of credit are similar to
those a borrower faces when buying a home. For instance:
A fee for a property appraisal (for estimating the value of the

property).
An application fee, which may not be refunded if the borrower does

not qualify for credit.
Initial charges, as in one or more points, whereby one point is equal

to 1% of the credit limit.
Closing costs, including fees for attorneys, title search, mortgage

preparation and filing, property and title insurance, and taxes.
Some charges during the plan, such as some plans imposing yearly
membership or maintenance fees.
A transaction fee also may be charged to the borrower each time he

draws on the credit line.
How is the Home Equity Plan Repaid by the Borrower?
A borrower should first confirm how he is going repay any money that he
borrows before entering into a plan. In some plans, a minimum payment
amount is set that will cover a part of the principal and the interest accrued.
However, this is unlike a normal installment loan; here, the portion that
goes towards principal may not be sufficient to repay the debt by the end of
the term. Some plans allow payments of interest alone during the life of the
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plan, without any amount going towards the principal. For example, if a
property owner borrows $20,000, he will owe the entire amount when the
plan ends.
Regardless of the minimum payment required, the borrower can pay more
than the minimum amount. Many lenders give choice of payment options
to the borrower. Generally, property owners prefer to pay the principal
amount regularly as it is done with other loans.
Whatever the payment arrangements may be during the life of the plan;
whether the borrower pays some or none of the principal amount of the
loan, whenever the plan ends, the borrower may be required to pay the
entire balance owed, all at one go. This balloon payment must be paid
either by refinancing from the lender, or by getting a loan from another
lender or by some other means.
Comparison between a Line of Credit and a Traditional Second

Mortgage Loan:
A property owner, who considers a home equity line of credit, might also
consider a traditional second mortgage loan, if he is looking to borrow
money. In this type of loan a fixed amount of money is provided that can be
repaid over a fixed time frame. The common payment schedule for this type
of loan requires equal payments that will pay off the entire loan within that
fixed time period. If the borrower opts for a home equity line of credit he
will get more flexibility while opting for a traditional second mortgage loan
will give him more security.
Lenders Disclosures:
As per the Truth in Lending Act, the lenders are supposed to disclose the
important terms and costs of their home equity plans, including APR, other
charges, the payments terms, and the information regarding any variable-
rate aspects. Usually, neither the lender nor any other person is allowed to
charge any fees until and unless the borrower receives this information.
These disclosures are given to the borrower when he receives an application
form and the additional disclosures are given once the plan opens. In case
of any change in the terms (other than a variable-rate aspect) before the
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opening of the plan, the lender has to return all fees if the borrower decides
against entering into the plan due to the change in the terms.
PACKAGE LOAN
A real property loan that is secured by more than the land and structure is
called a package loan. This includes fixtures that are attached to the
building such as appliances, carpets, curtains, furniture and so on.
BLANKET LOAN
A trust deed or mortgage covering more than one parcel of property may be
secured by what is known as a blanket loan. This loan commonly provides a
release clause which allows release of any particular parcel on repayment of
a specified part of the loan. It is typically used in connection with housing
tracts or construction loans.
OPEN-END LOAN
In this type of loan, an additional amount of money may be loaned to a

borrower later under the same trust deed. This open-end loan sustains the
original loans priority claim against the property.
SWING LOAN
A swing loan, also called a bridge loan, is a temporary, short-term loan. It

is made on a borrowers equity in his present home. When the borrower
purchases another property and needs money to close the sale, his current
home is not sold but rather used to secure a new loan by a trust deed or
mortgage against it. Normally there are no payments and the interest
accrues during the term of the loan. When the borrower sells his home, the
swing loan as well as the interest is repaid from the proceeds of the sale.
This is done through an escrow.
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WRAP-AROUND LOAN
A wrap-around loan is also called an all-inclusive trust deed (AITD). This

type of loan wraps an existing loan with a new one. The borrower makes
one payment for both the loans. The new trust deed i.e., the AITD is
inclusive of the current encumbrances, like the first, second, third, or more
trust deeds and also the amount that the seller will finance.
If a home owner wishes to use this type of financing for securing real
property, he must make sure that it is legally possible to wrap the existing
loan with the new AITD. Some loans do have alienation clauses (due-on-
sale) as a part of the promissory note, prohibiting the transfer of the
property to a new owner without the permission of the primary lender. It is
advisable to seek legal counseling to confirm that all parties are well aware
of the legal outcome of their actions.
The AITD is secondary to existing encumbrances as the AITD is created

after the encumbrances. This indicates that any existing encumbrances take
priority over the AITD, even though they are included (wrapped) by the
new AITD. The buyer receives title to the property, at closing.
An AITD is generally used in transactions between buyer and seller with an

intention of making the financing appealing to the buyer and valuable to
the seller at the same time. Here, the buyer does not assume an existing
loan nor does the seller carry back a second trust deed; the AITD does both
for the parties, thus being beneficial to both.
Advantages of a Wrap-Around Loan
Seller:
Generally gets full-price offer
Increased percent on amount carried
Buyer:
Low down payment
No qualification needed for a loan or payment of loan fees
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In a tight money market or when there is credit deficiency and it becomes
difficult for most buyers to qualify for traditional loans or for sellers to
refinance existing loans, buyers and sellers might have a very good option
in an AITD.
An existing loan is not disturbed by the AITD. The seller, who acts as the
new lender, keeps making payments while also obtaining a new increased
loan at a higher interest rate to the borrower. The AITD amount is inclusive
of the unpaid principal balance of the existing (primary) loan and the
amount of the new loan being made by the seller. The payment on the new
larger loan is made by the borrower to the seller, who then makes payment
to the holder of the existing (primary) loan. Thus the new loan wraps
around the existing (primary) loan.
Usually, a seller carries back a wrap-around trust deed at higher rate of

interest than the primary trust deed to increase the revenue. The original
trust deed is paid off by the seller from the payments on the wrap-around,
keeping the difference as his profit. This type of financing is beneficial when
the primary interest rate is low, when it becomes feasible for the seller to
charge a higher interest rate on the wrapped loan.
However, a wrap-around loan is not for all purposes. It will not work in
case a seller is looking to cash out. Plus, most loans have a due-on-sale
clause, which cannot be wrapped without the lenders knowledge and
approval. Depending on how motivated the buyer and the seller is, the
AITD is created, keeping in mind all the risks involved. This is also how the
term creative financing evolved.
These payments are normally collected by the note department of a bank or

a professional collection company. The payments are then sent to the
relevant parties. By doing this, the borrower of the AITD is assured that all
underlying payments are forwarded and kept current by a neutral party.
UNSECURED LOANS
In an unsecured loan, the lender receives a promissory note from the
borrower but without a security (such as a trust deed or mortgage) for
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payment of the debt. The only remedy in case of a default would be a
tedious law suit. This is a typically traditional I.O.U.
ALTERNATIVE FINANCING
In the unpredictable economy of the present day, alternative financing is a
practical option for lenders and borrowers. As the priorities of each lender
and each borrower are different from the other, there is no single type of
financing that fits everyones requirements.
Consumers needs keep changing and to meet these credit demands the
lenders have responded by offering various options. Previously, the
borrowers intending to buy a home had no choice besides a fixed-rate loan.
But now, numerous adjustable-rate loans are available for consumers.
As people saw the benefits of these loans, they recognized the solution to
the perplexity of a fast-changing market. It is the responsibility of real
estate and loan agents to introduce these new types of loans to consumers
and help them choose the one best suited to their requirements.
PLEDGED SAVINGS ACCOUNT MORTGAGE
A borrower who has a large amount of money in a savings or thrift account

can use that account as security for a lender. For the new lender, the
borrower has to keep a certain amount of money for a specified length of
time. This is because the new lender requires a certain ratio of new loan
amount to the balance amount in the account. This pledge account may be
released by the lender when the property has attained sufficient equity to
qualify under normal ratios.
GRADUATED PAYMENT MORTGAGE
In a Graduated Payment Mortgage (GPM), partially deferred payments of

principal are made at the start of the term with this payment increasing as
the loan matures. This loan is appropriate for those buyers who are
expecting to earn more in future years and can make bigger payments at
that time. This loan is also known as a flexible rate mortgage.
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As the borrowers and mortgage companies are looking for alternatives to
facilitate qualification for home financing, the GPM is making a comeback
against the conventional Adjustable Rate Mortgages.
In a GPM, unlike an ARM, there is a fixed-note rate and payment schedule.

Usually, the payments in a GPM are fixed for a year at a time. Every year,
for five years the payments graduate at 7.5% to 12.5% of the payment of the
previous year.
For both conforming and jumbo loans, GPMs are available in 30-year and
15-year amortization. The GPMs have scheduled negative amortization of
approximately 10% to 12% of the loan amount as per the rate of the note;
this is with the graduated payments and a fixed-note rate. The level of
amortization will be higher if the note rate is higher. This is similar to the
probable negative amortization of a monthly adjusting ARM of 10% of the
loan amount. In both these loans, the consumer is able to pay the additional
principal amount and get rid of the negative amortization. On the other
hand, the GPM has a fixed payment schedule, so the additional principal
payments reduce the term of the loan. The additional payments in the
ARMs prevent the negative amortization, decreasing the payments but
keeping the terms of the loan constant.
Most significantly, the note rate of a GPM is about .5% to .75% higher than
the note rate of a straight fixed-rate mortgage. In the long run, the
mortgage cost becomes more expensive for the borrower due to the higher
note rate and GPMs scheduled negative amortization. Plus, the borrowers
monthly payment can in rise up to 50% by the final payment adjustment.
The GPMs lower qualifying rate possibly maximizes the borrowers

purchasing power. This is useful in a market with brisk appreciation. On
the contrary, in markets where appreciation is cautious and with the
borrower looking to move during the scheduled negative amortization
period, eventually the property can be encumbered for more than its worth.
SHARED APPRECIATION MORTGAGE
The lender and the borrower, under the shared appreciation mortgage
(SAM), agree to share a certain percentage of the appreciation in the
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market value of the property which is used as security for the loan. The
borrower is offered beneficial loan terms in exchange for shared equity.
ROLLOVER MORTGAGE
The rollover mortgage (ROM) is a loan in which the interest rate and the
monthly payment are renegotiated, generally every five years.
REVERSE ANNUITY MORTGAGE
A reverse annuity mortgage is used by elderly homeowners who have

owned their homes for a long period of time and have a large amount of
equity, without much monthly income. The built-up equity is used by this
loan to pay the borrower a fixed annuity on the basis of a percentage of the
property value.
The loan does not have to be repaid by the borrower until a particular event
does not occur, such as a death or sale of the property; it is then that the
loan needs to be paid off. By increasing their loan balance every month, a
retired couple may draw on their home equity.
CONTRACT OF SALE
The contract of sale is also called an installment sales contract, or an

agreement of sale, or a conditional sales contract, or a land sales contract.
In this type of agreement, legal ownership of the property remains with the
seller until the buyers last payment. When normal financing is not
possible, this contract between the buyer and seller is made.
The buyer (vendee) holds an equitable title. Even though legal title is held
by the seller (vendor), the vendee may enjoy the possession and use of the
property. Similar to the holder of an AITD, the vendor pays off the original
financing as he receives payments from the vendee on the contract of sale.
There are a lot of similarities between a contract of sale and an AITD, but a
very important difference between the two is that, with an AITD the title
passes to the buyer; with a contract of sale, though, title stays with the seller
until the contract is paid off.
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CHAPTER SUMMARY
When a loan is procured for the financing of real property, some type
of collateral (security) is normally required along with a promise to
repay the money borrowed.
A written promise to pay back a fixed sum of money at specified

terms and at a time mutually decided upon is called a promissory
note, or simply, a note.
A fixed-rate loan is the most common type of fully-amortized note.
With ARMs, the interest rate is tied to a movable economic index.
In a hybrid note, the interest rate is fixed for an opening period of

three, five, seven, or 10 years. Then the interest rate is tied to an
economic index that adjusts every year.
A person who purchases an existing promissory note for value, and in

good faith, without notice that it is due for payment or that it has
been dishonored or claimed by another person is called a holder in
due course.
A home equity line of credit is a type of revolving credit by which a

borrowers home serves as collateral.
A wrap-around loan is also called an all-inclusive trust deed (AITD).

This type of loan wraps an existing loan with a new one.
In a Graduated Payment Mortgage (GPM), partially-deferred

payments of principal are made at the start of the term and this
payment increases as the loan matures.
A reverse annuity mortgage is used by elderly homeowners who have

owned their homes for a long period of time and have a large amount
of equity without much regular income.
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CHAPTER QUIZ
1. Which of the following is NOT a characteristic of a note?
a) It is an I.O.U.
b) It requires a mortgage for validity.
c) It is a promise to pay.
d) It is a negotiable instrument.
2. A common type of ___________ note is a fixed-rate loan.

a) Fully amortized
b) Partially amortized installment
c) Straight
d) Adjustable
3. This note type has an interest rate tied to a movable economic index:
a) Fully amortized note
b) Straight note
c) Adjustable note
d) Partially amortized installment note
4. _______ is added to indexes to set interest rates for the borrower:

a) Introductory rate
b) Margin
c) Interim caps
d) Payment caps
5. Which of the following is a correct feature of a hybrid note?

a) Only interest or no payments are made during the notes term.
b) The interest rate is first tied to a movable economic index.
c) The interest rate is fixed for an initial of 3, 5, 7 or 10-year period,
then tied to an economic index that adjusts yearly.
d) The interest rate remains fixed for the life of the loan.
6. Assuming a loan includes all of the following, except:

a) Agreeing to make its payments.
b) Relieving the liability of the original mortgagor.
c) Being legally liable for its provisions.
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d) Taking responsibility for maintaining the property.
7. When a property is purchased subject to an existing mortgage, all of

the following is done, except:
a) The title is taken by the buyer.
b) Buyer assumes responsibility for maintaining the property.
c) Primary lender may not be informed, but buyer starts making
payments.
d) Buyer becomes legally liable for the mortgage provision.
8. A(n)________clause allows the lender to call an entire note due if a

specific event occurs, such as defaulting on insurance premiums.
a) Subordination
b) Acceleration
c) Alienation
d) Assumption
9. Which loan is also known as an All-Inclusive Trust Deed?

a) Wrap-Around loan
b) Swing loan
c) Open-End loan
d) Package loan
10. In a _________, there are partially-deferred payments of principal

at the start of the term which increases as the loan matures.
a) Shared Appreciation Mortgage

b) Rollover Mortgage
c) Reverse Annuity Mortgage
d) Graduated Payment Mortgage
11. A home equity line of credit is a type of _______credit through

which a borrowers home becomes the collateral.
a) Revolving
b) Special
c) Mortgage
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12. A contract of sale is also called all of the following, except:
a) Agreement for land

b) Installment sales contract
c) Agreement of sale
d) Land sales contract
Answer Key:
1. B 7. D
2. A 8. B
3. C 9. A
4. B 10. D
5. C 11. A
6. B 12. A
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CHAPTER FIVE
TRUST DEEDS AND MORTGAGES
INTRODUCTION
To buy a real property, the purchaser enters into an agreement by paying a

small amount of the price as a down payment; the rest of the money is
borrowed from a mortgage lender. A promissory note is then executed by
the borrower and to secure the loan, either a trust deed or a mortgage is
used.
The lenders (creditors) interest in the borrowers (debtor) property is

called the security interest and the trust deed or mortgage is the evidence
of that security interest. The security interest relies on the property used as
security, to be sold off by the creditor in case the borrower defaults on the
loan. The proceeds from the sale are used to pay off the debt.
A document called a security instrument describes the rights and duties of

lenders and borrowers. Trust deeds are the most prominent instruments
used to secure loans on real property in California and other states (as
mentioned later in this chapter).
Some states also use mortgages as security for real property loans.
Mortgages fulfill the same role as trust deeds. You might hear the term
mortgage used very commonly in California and other states using trust
deeds; as in: mortgage broker, mortgage company, and mortgage payment.
But the term mortgage actually refers to a trust deed.
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TRUST DEED
A loan on real property is secured using a trust deed. The property then
becomes the collateral for the loan. There is an involvement from three
parties, when a promissory note is secured by a trust deed: the borrower
trustor, the lenderbeneficiary, and the neutral third partytrustee.
The following elements are included in a valid trust deed:
The date of execution

Names of borrower as trustor, lender as beneficiary, and the trustee
Reference to promissory note and the loan amount
Description of the property that is used as security
Power of sale
Assignment of rents
Signature of the borrower, that is notarized
As the borrower agrees in the trust deed to give limited title (bare legal title)
to the trustee, he may be able to use and enjoy the property as long as he
fulfills the terms of the loan. The restricted title that is given to the trustee
stays inactive, until there is need to either re-convey the title to the
borrower or the property is foreclosed upon due to default.
As mentioned above, the address of the property that is used to secure the
loan is included, along with the power of sale clause in favor of the trustee
and the right to give rents collected to the lender in case of foreclosure.
The borrower procures a loan from the lender and signs a promissory note
and a trust deed. Through the trust deed, the borrower conveys to the
trustee the bare legal title, which is held in trust until the note is fully paid.
The borrower signs the trust deed and normally records it in the county
where the property is located. This is then sent to the lender, together with
the promissory note, which the lender retains until the note is fully paid. A
lien is created against the property because of the recording, giving public
notice of the existence of a debt against the property.
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Through the bare legal title the trustee can perform just two actions: 1) Re-
convey the property to the borrower once the final payment of the loan is
made, and 2) Foreclose on the property in case a default takes place. The
title is held in trust by the trustee until the loan is fully paid off, then a
reconveyance deed is signed by the trustee; this is recorded in the county to
give public notice that the lien has been fully paid. On the other hand, if the
borrower defaults, then the trustee is notified by the beneficiary to file a
foreclosure.
Although the borrower has given the bare legal title to the trustee by
signing the trust deed, the trustee has limited powers of just re-conveying
the property or foreclosing upon it. The legal ownership of the property is
still with the borrower along with the usual rights that go with it, such as
the right to possession, will, encumber, and transfer.
Often, the trustee does not even know of the loan until notified to carry out
one of the two tasks that are required by the trust deed. In many states, the
duties of the trustee are performed by one of these: a title or trust company,
escrow holder or the trust department of a bank.
When a loan is being paid off under the trust deed, the lender sends the
note and trust deed to the trustee and then requests a reconveyance for
him. The trustee cancels the note and signs a reconveyance deed that
returns the title to the borrower. The reconveyance deed should be
recorded; this provides public notice of the discharge of the loan. The
recording of the reconveyance deed will remove the lien from the property.
In case a borrower defaults, the beneficiary sends the trust deed to the
trustee and asks him to sell off the property (foreclose). The proceeds from
the sale will be used to pay off the loan amount. The sale of the property can
be started by the trustee, without the court orders as the borrower has given
title to the trustee in the trust deed and also the power of sale (given by the
borrower) authorizes the trustee to sell the property.
There is an assignment of rent clause in some trust deeds, this clause allows
the lender to take physical possession of the property and collect any rents
or income generated by the property during the foreclosure period. The
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rents collected would be used as a compensation for the loss incurred on
the loan.
Trust Deeds Contain:
Power of Sale Clause

By signing the trust deed the trustor gives the trustee the right to foreclose,
sell, and convey ownership to a purchaser of the property, if there is a default
on the loan by the borrower.
Assignment of Rents Clause

If the borrower defaults, the lender can take possession of the property and
collect the rents being paid thereof.
It should be noted that a trust deed is the security against a loan procured.
The borrowers failure to pay may lead to the lender using the proceeds
from the sale of the property that is used as collateral -- secured by the trust
deed -- for payment of the loan. The foreclosure process is used by the
lender to collect the amount owed, in case a borrower defaults on the loan.
According to the deed of trust, on the basis of the statutory time frame, the
time period may be as little as four months. We shall cover foreclosure later
in this chapter.
When recorded, the trust deed becomes a lien on the described property
that is used to secure the repayment of a loan. The trust deed will be valid,
even if it is not recorded and it will still be considered as security for the
loan. But recording definitely affirms priority for the trust deed if there is a
foreclosure. The trust deeds will get paid off in the exact order in which
they were recorded.
Depending on the locale and the state in which the property is located,
either a trust deed or a mortgage may be used to secure a loan. Some states
use trust deeds while others use mortgages as security for procuring a loan.
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Trust Deeds used in States as Basic Security Instruments
Alaska Mississippi
Arizona North Carolina
California Oregon
Colorado Tennessee
District of Columbia Texas
Idaho Virginia
Maryland West Virginia
Trust Deeds used in States in Part
Alabama Nevada
Delaware New Mexico
Hawaii Utah
Illinois Washington
Montana
FEATURES OF A TRUST DEED
There are distinct differences between trust deeds and mortgages. We will
study those in the following part of the chapter.
Parties
In a trust deed there are three parties besides the trustor or borrower; the
trustee, and the beneficiarylender.
The trustor or borrower is the one who holds equitable title as the
loan is being paid off, and conveys bare legal title to the trustee
through the trust deed.
The trustee or neutral third party holds bare legal title until the
reconveyance or foreclosure takes place. A trustee is not usually
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involved in the property and its matters until a reconveyance or
foreclosure is required.
The beneficiary or lender holds the note and trust deed until
reconveyance or until the debt is repaid.
Title
The most distinctive feature of a trust deed is the title conveyance to a

trustee by a borrower until the loan is fully paid off. When a loan is secured
using a trust deed, the ownership is technically retained by the borrower
but the bare legal title is transferred to the trustee through the trust deed.
The trustee can only re-convey or foreclose on the property; he does not
have any other rights concerning the ownership of the property. Normally,
the trustee is only notified when either a reconveyance (loan is fully repaid)
or a foreclosure (borrower defaults) action becomes necessary.
When the trust deed -- not the note -- is signed by the trustor, it is recorded
in the county where the property is located. After recording it is sent to the
lender who retains it for the life of the loan. Recording of the trust deed is
done so as to give public notice of the lien against the property. This will be
of help to anyone who is interested in searching for the title of the property.
The reconveyance deed is also recorded once it is signed by the trustee. This
is done to give the public notice that the lien is paid off.
Statute of Limitations
The rights of the lender or the beneficiary according to the trust deed do not
end when the statute runs out on the note. The trustee holds the bare legal
title with a power of sale clause, thus he can still sell the property to repay
the loan amount. The power of sale in a trust deed does not expire.
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Remedy for Default
The lender, under a trust deed, has two options for foreclosure. First option
is foreclosure under the power of sale. This sale is held by the trustee, the
auction type of sale in which the property goes to the highest bidder. The
second option is judicial foreclosure when the property is foreclosed by
court action.
Reinstatement
When a borrower in a trust deed defaults on the loan, the loan may be
reinstated if all delinquencies and fees are paid prior to five business days
before the trustees sale.
Redemption
Under a trust deed that has a power of sale clause, the sale is final and there
is no right of redemption after the trustees sale.
Deficiency Judgment
A judgment against a borrower for the difference between the unpaid loan
amount + interest + costs and fees of the sale, and the amount of the actual
earnings from the foreclosure sale is called a deficiency judgment. This
implies that in case the property sells for less than the amount owed to the
lender, the borrower will be personally responsible for repayment following
the filing of the deficiency judgment.
In most cases, where a loan is secured by a trust deed and a lender

forecloses using the power of sale (trustees sale), a deficiency judgment will
not be applicable. In states that use trust deeds solely for securing loans,
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the only security for a beneficiary then is the property itself. Other personal
property and real assets of a defaulting borrower will be protected from
judgment under the trust deed.
Reconveyance
The trustee issues a deed of reconveyance on the beneficiarys request, once

the payment is fully made.
TRUST DEEDS: FORECLOSURES
Foreclosure is a legal procedure that a lender uses when a borrower of a

loan secured by a trust deed defaults. Through this procedure, the rights
and title of the borrower is terminated by selling off the encumbered
property. The proceeds from the sale are used to pay off the debt and other
liens against the property. A trust deed that includes the power of sale
clause may be foreclosed by one of these two methods: 1) Trustees sale or
non-judicial foreclosure, and 2) Judicial foreclosure.
PROCESS OF A TRUSTEES SALE
A trustees sale or non-judicial foreclosure takes place only when a trust

deed is inclusive of a power of sale clause. The trustor (borrower) gives the
power of sale to the trustee through the trust deed that he signs at the time
of closing. Almost all trust deed contains this clause, and in California and
other states, a trustees sale is the preferred way of foreclosure. As noted
earlier, generally in a trustees sale there is no allowance for a deficiency
judgment. Also, the debtor does not have any right of redemption at the end
of the sale.
The debtor or any other party with a junior lien may reinstate (restore) the
loan in default, during the statutory reinstatement period. This period
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begins five days before the date of sale. After the end of the statutory
reinstatement period, the debtor still has a chance of redeeming the
property and avoid the foreclosure sale by paying off the entire debt,
including interest, costs, and other fees, before the date of the sale.
Foreclosure Method
First, the lender requests the trustee to file for a notice of default. This
notice contains the legal description, the name of the borrower, the name of
the lender, and the reason for the default. A statement of a typical default
might be: Non-payment of the installment of principal and interest which
became due on June 30, 2009, and all subsequent installments of principal
and interest, including delinquent real estate taxes, fees and costs. The
notice will then state the amount of default. The trustor (borrower) gets
three months from the date of recording to cure the default by paying all
the balance payments, including the foreclosure charges of the trustee and
any unpaid real estate taxes. There have been cases when the maturity date
of the note has passed with the entire principal amount still due, including
the accrued interest, late fees, and foreclosure fees and other costs.
If the trustor fails to cure the default within three months, the trustee
records the second notice, the notice of trustees sale. This notice gives the
date for the public auction of the property. The terms of this sale (auction)
are almost always on a full cash basis. The sale is generally held 21-30 days
after the filing of the notice of the trustees sale. The trustor still has a
chance to cure the default until five days before the actual date of trustees
sale. In case a trustor tries to cure the default one or two days prior to the
trustees sale, the beneficiary (lender) may demand the entire principal
amount, since the curing period is over.
As we already know, the sale is a public auction and anyone interested in

bidding for the property can do so with cash or cashiers checks for 100% of
the bid. The opening bid usually comprises the amount of money owed to
the beneficiary, including all accrued interest, late fees, foreclosure fees,
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and so on. However, usually the bidding opens at less than the amount
owed.
If outside bidders are there to bid at the auction, then the beneficiary
(lender) joins the bidding process until the amount owed is realized or the
lender is satisfied with an amount less than whats owed. In the sale, the
trustee takes the winning bid price from the successful bidder and issues a
trustees deed to the winning bidder.
In case there are no outside bidders at the sale, then the property reverts to
the beneficiary. The trustee then issues a trustees deed to the original
beneficiary and he becomes the owner of the property. Any junior liens are
eliminated by the foreclosure process.
If a first trust deed goes to trustees sale and there are no bidders present,
then the first trust deed beneficiary would become the owner of the
property and the sale would eventually eliminate any second or third trust
deed. On the contrary, if a second trust deed beneficiary goes to a trustees
sale, the new owner acquires the property subject to the first recorded
trust deed.
A non-judicial foreclosure is a comparatively simpler process as there is no

involvement by attorneys or courts. A trust deed of $90,000 or less would
pay a few hundred dollars to the trustee as his fee instead of thousands of
dollars to an attorney. It takes approximately four months for completion of
a foreclosure process. When the lender declares a default, it either gets
cured or paid off, or the lender becomes the owner of the property within
the four month process.
Notice of Default
The notice of default needs to be executed by the beneficiary or the trustee.

It should be recorded in the office of the county recorder where the
property is located, and must be done at least three months before giving
the notice of sale. After recording the notice of sale, within 10 days a copy of
the notice must be sent to all the persons who have recorded a request for
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notice by certified or registered mail. Also, a copy must be sent within one
month after recording to all the parties who have recorded interests in the
property.
Notice of Default to be Sent to:
Successors in interest to the trustor

Junior lienholders
Vendee of any contract of sale
State controller, if there is any tax lien against the property
Request for Notice
A request of notice is recorded by someone who is interested in a particular

trust deed and wants to be informed of a notice of default and notice of sale.
This request of notice should be recorded with the county recorder where
the property is located at the time the trust deed is created. The party most
interested in being notified of a default on a trust deed would be the seller
who is holding a second trust deed. In case a borrower defaulted on the first
trust deed, the second trust deed holder would want to be informed at the
earliest possible time, so that he could start foreclosure on the second trust
deed.
Notice of Sale
Once the notice of default is recorded, the trustee should wait three months
before recording a notice of trustees sale (if the loan is not reinstated by the
borrower).
A notice of sale should have a description of the property; it must be

published in a daily newspaper of general circulation in the locality where
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the property is located. The notice needs to be published at least once a
week for 20 days (with a gap of at least seven days between each
appearance). The notice of sale must be posted in public in the city where
the sale takes place.
The Sale
The trustees sale takes place at public auction for cash and is conducted by
the trustee. It is held in the county where the property is located,
approximately four months after the recording of the notice of default.
Till the time the auction bidding is over, the debtor or a junior lien holder
can still redeem the property by paying the defaulted loan amount in full,
including all fees, costs, and other permissible expenses. By clearing all
delinquent payments and all the other necessary fees at any time until five
business days before the date of the trustees sale, the loan can be
reinstated.
The Order in Which the Trustee Applies Foreclosure Sale Proceeds
1. Trustee: fee, costs, and sale expenses

2. Beneficiary: to clear the full amount of unpaid principal and interest, charges,
penalties, costs and expenses
3. Junior lien holders: according to the order of priority
4. Debtor: any leftover amount
Bidding at the auction is open to all, but the first lien holder or the holder of
the debt being foreclosed is the only one who gets to credit bid (i.e., bid
the amount owed on the defaulted loan, without actually paying any
money). The other bidders have to pay cash or cashiers checks.
The highest bidder is the new buyer who receives a trustees deed to the
property. From this point, the debtor no longer has the right to redeem the
foreclosed property.
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Timeline for a Trustees Sale
Beneficiarys notification to the trustee to foreclose

Recording of the notice of default by the trustee
Period for reinstatement (up to five days before the sale)
Notice of trustees sale and publication of date, time (three weeks) and place of
sale
Sale takes place and the highest bidder wins
Buyer gets the trustees deed (the sale is finalized and borrower loses the right
of redeeming the property)
There may be certain liens that are not eliminated by a foreclosure sale, to
which the sale may be subject to. This implies that the new buyer must
repay those liens. The liens that are not eliminated by a foreclosure sale are
federal tax liens, and assessments and real property taxes.
Junior Lien Holders

Once the sale of property at a trustees sale is completed, it terminates the
trust deed lien that secured the debt to the beneficiary (lender) and also
terminates any junior liens. Thus, the junior lien holder(s) must make a bid
for the property to protect their interest or else lose the right to be repaid
on the loan if the sale amount is insufficient to repay all trust deeds against
the property.
When the junior lien holder finds out about the imminent foreclosure on a
trust deed senior to the one he is holding, there are two options available;
to stay quiet and hope the proceeds from the sale are enough for a pay-off
for his trust deed, or to start his own foreclosure. This will then stop the
first foreclosure that has been filed.
If the junior lien holder has decided to file his own notice of default, then he
has the right to claim the property after the approved time period has
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elapsed; he does not have to bid against other probable buyers at the
trustees sale. The junior lien holder gets the property subject to all loans
senior to his, with the need to keep them current or face foreclosure.
The property is now owned by the junior lien holder which he may keep
until the property regains its previous value and then sell is sold on the
open market. During the foreclosure sale it would not have fetched enough
to pay off all the liens and most probably will not now sell at a high enough
price for the new owner (previous junior lien holder) to regain the
investment made.
What can be done is to take a loss by selling the property in the market or
renting it out for a possible negative cash flow and wait for the market to
change, allowing the property to regain enough equity for a sale with a
positive return.
JUDICIAL FORECLOSURE
A beneficiary (lender) may opt for a judicial foreclosure rather than a non-
judicial trustees sale. This would mean that a lengthy court action may
transpire instead of an automatic and lawfully specified three month, 21
days minimum foreclosure period. The beneficiary generally chooses the
judicial foreclosure option because it allows a deficiency judgment through
which the lender obtains the right to collect any unpaid amount.
TRUST DEED: BENEFITS

In some states, the trust deed has proved to be a more beneficial choice
than a mortgage. Following are the benefits of a trust deed to a lender:
If a default occurs, the lender obtains possession of the property and

collects rent.
The foreclosure process is short and simple.
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The title is held by the trustee, which he can easily grant to a buyer at
the foreclosure sale.
There is no possibility of redemption after the foreclosure.
A trust deed does not have an expiration date.
Following are the benefits of a trust deed to a borrower:
The only security for the loan is the property and no deficiency
judgment is allowed.
The borrower only loses the property in question; his other assets
remain protected.
Regardless of what is used (a trust deed or a mortgage) to secure a

promissory note, the lender and the borrower both have the full power of
the law (depending on the state in which the property is located) to impose
their rights in regard to the repayment of a loan.
MORTGAGES
The word mortgage is known to most people. A mortgage is a two-party
instrument; it is basically a contract for a loan. The parties to a mortgage
are the mortgagor (the borrower) and the mortgagee (the lender).
Generally, this loan contract is recorded against the real property.
A defaulting mortgagor causes distress, with more drastic consequences,

perhaps, in states where trust deeds are used. When a mortgagee in the
Midwest is facing default, he first calls for an attorney, and second, files for
a lawsuit generally known as a judicial foreclosure, which can lead to a
court-ordered sheriffs sale. This normally might happen one or two years
after the default. Thus, this is a lengthy and expensive process involving the
mortgagors right to redeem the property, as well. After the foreclosure, the
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mortgagor (borrower) normally has up to one year in which to redeem the
lost property.
A mortgage is basically a financial instrument used to secure a property for

paying off a promissory note. Since it serves as a security for a loan, its
purpose is the same as that of a trust deed. A mortgage then becomes a lien
against the property until the loan is paid off.
The term mortgage is used to describe some financial transactions. To

avoid confusion, note that the use of trust deeds is common in 14 states,
and even though there may be reference to terms like home mortgage,
mortgage loan broker, and mortgage banker in those states, actually they
are just using trust deeds to secure the loans.
Just like a trust deed, a mortgage, too, is an agreement independent of the

promissory note, although it is dependent on the note for its existence. We
already know that the promissory note serves as evidence of the loan and
thus the mortgage becomes the security for the loan (just as the trust deed
is the security in states using that document).
The promissory note may stand independently, without relying on a

mortgage as security. At this juncture, it would be a personal, unsecured
note. However, the mortgage, to be considered valid, needs to be supported
by the note.
The following elements are included in a valid mortgage:
Date of signing
Names of borrower as mortgagor, lender as mortgagee
Reference to promissory note and the loan amount
Description of the property that is used as security
Defeasance clause
Covenants
Signature of the borrower, which is notarized
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There are two different theories as to how a title is held in a mortgaged
property. Some states follow title theory, in which the borrower deeds the
property being mortgaged to the lender when signing the mortgage. Other
states follow lien theory, through which the borrower conveys only a lien
right to the lender during the term of the loan. An intermediate theory is
followed by some states which follow the concept that a mortgage is a lien
should the borrower default; then, title is automatically transferred to the
lender. Although the borrower has the possession of the property during
the entire term of the mortgage, the title may be held by anyone.
There are certain promises and covenants made by the borrower to the
lender in the mortgage document. Some of the promises made by the
borrower are: to pay all taxes; not destroy or damage the improvements; to
keep enough insurance against the property; and, to maintain the property
in good condition. An acceleration clause -- giving the lender the right to
order payment of the loan in full, in the event of a default by the borrower --
may or may not be included in the mortgage instrument.
MORTGAGE FEATURES
The lender holds a mortgage for the life of a loan, or until the borrower pays
off the loan. Mortgages have similarities and differences which we shall
study as the chapter progresses.
Parties
There are two parties in a mortgage, i.e., the mortgagor (borrower) and the
mortgagee (lender). The mortgagor (borrower) signs a promissory note and
the mortgage to receive a loan from the mortgagee (lender). The mortgage
may become a lien against the mortgagee till the debt is fully repaid.
Alternatively, the mortgage may give the actual title to the lender till the
debt is paid in full.
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Title
A lien may be created by the mortgage on the real property or the mortgage
may give actual title to the lender. This depends on the state in which the
property is located. Title may be conferred upon the borrower, or else to the
lender; just as in a trust deed where a deed of trust conveys title (bare legal
title) to a trustee. In both cases, the borrower retains possession of the
property.
Statute of Limitations
The statute of limitations on a note secured by a mortgage expires in four
years. This implies that a lender should sue the borrower within four years
of default to get back his money, or else the mortgage expires.
Remedy for Default

Judicial foreclosure or a filing a law suit is the common remedy for default
of a mortgage. A non-judicial foreclosure is possible if the mortgage
contains a power of sale clause.
Reinstatement
A borrower who has defaulted under a mortgage may reinstate the loan by
paying off all delinquencies, including the costs of the foreclosure process.
He may do so any time before the courts approval of the foreclosure.
Redemption
The right of redemption, as it is known in trust deeds, is called equity of
redemption' in the states that use mortgages instead. This equity of
redemption allows a defaulting borrower to redeem the property for a
specified time period before or after the foreclosure sale. The borrower can
redeem the property by paying off the amount of money owed -- the
balance accruing from when the first lapse in loan payments occurred --
until the foreclosure sale happens and the property is sold off.
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Deficiency Judgment
A lender foreclosing against a defaulted mortgage may attain a deficiency
judgment against the debtor. A deficiency judgment is allowed in some
states since court intervention is required for a foreclosure against a
mortgage. As already discussed, a deficiency judgment is filed by the lender
against the borrower for the difference between the unpaid amount of the
loan and the proceeds from the selling price (if the proceeds do not cover
the balance of the loan amount). If a judgment is granted by the court, the
borrower becomes responsible for the amount of debt after the foreclosure
sale. The lender may obtain a personal judgment that remains effective for
years against the borrower.
Satisfaction
Satisfaction of a mortgage means payment in full. This requires the lender
to deliver the original note and mortgage to the party making the request. It
is advisable to record this release to give public notice of the mortgage
encumbrance being paid in full.
MORTGAGE FORECLOSURES
When it becomes evident that the borrower will not be able to repay the
loan, or be able to sell the property for enough funds to pay off the
borrowed amount, then the lender has the foreclosure option as the remedy
for defaulting on the loan.
The foreclosure laws vary in each state; however, there are three basic types
of foreclosure proceedings. A non-judicial foreclosure occurs when the
security instrument (trust deed or mortgage) contains a power of sale
clause in the event of default. In states that recognize judicial foreclosure,
the lender proves that the borrower has defaulted on the terms of the loan
and requests a court-ordered sale of the property. A lesser known remedy,
strict foreclosure, allows the lender to take title to the property as soon as
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the borrower defaults. The lender can either sell the property or keep it to
satisfy the debt.
If money is left over and above the loan amount following a foreclosure
sale, the lender has to return the proceeds, along with certain fees, to the
borrower.
The foreclosure process used basically depends on the mode of security

instrument (for the purchase of real property) that the state approves, i.e.,
either a trust deed or a mortgage. Most states using mortgages conduct
judicial foreclosures, while states with trust deeds conduct non-judicial
foreclosure. The main difference between the two foreclosure methods is
that judicial foreclosure necessitates a court action.
NON-JUDICIAL FORECLOSURE
The foreclosure procedure in which the sale of a mortgage property is
conducted by the lender, without any court intervention, is called non-
judicial foreclosure or foreclosure by power of sale. If the clause is stated
in the mortgage, this process may be executed.
The sale procedure is ordered by the lender after recording the notice of
default in the county where the property is located.
Next is the waiting period during which the borrower is given the chance to
redeem the property by bringing the loan current, along with taxes,
insurance, and any fees resulting from the foreclosure. The length of the
waiting period is determined by state law.
If the default cannot be cured by the borrower, the property is sold by the
lender at public auction. If state laws allow for the borrower to redeem the
property after the sale, he has up to one year to do so.
If the property sells at the public auction for less than the loan amount -- if
a deficient amount is received at the sale -- some states authorize the lender
to claim the deficient amount through a court action, which grants a
deficiency judgment.
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JUDICIAL FORECLOSURE
To foreclose through a judicial process, a lender has to prove the default of
the mortgagor. A judicial foreclosure requires the lender to file a lawsuit.
The appointed attorney tries to resolve the default by consulting with the
mortgagor. If the mortgagor is not in a position to pay off the default, then a
lis pendens (action pending) is filed by the attorney with the court. A lis
pendens is a notice given to the public that a pending action is filed against
the mortgagor. This produces a cloud on the title, which a prospective
buyer would be notified of, giving him the option of whether to go ahead
with the sale. The reason a court action is taken is because it would produce
evidence of a default thus enabling to lender to move ahead with the
foreclosure
Of these foreclosure methods, judicial foreclosure is the more expensive

and lengthy procedure. Nevertheless, it does help in recovering that portion
of the loan which remained un-repaid after the sale of the property at the
public auction. In the event of a foreclosure sale realizing an amount
insufficient to cover the delinquency, the lender can sue to obtain a
deficiency judgment against the borrowers other assets, making the
borrower personally responsible for repayment.
The county sheriff or court-appointed referee conducts the judicial

foreclosure. Anyone, including the defaulting borrower, may bid on the
property. The bid amount must be paid in cash. At times, a 10% cash
deposit of the accepted bid is made at the sale with the balance becoming
due after 30 days of the closing. If the foreclosing lender bids on the
property, he may do so up to the amount owed, and not have to pay any
money. This is possible if no one else makes a bid higher than the lenders.
The lender can now hold the property back or sell it off later, as he wishes.
The property till then will be owned by the bank or would be termed as
Real Estate Owned (REO). On the other hand, if a buyer purchases the
property for less than the total encumbrances, then the junior liens are
terminated; if the original borrower is the successful bidder for the
property, then the junior liens remain in force.
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Depending on the state in which the property is located, the successful
bidder at the foreclosure sale will either get a referees deed in foreclosure
or sheriffs deed, or a certificate of sale. The first two types of deed are
special warranty deeds conveying title to the buyer, which the borrower was
holding when the original loan was made. The referees deed or sheriffs
deed are mainly used in states where there is no statutory redemption law,
where the buyer receives immediate possession of the property after its
sale. The sale is final without a redemption option for the buyer.
In states that follow statutory redemption laws, a certificate of sale is issued

to the buyer at the foreclosure sale. The borrower has from one month to
one year (or even more) after foreclosure to redeem the property. He must
pay off the judgment to regain the title to the property. In some states, the
buyer obtains possession of the property only after this redemption period
is over.
Timeline in a Judicial Foreclosure
Lawsuit is filed by the lender against the borrower and any other party who
has acquired an interest in the property after the recording of the mortgage
being foreclosed.
Lender gives evidence of loan default by the borrower to the court.
Lender asks for judgment, with the following instructions:
The borrowers interest in the property be detached,
Sell the property at a public auction,
That he (the lender) be paid from the sale.
The complaint and summons copy is delivered to the defendants.
Lis pendens is filed, informing the public of the pending litigation.
Public auction takes place, and the property is sold to the highest bidder.
Highest bidder receives the sheriffs deed or certificate of sale.
Some states allow statutory redemption.
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Priority of Payment
More than one loan may be secured using the same property. The property
may have a second and even a third mortgage against it. These are called
junior mortgages. This practice is not uncommon and does not pose any
problems for the original lender, as long as payments are being made on all
loans by the borrower. However, this becomes an issue when a default
happens on one or more of the loans, and the property sells (at the
foreclosure sale) for less than the amount required to cover all the loans
against it.
In many foreclosures, the sale proceeds do not cover all of the debt
amounts. So, an impartial system of priorities for paying off the holders of
mortgages against a property was initiated. The proceeds of the sale satisfy
the debt with the highest priority first, then the next highest, and so on,
until all the holders of the debt relating to the property in question are
satisfied or else all the proceeds of the sale are exhausted.
Obviously, every lender will want the senior position in terms of priority of
recording. Recording of the mortgage determines its priority, thus the first
recorded mortgage is first to get paid if the borrower defaults. The second
recorded mortgage is paid next, then the third, etc. The date and time of the
recording of the mortgage is stamped on the document by the county
recorder, with that stamp determining priority.
The priority system of paying off the holders of mortgages in event of a

foreclosure, when the sale amount does not satisfy all the mortgage holders,
settles the issue of which mortgage should be paid first. Of course, at times
the money is not even enough for the holder of the first mortgage to be fully
repaid. At this stage, the holder of the first mortgage must decide whether it
will worth opting for a deficiency judgment. If the unpaid amount is not
large, then it may not be sensible to invest in a lawsuit to recover the
deficiency. Most states allow the lender to acquire a deficiency judgment to
recover any amount of the unpaid loan at the foreclosure sale. As discussed,
the judgment holds the borrower personally responsible for the remaining
amount of the debt after the foreclosure sale.
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Junior Lienholders
In a process that is similar to what happens with trust deeds, the
foreclosure sale of the property removes the mortgage securing the debt to
the mortgagee, or lender. It also removes any junior mortgages. This
implies that the holder of the junior lien -- the second- or third lien
should make a bid for the property, so as to protect their interest.
Otherwise, the junior lienholder might lose the right to collect his unpaid
loan if the sale amount is deficient for a complete pay-off on all mortgages
held against the property.
When a lienholder comes to know of an impending foreclosure on a

mortgage senior to his, the junior lienholder has two options: First, hope
that the proceeds from the sale will be sufficient to pay off all the
mortgages. The second option is to start their own foreclosure.
If the junior lienholder decides to file a notice of default, he acquires the

right to claim the property once the statutory time limit has passed. He will
not have to bid against other probable buyers at the foreclosure sale. The
junior lienholder obtains the property subject to all loans senior to his loan.
He is under obligation to keep the loans current or else he may face a
foreclosure.
Finally, if the junior lienholder owns the property he may keep until it
regains its past value or try to sell it on the open market, as it may not have
brought enough at the foreclosure sale to pay off all unpaid liens. Yet, it
probably will not sell at a high enough price for the new owner (former
lienholder) to receive the investment returns.
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CHAPTER SUMMARY
A loan on real property is secured using a trust deed. The property

then becomes the collateral for the loan.
Through the bare legal title the trustee can perform just two actions:
1) Re-convey the property to the borrower once the final payment of
the loan is made, and, 2) Foreclose on the property in case a default
occurs.
The most distinctive feature of a trust deed is the title conveyance to a

trustee by a borrower until the time the loan is paid off.
Foreclosure is a legal procedure that a lender uses when a borrower of

a loan secured by a trust deed, defaults.
Satisfaction of a mortgage means payment in full. This requires the

lender to deliver the original note and mortgage to the party who
makes the request.
A lesser-known option, strict foreclosure, allows the lender to take

title to the property as soon as a default by the borrower occurs. The
lender either sells the property or keeps it to satisfy the debt.
Depending on the state in which the property is located, the

successful bidder at the foreclosure sale will either receive a referees
deed in foreclosure, a sheriffs deed, or a certificate of sale.
In states that follow statutory redemption laws, a certificate of sale is

issued to the buyer at a foreclosure sale. The borrower has from one
month to one year (or even more) after foreclosure to redeem the
property.
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CHAPTER QUIZ
1. In a trust deed, the lender is called a ________.

a) Trustee
b) Trustor
c) Beneficiary
d) Recorder
2. A trust deed can include a(n):

a) Power of sale clause
b) Assignment of rents clause
c) None of the above clauses
d) Both of the above clauses
3. Bare legal title is held by a trustee.

a) True
b) False
4. Recording a reconveyance deed by a borrower gives public notice of:

a) Foreclosure
b) Default
c) Discharge of the loan
d) Ownership of title
5. Under a trust deed with a power of sale, there is no right of ______

after the trustees sale. This sale is final.
a) Reinstatement
b) Redemption
c) Deficiency judgment
d) Reconveyance
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6. The statutory reinstatement period in a trustees sale runs until ____
days before the date of sale.
a) Four
b) Five
c) Six
d) Seven
7. The notice of default on a trust deed must be executed by the:

a) Junior lienholders
b) Successors in interest to the trustor
c) Vendee of any contract of sale
d) Beneficiary
8. Which of these statements is correct in reference to a trust deed:

a) A trust deed never expires
b) Redemption is impossible after the foreclosure sale in a trust deed
c) A deficiency judgment is always allowed to a borrower
d) The title is held by the trustor in a trust deed
9. Which of the following is required in the satisfaction of a mortgage:

a) A default
b) A foreclosure
c) Payment in full
d) Sale of property
10. Who is a junior lienholder?
a) Holder of a first mortgage

b) Holder of a second mortgage
c) A lender who is a minor
d) A lender who is a borrower
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11. More than one loan may be secured using the same property.
a) True
b) False
12. A successful bidder at a foreclosure sale could receive a:

a) Sheriffs deed
b) Certificate of sale
c) Referees deed in foreclosure
d) All of the above.
Answer Key:
1. C 7. D
2. D 8. B
3. A 9. C
4. C 10. B
5. B 11. A
6. B 12. D
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CHAPTER SIX
MORTGAGE LENDERS
INTRODUCTION
Money and credit are used by consumers for developing and acquiring real
property. The real estate mortgage financing system basically consists of
institutions that make and purchase instruments of finance for use in the
markets where they are transferred. The flow of funds in the financial
system is facilitated by those institutions and markets.
Institutions making real estate loans are known as financial

intermediaries. These financial institutions are a link between the suppliers
and credit users. Money and credit is made available to the borrowers by
these conventional lenders.
The financial intermediaries whose primary job is to transfer money from

investors to borrowers are: institutional lenders, such as commercial banks;
thrifts, such as savings and loans associations, savings banks, mutual
savings banks, and credit unions; life insurance companies; investment
companies, such as mutual funds and Real Estate Investment Trusts
(REITs) and pension funds. There are non-institutional lenders which
comprise mortgage bankers and mortgage brokers, investment companies,
private individuals and non-financial institutions.
Being a link, the financial intermediary gathers funds from different

sources, i.e., individual savers, short-term and long-term investors, and
converts them into loans for the consumers. This system is called
intermediation.
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The mortgage lenders may not all be depository institutions, but they are all
financial intermediaries. A depository institution is one which accepts
deposits by way of savings accounts. Mortgage bankers, who are originators
of most residential loans, are not depository institutions. They borrow from
other institutions to make mortgage loans. These originated loans are then
sold to other institutions.
In the modern day mortgage lending market, a large number of loans are
held by either the originator or sold on the secondary market. A few
number of individuals hold mortgage loans, but mostly they are held by
institutions.
INSTITUTIONAL LENDERS
A financial intermediary or depository such as a commercial bank, thrift, or
life insurance company that contributes its depositors money for investing
in different ways, such as trust deeds and mortgage loans, is an institutional
lender.
COMMERCIAL BANKS
Commercial banks make the widest variety of loans. These include loans for
buying real estate, home equity loans, and business loans. Generally,
though, commercial banks make short-term or interim loans to finance
construction. Longer-term loans may be funded, as well, after a
construction loan is paid off.
Consumer checking, savings accounts, and certificates of deposit are

managed by commercial banks. These funds and also borrowed amounts
from other intermediaries are used by commercial banks for loans to
investment buyers, builders, and other businesses. The commercial banks
are the largest originators of commercial real estate loans for acquiring,
developing, and construction of real estate projects. Mostly, the loans
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funded by the commercial banks are for short-term construction loans (six
to 36 months), although other types of loans are also arranged.
A federal or state government may charter the commercial banks. The state
agency (which may be a member of the Federal Reserve System) regulates
state-chartered commercial banks. However, all commercial banks that are
federally chartered must be members of the Federal Reserve System. The
deposits are insured by the Federal Deposit Insurance Corporation (FDIC).
THRIFTS
For residential mortgage credit, the largest source is thrifts. Any of the
following depositories of consumer savings could be a thrift institution:
Savings and loan associations,
Savings banks,
Mutual savings banks, and
Credit unions.
The major difference between savings and loan associations and mutual
savings banks is the type of ownership. The mutual savings bank is a
cooperative type of ownership, while a savings and loan association is like a
stock company. The same trade association is shared by the two, the U.S.
Savings and Loan League. Their supervising government agency is also the
same, the Office of Thrift Supervision. The FDIC insures the deposits for
both these institutions. Credit unions, on the other hand, are directed by
their charters to provide services for members of a particular organization,
such as employees of fire departments, utilities, corporations or other
groups.
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SAVINGS AND LOAN ASSOCIATIONS
In the beginning of the 19th century, a large number of people migrated to

urban areas of the United States. They were looking to save their funds and
earn profits while safeguarding their money; for this purpose, financial
institutions were required. Even their home purchases needed financing.
Conventionally, money for home financing was borrowed from savings and
loan associations.
The first savings and loan association in United States was probably formed
in Philadelphia in 1831. It followed the pattern similar to those institutions
in Great Britain. The growth of the industry led to an unfolding of two
distinct characteristics. First, was the use of long-term fixed mortgage
home loans, and the second was the accumulation of small long-term
individual saving accounts. During this period, the savings and loan
association normally took deposits and made loans within the same
community.
Savings and loan associations were considered to be beneficial institutions

that offered a public service: to encourage personal savings and the making
of home loans. Thus, taxes were levied favorably to them. As per the
Revenue Act of 1913, permanent national income taxes were assessed upon
corporations and individuals. However, savings and loan associations were
exempted from this federal income tax.
The period during the 1920s saw an expansion in industries and personal
incomes of individuals. As a result, savings and loan associations also grew
considerably. In 1929, the stock market crashed, the overall economy
started to degenerate and the Great Depression. Because of the dreadful
economic situation, the financial operations of banks and other financial
entities had had to bear the mass withdrawal of deposits and the inability of
the borrowers to make loan repayments. It led to the closure of many
financial institutions; however, the savings and loan institutions faced
fewer closedowns as compared to other financial organizations.
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To try to re-instill confidence of depositors in the savings and loan
associations, the new presidential administration sponsored legislation
which included the following:
The Home Owners Loan Act of 1933 inaugurated federally-chartered

The Federal Savings and Loan Insurance Corporation (FSLIC) was

another new organization given the responsibility of insuring deposits
according to specific limits.
The Federal Home Loan Bank Act of 1932 established the Federal
Home Loan Bank System, comprising a bipartisan body of three
members that was supervised by the Federal Home Loan Bank Board.
Twelve regional banks provided short-term and long-term loans to
savings and loan association members. The Federal Home Loan Bank
System is designed after the Federal Reserve System. The Federal
Home Loan Bank of San Francisco is the 12th district bank, serving
California, Arizona, and Nevada.
The 1939 Internal Revenue Code provided favorable tax treatment for
Because of the shortfall of consumer goods and building materials during

World War II, savings deposits in all financial institutions, along with
savings and loan associations, increased briskly. As the associations were
not able to make large amounts of mortgage loans, they had to purchase
government bonds.
After the war, the S&Ls enjoyed a high rate of growth in deposits as well as
loans made. The growth of savings and loan associations in both size and
intricacy pressured the financial authorities to bring these associations
under the federal income tax system and apply equitable taxation.
The savings and loan associations for the first time were subjected to
federal income tax and filing procedures in 1952. But, relying on the
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generous rules applying to bad debts, the S&Ls were able to escape the
incurring of income tax most of the time.
These exemptions came to an end with the Revenue Act of 1962, although
some favorable tax treatment continued. What seemed to be tax exemption
was actually a generous bad debt reserve. This provision for bad debt
reduced the amount of taxable income to a large extent.
The Tax Reform Act of 1969 resulted in a huge amount of savings and loan
income to be taxed. This was done by including the following important
provisions through this Act:
Net bond profits were taxed as ordinary income. (The previous tax
laws taxed profits at capital gains rates, and losses as ordinary
income.)
Bad debts deductions were reduced.
The bad debt deduction in excess of experience was classified as a tax

preference item. The minimum tax rate was raised from 10% to 15%
by the Tax Reform Act of 1976. This act also reduced the tax rate
exemption.
Uniform growth in total assets and profitability brought about some

stability in the S&Ls during the 1970s but as the 1980s approached, the
industry was facing a survival threat. The financial mess-up and
degradation led to the infamous federal bailout.
Before the deregulation of the lending industry in 1980, S&Ls that were
federally-chartered had to hold at least 80% of their assets in residential
loans for encouraging lending on residential real estate. The special tax
laws permitted the owners of S&Ls to defer payment of income taxes on
profits, provided that the profits were held in surplus accounts and not
given to the owners. There was a set limit on the interest rate that could be
paid on savings accounts. This gave the savings and loan associations a
reliable source of funds at a fixed interest rate, making it possible to provide
long-term loans at reasonable rates.
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In the 1970s, a problem surfaced, as mass numbers of savers began
withdrawing their money from the S&Ls to invest in ventures paying higher
interest rates. This process -- called disintermediation was spurred by the
uncontrolled inflation that was causing interest rates to rocket higher. As
the law restricted S&Ls from offering competitive interest rates, depositors
started investing their money in government securities, corporate bonds
and money market funds which offered them a greater return on their
investments.
By 1980, S&Ls attempted to find a remedy to their problems by winning

federal government/regulatory approval for deregulation of depository
institutions. The Depository Institutions Deregulation and Monetary
Control Act of 1980 allowed S&Ls to enter the business of commercial
lending, trust services, and non-mortgage consumer lending. For a few
years this proved profitable, but soon the S&Ls began to break down
because of the lack of conscientious practices and faulty management.
This crisis led to the formation of the most important legislation for the
S&L industry in over 50 years, the Garn-St. Germain Depository
Institutions Act of 1982. This crucial act:
Provided more business opportunities for S&L associations.

Previously, federal savings and loan associations were limited in the
type of investments they could make.
Provide more liberal investment guidelines, although investment

opportunities were still limited compared to other financial
institutions. For instance, the Act permitted an increase in the
amount of assets invested in nonresidential real estate from 20% to
40% of the S&Ls total assets.
Terminated the advantage that the savings association had over

commercial banks. Previously, they could pay 25% more interest on
deposits, thus encouraging more savings in S&L associations.
Gave the Federal Home Loan Bank Board and the Federal Savings
and Loan Insurance Corporation new powers so that the financially
distressed savings associations could be salvaged.
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Approved emergency rescue programs to bail out troubled savings
associations.
In the latter part of 1982 the interest rates dropped and as the year ended
the savings and loan associations started receiving more in interest income
than the interest expense they were paying on the deposits. In 1981 and
1982 over 800 S&L associations vanished (although many of those had
merged into other institutions).
S&Ls kept failing during the rest of the decade and into the 1990s. Some of
the reasons for these failures were:
Loans were concentrated in a geographic region which was

dominated by a particular industry; oil. For instance, Colorado and
Texas are major energy states and the oil and gas companies there
were depressed by the falling oil prices in the early part of 1980s. The
fall in oil prices led to high levels of unemployment in this region.
This unemployment in turn led to defaults on residential loans and
sagging occupancy for commercial rentals, as well. These falling real
estate values affected the savings and loan associations to a huge
extent.
In the 1990s, defense spending and military bases faced cutbacks. The
geographic regions dominated by the defense industry saw high levels
of unemployment. This led to defaults in mortgages in the residential
market, negatively affecting the financial institutions.
Concentration of investments (as in junk bonds) that were negatively

affected by the economy.
Fraud.
With the Tax Reform Act of 1986, the domination of mortgage lending by
S&Ls ended completely. Many of the tax benefits enjoyed by the real estate
industry (which made it a desirable investment option) were eliminated by
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this act. The tax law changes affected builders and developers, who could
not sell their properties and many more properties financed by the S&Ls
went back to the lenders by way of foreclosure.
There was no income being generated from the foreclosed properties.

Evaluations of earnings and loan portfolios affirmed that a fiasco was
developing. Reviewing the financial debacle and poor business ethics, the
National Association of Realtors (NAR) measured the situation:
Deregulation and new investment powers made financial and managerial

demands that most thrift executives had not considered. Speculative
investment, a regulatory system that failed to exercise controls, basic
mismanagement and unprecedented level of fraud, abuse and greed
perpetrated by many thrift executives resulted in the inevitable legislative
backlash.
After the insolvency of the FSLIC in 1989, the Federal Deposit Insurance
Corporation took charge of its insurance obligations. The Resolution Trust
Corporation was formed to buy and sell defaulted savings and loans
associations. The Office of Thrift Supervision was set up to find struggling
savings and loan associations before they completely failed.
Financial Institutions Reform, Recovery, and Enforcement Act

(FIRREA): The inevitable legislative backlash to the way the savings and
loan industry was behaving was the formation of the Financial Institutions
Reform, Recovery, and Enforcement Act (FIRREA) in 1989 by the
Congress.
By enforcing this act the government was trying to rebuild a defamed

industry which had disregarded the welfare of consumers and resorted to
corrupt practices within the banking business.
The FIRREA authorized the Office of Thrift Supervision (OTS) and the
Housing Finance Board to supervise the savings and loan regulation duties
that were initially carried out by the Federal Home Loan Bank Board
(FHLBB) under the old system. The insuring of deposits in all federally-
chartered banks and savings institutions up to $100,000 per account for
commercial and savings banks is now done by the Federal Deposit
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Insurance Corporation (FDIC), which also regulates the Savings
Association Insurance Fund (SAIF) and the Regulation Trust Corporation
(RTC). Apart from these agencies, many other government entities were
created to deal with the banking crisis and to streamline banking
transactions.
Before 1992, S&Ls were the largest private holders of residential mortgage
debt and also the largest originator of residential mortgages in the U.S.
Once their problems mounted, the commercial banks stepped in. Banks
started making more mortgage loans, with mortgage bankers and
commercial bankers as mortgage loans originators. When it comes to
assets, though, the savings and loan industry is still the third largest group
of financial institutions in the U.S. Only commercial banks and life
insurance companies come before the S&Ls.
Although the S&Ls market share was now lower than in the period they
had dominated the residential mortgage market, S&Ls remain a major force
in mortgage lending. After the issues over the past several decades, this
industry has managed to stay active in both the primary and secondary
money markets. The institutions that survived are a large source of
mortgage money and give priority to residential lending.
Savings Banks
Savings banks are unique types of thrift institutions that at times, act like
commercial banks and at others, like S&Ls. The savings banks lending
practices run in a cyclical fashion, dependent on changing savers habits in
depositing funds.
In the beginning of the 19th Century, when lending institutions were being
established, the worker with an average income -- not wealthy, but looking
to protect his money -- was being ignored from an investment point of view.
Savings banks were then established for this group of people.
Savings banks were mutual organizations in the beginning. They mainly

relied on the savings of the customers for all the capital they needed to
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become successful; they did not sell stock in the company to shareholders.
To stay competitive alongside other lending institutions after the
deregulation of the mid-1990s, savings banks became stock institutions,
raised more capital, and changed their image.
The differentiation between banks that are mutual organizations and those
that are stock institutions is that the depositors share ownership in the
mutual savings bank which is managed by a board of trustees. A stock
company represents stockholders of the bank and is managed by a board of
directors.
Savings banks are authorized to make mortgage loans, but they mostly
specialize in consumer and commercial loans. These banks are also
involved in purchasing low-risk FHA/VA and conventional mortgages from
other mortgage lenders and mortgage bankers. As a majority of savings
banks are situated in the capital-surplus areas of the Northeast and carry
more than enough funds required locally, savings banks play an important
role in the cycle of savings and investment by buying loans from areas that
have insufficient capital. This kind of fund flow, from areas with excess
funds to areas with scarce funds, helps encourage a healthy financial
environment nationwide.
Savings banks are categorized as state- or federally-chartered. If the bank is

chartered by the state of California, it is licensed by the California
Department of Business Oversight (DBO) and insured by the FDIC. The
DBO licenses state-chartered banks and credit unions, too. (A California
state-chartered bank may be also be a member of the Federal Reserve
Bank).
As noted above, federally-chartered savings banks are regulated by the

Office of the Comptroller of the Currency and are insured by the FDIC.
Mutual Savings Banks
The depositors are the owners of the mutual savings banks. The return on
their investments is determined by the success of the banks investment
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policies. Most mutual savings banks are located in the northeast states. The
earnings of the banks are shared by its depositors after expenses, reserves,
and contributions to surplus. Lately, mutual savings banks have been
granted permission to convert to the status of savings bank.
Credit Unions
An association consisting of members whose occupation is of the same

nature is called a credit union. These members come together for their
mutual benefit; they save money in their own bank and receive better
interest rates. Secured and unsecured loans are both made at lower rates
than offered by other lenders. Credit unions are a fast-growing source of
funds for consumers because of their low overheads and other costs
involved in business. Credit unions are regulated by the National Credit
Union Association Board (NCUAB) and the deposits are insured by the
federal National Credit Union Share Insurance Funds.
INSURANCE COMPANIES
Usually insurance companies invest in real estate by making large

commercial loans to developers and builders. They normally do not make
loans to the single-home residential market. However, they do buy loans
from mortgage companies and invest in guaranteed or government-insured
loans. Customers make regular and periodic payments to insurance
companies in return for the promise that loss, if any, will be covered in case
a described event occurs for which the customer is insured. The funds are
to be invested by the insurance companies so that reserves can be built up
in the event they might have to actually pay a claim. Because of the lengthy
time line of its investment goals, commercial real estate is a more desirable
long-term investment option for insurance companies.
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NON-INSTITUTIONAL LENDERS
Along with institutional lenders, there is also another group who are known
as non-institutional lenders. This group comprises mortgage companies
and private individuals, as well as other non-financial lenders like pension
funds and title companies.
MORTGAGE BANKERS AND BROKERS
Most residential mortgage loans in this country are originated by mortgage

bankers. These persons are like financial agents between borrowers and
lenders. Although a mortgage banker seems like an institution accepting
deposits, actually a mortgage banker is a borrower, too.
A mortgage banker is similar to a mortgage broker in most ways, except

for one large difference. A mortgage broker originates a loan when he takes
applications from a borrower and sells that unclosed loan to another
mortgage lender. After that, the mortgage broker is not concerned with that
loan once he has sold it and been paid for it. On the other hand, the
mortgage banker sells all of the mortgages he originates. He also closes and
continues to service the loans after the sale.
Mortgage bankers actually make mortgage loans to consumers and sell

those to institutional investors. While some mortgage companies have their
own funds, others act as negotiators for the institutions which have the
money and the borrowers who need it.
Commercial banks fund many mortgage bankers on short-term lines of

credit while the mortgage bankers arrange to sell pools of loans originated
by them. The process which assembles a number of mortgage loans into
one package, before selling them to an investor is called warehousing. With
the sale of these loan packages, capital is raised, which is used to make
more loans. These loans are again packaged and sold, thus the cycle is
repeated.
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Often, a mortgage banker acts as a mover of funds. He transfers funds from
a region of the country where money to be loaned is available in abundance,
to another region of the country where the capital is scarce.
Nonetheless, the major role of the mortgage companies is to originate and

service loans and sell them in the secondary mortgage market. By being a
middleman, the mortgage banker follows all the standard procedures set
forth by the buyers of the loans.
Usually, loans that are easily saleable in the secondary market are preferred
by a mortgage company. Example: government-insured or government-
guaranteed mortgages, i.e., FHA/VA, or conventional mortgages that come
with advance purchase commitments.
When a borrower seeks a loan from a mortgage broker or banker,

procedures are followed to assess the salability of the loan in the secondary
market.
Procedures for Applying for a Loan
A loan application is filled out by the applicant.
A credit report is ordered.
The property in question is appraised.
The investor is presented with the application package which includes the
application form, financial statement of the borrower, appraisal and copy of the
sale agreement.
The investor either accepts or declines.
Approval is sent to the mortgage company.
After loan conditions are met, funds are sent by mortgage banker to escrow for
closing.
After closing, documents are sold to the investor, while the mortgage banker
services the loan. (He accepts and keeps record of payments and tracks the life
of the loan.)
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These companies pool the funds of many investors and invest in a portfolio
of assets. There may be certain types of industries or investments in which
the investment companies specialize, such as income stocks or growth
stocks or Real Estate Investment Trusts (REITs).
A REIT is one of the ways by which private individuals can be involved in

the real estate market as investors. These individuals come together, each
one with his small amount of capital and pool their resources to buy real
estate. The risk of any loss that may incur is divided among the investors.
The investors in REITs are an assortment of real estate and mortgage
investors as a group. A minimum of 100 investors are required. There are
crucial legalities that are required for qualification as a trust and also for
special tax benefits.
Created by the Internal Revenue Code, a REIT may be a real estate

company or group of individuals which have planned to qualify under
certain tax provisions to become an entity distributing its profits to
shareholders, the larger portion of which is received from the sale of its
properties. It is not the REIT that pays taxes on its profits; rather, it is the
individual members of the trust who pay the taxes, at their own tax rates,
on the dividends divided among them.
Requirements for REIT Assets
A minimum of 75% of the value of a REITs assets must be in real estate, cash
or government securities.
A maximum of 5% of the value of the assets may consist of the securities of any
one issuer in case the securities are not supposed to be included under the 75%
test.
A REIT may hold a maximum of 10% of the outstanding voting securities of

any one issuer if those securities are not supposed to be included under the
75% test.
(Contd. on next page)
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A minimum of 95% of the gross income of the entity must come from
dividends, interest, rents or gains from the sale of certain assets.
A minimum of 75% of gross income must come from rents, interest on

obligations secured by mortgages, profits from the sale of certain assets, or
income deducible to investments in other REITs.
A maximum of 30% of the gross income of the entity can come from sale or
distribution of stock or securities held for less than six months or real property
held for less than 4 years, besides property involuntarily converted or
foreclosed on.
Distribution of Income
Distributions to shareholders must equal or exceed the sum of 95% of REIT

taxable income.
Stock and Ownership
Shares in a REIT need to be transferable and must be held by a minimum of

100 persons.
A maximum of 50% of REIT shares may be held by five or fewer individuals

during the latter half of a taxable year.
PRIVATE MONEY INVESTING
Private money refers to funding that originates from private individuals,

friends, family, IRAs or any source other than institutional or conventional
means. It is sometimes referred to as hard money. Indeed, private
individuals can also be lenders. Usually, it is done by carrying back a trust
deed on the sale of their home, or otherwise they can go through a
mortgage broker, who then finds a borrower. Generally, private loans are
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short term, with the lender mainly looking for the safety of the loan and a
high return on the investment. Lenders are predominantly small, highly-
specialized mortgage brokers who have become familiar with commercial
real estate lending.
Private money investing is the reverse side of the coin of hard money
lending (a type of financing in which a borrower receives funds based on
the value of real estate owned by the borrower). Private money lenders are
generally considered more relationship-based than hard money lenders.
The practice is not well publicized and is largely centered in California.
NON-FINANCIAL INSTITUTIONS
Pension funds, title companies, trust departments of banks, universities,

and mortgage investment companies all hold real estate loans as
investments, although, of course, not usually as part of their part of their
primary purpose.
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CHAPTER SUMMARY
Generally, it is commercial banks which make short term or interim

loans to finance construction. Long-term loans may be used only after
a construction loan is paid off.
For residential mortgage credit, the largest source is thrifts.
The major difference between savings and loan associations and

mutual savings banks is type of ownership. Mutuals are a cooperative
type of ownership, while S&Ls are like a stock company.
The first savings and loan association in the United States was
probably formed in Philadelphia in 1831. It followed the pattern
similar to those institutions in Great Britain.
The Home Owners Loan Act of 1933 first established federally-

chartered savings and loan associations.
The Federal Home Loan Bank Act of 1932 established the Federal
Home Loan Bank System, comprising a bipartisan body of three
members which was supervised by the Federal Home Loan Bank
Board.
The inevitable legislative backlash to the way the savings and loan
industry was behaving led to the formation of Financial Institutions
Reform, Recovery, and Enforcement Act (FIRREA) in 1989 by
Congress.
The FIRREA authorized the Office of Thrift Supervision (OTS) and

the Housing Finance Board to supervise the savings and loan
regulation duties that were initially carried out by the Federal Home
Loan Bank Board (FHLBB) under the old system.
Savings banks are unique types of thrift institutions that at times act
like commercial banks and at times like S&Ls.
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Created by the Internal Revenue Code, a REIT may be a real estate
company or a group of individuals that have planned to qualify under
certain tax provisions to become an entity distributing to its
shareholders, the bigger part of its profits received from the sale of its
properties.
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CHAPTER QUIZ
1. ________ are all-purpose lenders.

a) Savings banks
b) Commercial banks
c) Thrifts
d) Insurance companies
2. The largest single resource for residential mortgage credit in the

United States is:
a) Thrifts
b) Commercial banks
c) Savings banks
3. Which of the following kind of businesses would not be called a thrift

institution:
a) Savings banks
b) Credit unions
c) Mutual savings banks
d) Mortgage bankers
4. The process of __________ begins as a result of sudden inflation

causing interest rates to soar to all-time highs.
a) Reverse annuity
b) Variable annuity
c) Disintermediation
d) Re-intermediation
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5. Measures taken by which act allowed S&Ls to enter the businesses of
commercial lending, trust services and non-mortgage consumer
lending?
a) The Garn-St. Germain Depository Institutions Act of 1982
b) The Depository Institutions Deregulation and Monetary Control
Act of 1980
c) The Tax Reform Act of 1969
d) The Revenue Act of 1962
6. The deposits in commercial banks and savings banks are insured by

the:
a) Federal Deposit Insurance Corporation
b) Savings Association Funds
c) Office of Thrift Supervision
d) Federal Home Loan Mortgage Corporation
7. The _____________ authorized the Office of Thrift Supervision

and the Housing Finance Board to supervise and regulate the savings
and loan industry.
a) The Garn-St. Germain Depository Institutions Act of 1982
b) The Tax Reform Act of 1969
c) The Depository Institutions Deregulation and Monetary Control
Act of 1980
d) The Financial Institutions Reform, Recovery, and Enforcement Act
of 1989
8. Which of these agencies was NOT created or strengthened under

FIRREA?
a) Federal Deposit Insurance Company
b) Federal Home Loan Bank System
c) Resolution Trust Corporation
d) Savings Association Insurance Fund
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9. The __________is the primary regulator of all federally-chartered
and some state-chartered thrift institutions, including savings banks
and S&Ls.
a) Housing Finance Board
b) Federal Housing Finance Board
c) Office of Thrift Supervision
d) Federal Home Loan Bank Board
10. Which of the following has been described as a distinctive type of

thrift institution that sometimes behaves like a commercial bank and
sometimes like an S&L:
a) Savings banks
b) Mutual savings banks
c) Credit unions
d) Mortgage bankers
11. An association whose members usually have the same type of

occupation is a:
a) Savings bank
b) Mutual savings bank
c) Credit union
d) Savings and loan association
12. Which of the following kind of institution is generally known for

investing in real estate by making large commercial loans to developers
and builders:
a) Mortgage bankers
b) Savings and loan associations
c) Commercial banks
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13. Which of the following kind of institution makes a practice of lending
its own money to make loans?
a) Mortgage bankers
b) Mortgage brokers
c) S&L associations
d) Investment companies
14.What minimum percent of a REITs assets must consist of real estate

assets, cash, and government securities?
a) 95%
b) 85%
c) 75%
d) 65%
15. Shares in a REIT must be transferable and must be held by at least

____ persons.
a) 50
b) 100
c) 200
d) 250
Answer Key:
1. B 6. A 11. C
2. A 7. D 12. D
3. D 8. B 13. A
4. C 9. C 14. C
5. B 10. A 15. B
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CHAPTER SEVEN
THE MORTGAGE MARKET
INTRODUCTION
In the 1980s, when the economy was on the recovery path after a decade of
economic turmoil, the real estate industry -- along with the government-
regulated financial institutions in particular -- was looking for new ideas to
service consumers.
The financial intermediaries, i.e., savings banks, commercial banks, credit

unions and mutual savings banks which are depository institutions
regulated by the government, lost their customers and their savings
accounts to the unregulated non-depository institutions, such as uninsured
money-market funds. The reason for this shift by consumers was they were
getting higher interest rates on their savings from these unregulated
institutions than from the government-regulated lenders who were bound
by law to provide only a certain percentage of interest on savings accounts.
As already discussed, the process of depositors removing funds from

savings is called disintermediation. The financial institutions used to make
home loans from these savings accounts money of the depositors. As it
occurs for all things scarce, money got costlier as less of it was available.
Fewer people could afford it as money became costlier, causing the
economy to fall further.
People started to postpone their plans of purchasing a home due to the

crisis in the banking industry, which eventually led to a crisis in the real
estate industry. There were no buyers, so obviously there were no sellers.
The economy came to a standstill as builders and developers stopped
executing projects. Due to high interest rates, and tight money and credit,
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money became deficient for mortgage loans and financial services came at a
premium. Feasible borrowers had to compete for the available funds and
had to pay a high price to get it.
A process where financial institutions that had previously been curbed by

law in their lending activities are now permitted to compete freely for
profits is known as deregulation. Lending activities may still be under
check, but loans can be marketed in a competitive atmosphere by all
lending institutions.
The housing finance system nationwide was restructured because of the

deregulation efforts of the federal government and the alternative mortgage
plans. Now the challenge was to make mortgage funds available, and at
better rates to the consumer, and also see that the financial institutions
made profits.
Back then, fixed-rate loans were the only option for home buyers. But then
lenders came up with the new Variable Rate Mortgage (VRM) which was
beneficial to all. Lenders offered loans to borrowers at affordable rates
while at the same time not tying them to the original rate of interest for the
rest of the life of the loan. These loans were connected to movable indices
that followed changes in the economy and allowed protection for the
lending institutions. The lenders were no longer bound with the old and
profitless low-interest-rate loans. This loan plan would activate the real
estate industry by creating new buyers and, as a result, new borrowers
would be created.
As a modification on the VRM loans concept, the banking industry devised

an alternative for borrowers in the form of Adjustable Rate Mortgages
(ARMs). In an ARM, the interest rate adjusts periodically in connection to a
pre-determined index and a pre-established margin.
Traditionally, the role of financial institutions and real estate has been
associated with each other in many ways, some of which were not profitable
for all parties. The events of the last several decades actually was a good
learning experience for all, resulting in some mutually agreeable goals for
bankers and consumers both.
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THE NATIONAL ECONOMY
Americas economic system is based on the capitalist system. Government
hopefully influences the general economic path in an effective fashion, and
assure reasonable and balanced competition. Still, it is individuals with the
right to own, control, and sell property, and make most of the decisions
pertaining to the general economy. The many choices that we all make on a
daily basis in regards to producing, earning, saving, investing, and spending
collectively contribute to the economy of the nation. Of course, real estate
plays a major role.
Net Worth
A huge part of the U.S. as a country (in geographic terms) consists of real
estate in the form of land and improvements. There is an income flow
paying for the use of real estate and also for raw materials, capital and
management, and labor, used in all kinds of construction work.
Major Employer
The real estate industry which comprises the construction, management,

finance, and brokerage fields is a major employer in the U.S. A large
segment of the population is employed in this industry which generates on
a national scale income in billions of dollars.
Appreciation and Inflation
In the present day scenario, appreciation in real estate value has beaten the
annual rate of inflation and is the single largest indicator of inflation. With
the decrease in the value of the dollar, savings accounts and other types of
financial savings have taken a back seat when it comes to savings and
investments for the future. Real estate has become a major means of
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protecting personal savings. In California, in particular, the value of
property has appreciated considerably over the years; for lucky
homeowners here, it has become as good as money in the bank.
THE FEDERAL RESERVE BANK SYSTEM (THE FED)
The Federal Reserve Bank System functions as the central bank of the
United States. Its primary function is to regulate the flow of money and
credit to boost economic development in a stabile setting. The national
monetary policy is developed by the Fed and the responsibility of
implementing the policies and setting the goals for money supply is shared
by the 12 Federal Reserve Banks.
The duties of the Federal Reserve Bank have four major aspects:
Executing the countrys monetary policy,
Regulating and supervising the banking institutions and safeguarding

the credit rights of consumers,
Stabilizing the financial system, and
Furnishing certain financial services to the federal government,

citizens, financial institutions, and foreign official institutions.
In an attempt to avoid drastic ups and downs of the business cycle which
leads to liquidity and credit crises, the Fed checks the changing economic
conditions and applies necessary measures. The supply of money and
availability of credit is influenced by the Fed, and thus greatly influences
the behavior of lenders and borrowers. These control measures affect the
interest rates, jobs and the economies of the world. The Fed makes use of
three primary tools to achieve its goals.
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PRIMARY TOOLS OF THE FED
Reserve Requirements: The amount of money in circulation is

increased or decreased by the Fed, by raising or lowering the reserve
requirements for member banks. Some percentage of every deposit has to
be kept aside as a reserve. When a larger reserve is required by the Fed, the
banks lend less, therefore interest rates increase and borrowing and
spending decreases. When the reserve requirement is lowered, banks have
more money to lend, the interest rate goes down, and borrowing and
spending increases, too.
Discount Rates: The Fed charges an interest rate from the banks on
money borrowed; this is the discount rate. A decreased discount rate
attracts more bank borrowing from the Fed. Money for lending increases if
there is more bank borrowing. On the other hand, if the discount rate is
raised, less money is available to the consumer for borrowing.
Open Market Operations: To influence the available amount of credit,

the Fed also buys and sells government securities. When securities are
brought by the Fed, banks have more money available to lend. But the
opposite happens when the Fed sells securities. The most flexible and
commonly used method for expanding or slowing the economy is this
process, called the open-market operations.
HISTORY OF THE FED
1775-1791: Initial currency of the U.S.
The Continental Congress printed the new countrys first-ever paper

currency to finance the American Revolution. The currency notes were
known as continentals, which were issued in a quantity that caused
inflation. The inflation was moderate at first but became uncontrollable as
the war continued. In the end, people did not rely in the notes anymore,
and considered them to utterly worthless.
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1791-1811: Earliest Attempt at Central Banking
Upon the persuasion of Treasury Secretary Alexander Hamilton, the

Congress set up the First Bank of the United States in 1791. Its
headquarters was in Philadelphia. This was the largest corporation in the
country then, dominated by big banking and money interests. Back then,
the average American was agrarian-minded and was not very happy about a
large, powerful central bank. In 1811, when the 20-year charter of the bank
expired, the Congress refused (by one vote) to renew it.
1816-1836: Failed Second Attempt
Once again by 1816 the political atmosphere was pointing towards the
possibility of a central bank. The Congress, by a slim margin, agreed to
charter the Second Bank of the United States. In 1828, Andrew Jackson,
who was totally against the central bank system, was elected president. He
was determined to eliminate the central bank. He targeted the banks
immense centrally-controlled power, which most Americans whole-
heartedly supported. In 1836 the Second Banks charter expired, and again
was not renewed.
1836-1865: The Period of Free Banking
During this period the state-chartered banks and unchartered free banks
took hold. They issued their own notes that could be redeemed in gold or
specie (money in coin form). To strengthen the economy, the banks also
started offering demand deposits. To encounter the rising volume of check
transactions, the New York Clearinghouse Association was set up in 1853.
Through this association the citys banks could exchange checks and settle
accounts.
1863: National Banking Act
The National Banking Act was passed in 1863, during the Civil War. This
Act provided for nationally-chartered banks, whose circulating currency
notes were backed by U.S. government securities. The Act was amended so
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that the state bank notes could be taxed but not the national bank notes,
thus forming a standard currency for the nation. Even after taxation on
their notes, the state banks continued to thrive because of its now popular
demand deposits, which had taken control during the Free Banking Era.
1873-1907: Panic in the Financial Sector
Even though the National Banking Act of 1863 did bring about measures to
stabilize the currency for national growth, bank runs and financial unrest
continued to afflict the economy. A banking panic that sparked in 1893 led
the United States into its worst depression yet felt; the falling economy was
only salvaged by the intervention of the financial mogul J. P. Morgan.
In the year 1907, a course of failed speculations on Wall Street, led to

another severe panic in the banking industry. To prevent the collapse, J. P.
Morgan was looked to again. By then, most of the citizens were demanding
reforms in the banking sector. The issue of the structure of these reforms
resulted in major division amongst Americans. The so-called progressives
sternly opposed the conservatives and powerful money trusts in the big
Eastern cities. By now most people agreed with the idea of a central
banking authority to support a healthy banking system as well as the elastic
currency that was urgently needed by the growing nation.
1908-1912: Setting for a Decentralized Central Bank
In response to the panic situation in 1907, the Aldrich-Vreeland Act of 1908

was passed. This Act provided for emergency currency issues during the
crisis and also set forth the National Monetary Commission to look for a
permanent solution to the banking and financial issues of the nation. This
commission, under Senator Nelson Aldrich, developed a banker-controlled
plan. Other progressives along with William Jennings Bryan strongly
opposed this plan; they wanted a publicly-controlled central bank and not a
bankers controlled one. When Democrat Woodrow Wilson was elected in
1912, he ruined the Republican Aldrich plan, and the stage was set for the
inception of a decentralized central bank.
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1912: Woodrow Wilson, Financial Reformer
President Wilson was admittedly not especially knowledgeable regarding

banking and financial matters, and sought expert advice from Virginia
Representative Carter Glass, the new chairman of the House Committee on
Banking and Finance. Wilson also took valuable advice from the
committees expert advisor H. Parker Willis who was a professor of
economics at Washington and Lee University. Glass and Willis worked over
a central bank proposal and by December 1912 Wilson was presented with a
proposal that in the future, with certain changes, would become the Federal
Reserve Act.
1913: The Federal Reserve System is Introduced
The Glass-Willis proposal went through much discussion from December

1912 to December 1913 and was finally reshaped into what Wilson signed
into law in December 23, 1913 as the Federal Reserve Act. This Act became
an excellent example of compromise; a decentralized central bank that
balanced the interests of both the private banks and individuals.
1914: Bank Operations Begin
Before the operations of the new central bank could begin, a strenuous task
of building a working institution around the newly formed Act had to be
performed. This was done by the Reserve Bank Organizing Committee
which comprised Treasury Secretary McAdoo, Secretary of Agriculture
Houston, and Controller of the Currency Williams. By November 16, 1914,
as Europe fell into the cataclysm that was World War I, the 12 selected
cities where the regional Reserve Banks were located opened up for
business.
1914-1919: Fed Policy During World War I
In mid-1914 when the war broke out, U.S. banks continued to function
normally; this was a result of the emergency currency issued under the
Aldrich-Vreeland Act of 1908. But the Feds capacity to discount bankers
acceptances impacted the United States greatly. This system helped United
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States with the flow of trade goods to Europe, indirectly providing financing
for the war until 1917, also the time the U.S. officially declared war on
Germany and the Fed began backing this nations war efforts.
1920s: The Start of the Open Market Operations
After World War I, the head of the New York Fed, Benjamin Strong, from
1914 until his death in 1928, understood that gold did not serve as the
primary factor in controlling credit anymore. The combative action of
Strong to avert a recession in 1923 by purchasing government securities
proved the power the open market operations had to influence the
availability of credit in the banking system. In the Roaring Twenties, the
Fed started using open market operations as a monetary policy tool. Strong
also upgraded the status of the Fed during his tenure as he promoted
relations with other central banks, particularly the Bank of England.
1929-1933: The Market Crash and the Great Depression
Virginia Representative Carter Glass, in the 1920s, had predicted that stock
market speculation would result in ghastly consequences. This prediction
was unfortunately realized in October 1929 with the crash of the stock
market and the resultant depression which was the worst ever faced by the
United States. About 10,000 banks failed in the 1930-1933 period. In
March 1933, new President Franklin Delano Roosevelt declared a bank
holiday, as government officials struggled to repair the countrys economic
condition. Many believed that the Fed failed to control the speculative
lending that caused the crash, while others believed that the Fed was
unable to understand the monetary economics well enough to take steps
that could have reduced the depths of the Great Depression.
1933: The Impact of the Great Depression
In response to the Great Depression, the Banking Act of 1933 was passed by
Congress. Also known as the Glass-Steagall Act, this was Congress attempt
to separate commercial and investment banking and required the use of
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government securities as collateral for Federal Reserve notes. The act also
established the Federal Deposit Insurance Corporation (FDIC), brought the
open market operations under the Fed and required bank holding
companies to be inspected by the Fed. This practice, in the future, would
have penetrating significance, as holding companies were to become the
prevailing structure for banks in times to come. As these extensive reforms
were enacted, President Roosevelt recalled all gold and silver certificates,
thus ending the panic hoarding of this metallic currency that was
hampering recovery.
1935: More Changes
The Banking Act of 1935 made further changes in the structure of the Fed
which included the forming of the Federal Open Market Committee
(FOMC) into a separate legal entity, termination from the Feds governing
board the Treasury Secretary and the Controller of the Currency, and also
fixing the members terms at 14 years. After World War II, the Employment
Act passed the responsibility of promoting maximum employment to the
Fed. The Bank Holding Company Act of 1956 appointed the Fed as the
regulator for bank holding companies owning more than one bank. The
Humphrey-Hawkins Act of 1978 required the chairman of the Fed to report
to Congress on monetary policy goals and objectives, twice every year.
1951: The Treasury Accord
The Fed most of the time supported the Treasurys fiscal policy goals from
the time it was founded in 1913 to the years after World War II. In 1951 as
the Korean conflict broke out, Fed chairman William McChesney Martin
was pressured by the Treasury to maintain low rates of interest so that
funds could be provided for the war effort. However, to break with the old
practice of supporting government bond interest rates, Martin closely
worked with the Treasury. Since this time, the Fed has sought independent
functioning, using the open market operations to support the monetary
policy goals.
1970s-1980s: Inflation and Disinflation
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Inflation skyrocketed in the 1970s as realty prices rose, oil was at an all-
time high, and the federal deficit more than doubled. Paul Volcker, who
became chairman of the Fed in August 1979, needed to take extreme
measures to free the economy of United States from the stranglehold of the
inflation. Under the influence of chairman Volcker during 1980s, the Fed
was able to bring double-digit inflation under check.
1980: Advent of Financial Modernization
Through the Monetary Control Act of 1980, the Fed had to price its
financial services competitively as opposed to private sector service
providers and also set up reserve requirements for the eligible financial
institutions. This Act was seen as a beginning of a new era of modern
banking industry reforms. As time passed, interstate banking rapidly grew
and banks started to offer interest-paying accounts and instruments to
attract consumers from brokerage firms. However, it was proving more
difficult to maintain barriers to insurance activities. The pace of change
continued, though and by 1999 the Gramm-Leach-Bliley Act was passed.
This Act allowed banks to offer a range of financial services which included
investment banking and insurance sales.
1990s: The Longest Economic Expansion
On Oct. 19, 1987 the stock market crashed, just two months after Alan
Greenspan was sworn in as Fed chairman. He responded to the crash by
issuing a single-sentence statement on Oct. 20, before the start of trading.
The Federal Reserve, consistent with its responsibilities as the nations
central bank, affirmed today its readiness to serve as a source of liquidity to
support the economic and financial system.
Since then, monetary policy has been conformed by the Fed to deal with
problems which include the credit crunch of the 1990s and also the Russian
default on government bonds. This has helped keep some global financial
issues away from the U.S. economy. Chairman Greenspans time in office
was marked by declining inflation and the longest peacetime economic
expansion in the history of America.
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2000 and on
In the financial services industry, many new challenges have been dealt
with by the Federal Reserve and its leader from 2006, Ben Bernanke,
including deregulation, technological advances in the payments method,
and resultant hacking of key financial systems, the ascendancy of China and
the corresponding shift to a truly global economy. The new Fed chairman,
Janet Yellen, who took office in February 2014, faces similar challenges.
STRUCTURE OF THE FED
The Federal Reserve System is made up of a network of 12 Federal Reserve

Banks (FRBs) and 25 branches, supervised generally by the Board of
Governors (BOG) in Washington D.C. The Reserve Banks are the operating
units of the central bank, serving other lending institutions, the U.S.
Treasury and, the public (indirectly). Reserve Banks also supervise the
commercial banks in their region. Since they serve as the banks for the U.S.
government, Reserve Banks takes care of the Treasurys payments, sell
government securities and assist with the Treasurys cash management and
investment activities.
Also, the Reserve Banks are responsible for conducting research on

regional, national and international economic matters. This research play a
major role in attaining a broad economic outlook for the national policy-
making platform, and supports Reserve Bank presidents who attend
meetings of the Federal Open Market Committee (FOMC).
The Board of Directors of each Reserve Bank supervises the management

and activities of the regional bank. Indicating the varied interests of each
region, these directors share local business experiences, involvement of the
community, and leadership. The board provides a private-sector viewpoint
to the Reserve Bank. The president and the first vice-president of the
Reserve Bank are appointed by each board, and approved by the Board of
Governors.
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The member banks hold stock in Reserve Banks and get dividends. But the
banks cannot sell or trade their Fed stocks, as stockholders in a public
company do.
The Federal Reserve System does its job effectively because Reserve Banks
interact directly with their district banks by way of examinations and
financial services and focus on important aspects of the regions.
Many have found describing the Federal Reserve a difficult thing to do

because of the complexity of the organization. There are both private and
public aspects of the Federal Reserve, it has centralized and decentralized
authority, and operates independently within the government under the
general supervision of Congress. The structure of the Fed provides
accountability, and insulation from centralized, governmental control of
banking and monetary policy.
Federal Open Market Committee (FOMC)
The Federal Open Market Committee (FOMC) sets the goals of monetary
policy. To make these goals a success, the Fed uses many methods to
measure the impact of its policies on the economy of the nation. The 12
Reserve Banks also play an important part in the success of this monetary
policy. After every meeting, the FOMC issues a directive to the Open
Market Desk at the New York Fed. Through these directives the FOMC has
general objectives it wishes the Open Market Desk to achieve, such as
easing, tightening, or maintaining the growth of the nations money supply.
Every day, the Open Market Desk buys or sells Treasury securities in the
open market, to achieve the given goals. Although the policy discussions of
the FOMC are held in private, its decisions are made known by the Fed;
since 1994, the FOMC has made its policy decisions public, immediately
after having made them.
The policy-making process receives valuable contribution from the research

economist at all the 12 Reserve Banks and from economists at the Board of
Governors. In general terms, Reserve Banks oversee the economies of their
districts and study relationships among national economic indicators. One
of the most important duties of the Reserve Bank is to prepare its president
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for participation in the FOMC discussions. They also collect loans and
deposit data from banks and bank holding companies. This data is used in
analyzing regional and national bank performance, credit demand, and
other banking matters.
Board of Governors (BOG)
The primary concern of Congress, when establishing the Federal Reserve,

was to address the banking issues of the nation. The Fed had to fulfill three
major responsibilities to meet this short-term requirement, i.e., to promote
safe, sound, and competitive methods in the nations banking system.
To achieve the above-mentioned goal, the Fed was given responsibility for
regulating the banking system and supervising certain types of financial
institutions. (Bank regulations refer to the written rules that define
acceptable behavior for financial institutions). This responsibility is fulfilled
by the Board of Governors. The 12 Reserve Banks supervise the state-
chartered member banks, bank holding companies, and international
organizations that carry out banking business in United States. The Fed
supervises these banks by implementing safe banking practices, fostering
consumer protection in financial markets, and ensuring the stability of U.S.
financial markets by acting as a lender. All these three duties have a
common goal of minimizing risk in the banking system.
The Fed has to protect consumers in lending and deposit transactions. The
Fed has been given the authority by lawmakers to make, define, and
implement laws protecting consumers from lending discrimination and
incorrect disclosure of credit costs or rates of interest.
However, the most significant supervisory duty of the Fed is to respond to a

financial crisis by acting as lender of last resort for the countrys banking
system. The Fed lends money to banks through its discount window, so that
a shortage at one institution does not disrupt the flow of money and credit
in the entire banking system. Generally, the Fed makes loans to fulfill a
banks abrupt need for short-term funds. To help the banks manage
seasonal changes in their customers deposit or credit demands, the Fed
also makes long-term loans.
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FURNISHING FINANCIAL SERVICES
The Federal Reserve is also assigned the important task of furnishing a safe
and effective method of transferring funds throughout the banking system.
Reserve Banks and their branches carry out this objective by offering
payments services to all financial institutions in the United States,
irrespective of size and location. Along with this objective there is the
responsibility to improve the payments system by working proficiently and
using technologically-advanced methods.
A Reserve Bank primarily serves as a bankers bank that offers a wide range
of payments services. The Reserve Bank dispenses currency and coins,
processes checks, and offers electronic modes of payment. The Fed and the
private sector compete with each other in their financial services to
promote modernization and effectiveness in the payments system. The Fed
does not look at making profits through its activities and sets its prices just
to recover costs.
Public demand for currency and coins in each district is met by the regional
Reserve Banks. Commercial checks are also processed by the Reserve
Banks. Billions of dollars are electronically transferred every day among
U.S. financial institutions. There are two types of electronic payment
services provided by the Federal Reserve Banks: funds transfer and the
automated clearing house (ACH). In the funds transfer service there is a
communications link between financial institutions and government
agencies. A countrywide network is provided by the ACH to exchange
paperless payments between financial institutions and government
agencies. An expansive range of recurring corporate and consumer
transactions, i.e., payroll deposit, electronic bill payment, insurance
payments, and Social Security distributions are all provided by the ACH.
Federal Reserve Banks also fulfill some of the following duties:
Maintains accounts for the U.S. Treasury,
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Processes government checks, postal money orders, and U.S. savings
bonds,
Collects federal tax deposits, and
Sells new Treasury securities, services pending issues and redeems

maturing issues.
THE MORTGAGE MARKET
Buying a home is probably the largest purchase a consumer makes in his

lifetime. Most consumers do not have monetary resources to purchase a
home on their own, so they have to obtain a real estate loan to finance their
purchase. The consumers have varied financial requirements which can be
met through a wide range of loan products.
The real estate lending industry has grown considerably and will soon cross
$4 trillion in outstanding loan balances. The United States total real estate
debt is the largest in the world, second only to the United States
governments debt. The residential real estate lending market is divided
into the primary mortgage market and the secondary mortgage market.
There are a number of other additional entities which service and support
the real estate lending process, as discussed below.
PRIMARY MORTGAGE MARKET
The complete process that a consumer undergoes in procuring a real estate

loan is covered by the primary mortgage market. In this process the
consumer has to complete a loan application form, have his credit and
property information validated, obtain loan underwriting by the lender, and
close the mortgage loan. Mostly, the first contact throughout this process is
the loan officer. The loan officer takes the consumer through the intricacies
of the primary market and assists in the following tasks:
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Identifying suitable loan program according to the consumers
requirements,
Completion of the loan application form,
Arranging necessary documentation to validate credit and property

evaluation,
Submit to the lenders, a compiled supporting information in a

suitable package,
Communicate between the lender and the consumer.
The process of procuring a loan still takes at least a few weeks for
completion, but in the future this time period is likely to speed up
considerably; the application process, credit validation, and loan
underwriting are soon to become automated. It is believed by industry
experts that very soon the primary market process will be completed within
hours or days, not the weeks and months it takes now.
SECONDARY MORTGAGE MARKET
The secondary mortgage market in United States attracts capital from

around the world with the objective of financing a wide range of mortgage
products that are specially planned to make homeownership affordable and
feasible. It is arguably the best secondary market.
The secondary market is the core of the lending process and an important
part of the nations economic well-being. The main task of the secondary
market is to make money available to primary lenders who then loan it to
consumers. These consumers make loan commitments which are then sold
on the secondary market and the money is paid back into the primary
market.
The secondary mortgage market comprises lending institutions such as

thrifts or mortgage bankers, private investors, and government credit
agencies. These entities buy pools of existing loans from the loan-originator
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sellers, the primary markets. Later they buy from and sell to each other
the existing mortgage loans originated in the primary mortgage market.
The secondary market participants purchase existing mortgages, but they

do not originate the loans; that is done with funds acquired by issuing
bonds or other types of debt instruments. The mortgages bought by them
are used as security for those debt instruments. The debt issue which is
known as a mortgage-backed or mortgage related security (MRS) is
collateralized by the mortgages that are brought in the secondary market.
These mortgage-backed securities are also brought and sold in the
secondary market.
The initial source of the funds used to buy the mortgage-backed securities
is investors who purchase the securities from the secondary market agency
or company. Then, more mortgages are brought by the agency using the
funds from the investor, such as a savings and loan or mortgage banker.
More mortgage loans are originated by the savings and loan or originator of
the loan using the funds received from the sale of the loan. Consumers and
the economy on the whole benefits as the funds supplied by the investors
ultimately turn into home loans to consumers.
The secondary mortgage market is necessary for the thrifts and other
financial institutions, so that they can sell their assets quickly when they
need more money, especially in a market where there is a demand for more
home loans from the consumers. Previously, most of the financial
institutions resources comprised depositors funds which were tied up in
long-term mortgage loans. As a source for quick money, these were not
convenient because of the anticipated risk of default or the unreliability of
the creditors who might be located in a country far away from where the
collateral for the loan was located. Things might become worse if there is
an area of the country with an over-abundant supply of capital, in the form
of deposits, resulting in excess money with nowhere to spend it. At the
same time, another area of the country has a greater demand for mortgage
loans, but because of lack of deposits there is no money to lend. Since
lending institutions were unable to buy and sell mortgages easily, the
supply and demand for money was never in harmony.
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There was a need to create a money market where loans could be easily
bought and sold and funds could be easily moved to an area that needed
more capital from an area with excess funds. Financial institutions in the
areas with excess capital were encouraged to purchase mortgages from
financial institutions in areas where capital was deficient. This would
stabilize the flow of cash and solve financial problems for many mortgage
lenders.
Three Main Contributors to the Secondary Mortgage

Market
Federal National Mortgage Association (FNMA or Fannie Mae): A

private shareholder-owned company, Fannie Mae, works to ascertain that
mortgage money is available for people in communities in all of United
States. Home owners cannot borrow money directly from Fannie Mae.
Rather, it works with lenders to make sure they do not lack mortgage funds,
so that as many people as possible may be able to get a loan for fulfilling
their dream of owning a home.
In 1938, Congress created Fannie Mae to boost the housing industry that
was suffering after the Great Depression. Fannie Mae was associated with
the Federal Housing Administration (FHA) and had the authority to buy
only FHA-insured loans to provide money to the lenders.
Fannie Mae became a private company in 1968, functioning with private

capital and sustained by itself. Fannie Mae bought mortgages over and
above the traditional loan limits, and reached out across the U.S.
Presently, Fannie Mae functions under a congressional charter that

influences it toward directing its efforts into increasing the availability and
affordability of owning a home for low-income, moderate-income, and
middle-income citizens. In spite of this, Fannie Mae does not receive any
funds or backing from the government. It is also one of the nations largest
tax payers and a consistently profit-making corporation.
The ten key commitments that resulted in the success of Fannie Mae are:
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Housing Leadership: Playing an important leadership role in
breaking down hindrances to affordable housing and home
ownership.
Honesty, Integrity, and Mutual Respect: Maintaining highest levels

of ethics in its everyday activities.
Financial Strength: Striving to strengthen its commitment to home

buyers and investors through excellent management of assets.
Excellence and Teamwork: Working hand-in-hand for producing the

best results in all aspects of business, and also maximizing its
capacity.
Diversity: Promoting a diverse workforce and identifying and valuing

every persons unique skills and ideas.
Corporate Citizenship and Responsibility: Making sure that Fannie

Mae, at all times, have a positive effect on the lives of its employees,
the communities in which they live, and the country they serve.
Innovation and Corporate Renewal: Finding new and innovative

methods of doing business, in an effort to achieve best results.
Employee Development: Nurturing the careers and jobs of its

employees.
Reward and Recognition: Recognizing the efforts of individuals and

team contributions to success and rewarding them accordingly.
Customer Service: Working towards providing the best possible

service to all customers.
Fannie Mae was first created as a secondary market for FHA-insured and
Veterans Administration-guaranteed loans and the private residential
mortgage market. Now, it supports the secondary mortgage market by
issuing mortgage-related securities and purchasing mortgages. Fannie Mae
purchases loans from lenders conforming to FNMA guidelines. In this way
the mortgage money is put back into the system, allowing lenders to make
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more loans. In the secondary market, FNMA is the largest investor. The
FNMA was divided into two separate systems in 1968: FNMA and GNMA.
GNMA remained owned by the government, whereas FNMA became a
privately owned corporation.
Government National Mortgage Association (GNMA or Ginnie

Mae): Ginnie Mae is a wholly-owned corporation formed in 1968 within
the Department of Housing and Urban Development (HUD). The main
purpose of this association is to serve low and moderate-income home
buyers.
On June 27, 1934 the National Housing Act was passed, one of many
measures to bolster the recovery of the economy. This act provided for the
setup of a Federal Housing Administration (FHA) which was to be headed
by a Federal Housing Administrator. One of the main functions of the FHA
was provided in Title II of the Act, for the insurance of home mortgage
loans made by private lenders.
Chartering of national mortgage associations by the administrator was

provided in Title III of the Act. These associations, regulated by the
administrators, were to be private corporations, with their primary purpose
being the buying and selling the mortgages to be insured by FHA under
Title II. Just one association was formed under this setup, on February 10,
1938 as a subsidiary of the Reconstruction Finance Corporation which was
a government corporation. This corporation was initially named National
Mortgage Association of Washington, later changed to the Federal National
Mortgage Association.
With the amendments made in 1948, the charter authority of the

Administrator was nullified and Title III became a legal charter for the
Federal National Mortgage Association. When Title III was revised in 1954,
Fannie Mae was converted into a mixed-ownership corporation. Its
preferred stock was to be held by the government and its common stock
was to be held privately. During this time Section 312 was enacted first,
giving title III the short title of Federal National Mortgage Association
Charter Act.
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With amendments made in 1968, the Federal National Mortgage
Association was divided into two separate entities, the Government
National Mortgage Association (Ginnie Mae) and Federal National
Mortgage Association (Fannie Mae). While Ginnie Mae remained in the
government, Fannie Mae became privately owned, surrendering its
government-held stocks. Since the 1968 amendments, Ginnie Mae has been
operating as a wholly owned government association.
Ginnie Mae was established as a government corporation under the

Department of Housing and Urban Development (HUD) to be a part of the
secondary mortgage market. Ginnie Mae guarantees pass-through
securities which are originated by the VA and FHA, thus supporting the
secondary mortgage market. The investors can have an undivided interest
in a pool of mortgages because of the pass-through securities. The
investors position in the mortgages is that of an owner, receiving regular
payments of principal and interest on the mortgages as if he was the
originating lender. The FHA and VA guarantees the underlying loan against
default, and Ginnie Mae guarantees the timely payment on the loans in the
pool. Ginnie Mae does not buy mortgages or issue securities; it rather acts
in a supporting role to other participants in the secondary market.
Federal Home Loan Mortgage Corporation (FHLMC or Freddie

Mac): Freddie Mac is a corporation held by shareholders who looking to
improve their quality of life by fulfilling the dream of every American to
own a home of their own. This objective is achieved by linking Main Street
to Wall Street by purchasing, securitizing, and investing in home
mortgages, and eventually providing homeowners and renters with low-
cost housing and more accessible financing for purchasing homes. Since the
time it was incorporated, Freddie Mac has been responsible for financing
one out of every six homes in America.
Residential mortgages are bought by Freddie Mac and are funded in the
capital markets in one of these two ways: (1) using mortgage-backed
securities, and (2) by using various types of debt instruments. As the
securities markets were made more efficient by Freddie Mac, funding costs
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were lowered and housing became more affordable for the people and
increased the shareholder value.
The motive behind Freddie Mac was to increase the availability of mortgage
credit. This was done by developing and maintaining a countrywide market
for conventional residential mortgage loans. Freddie Mac bought the
approved existing mortgage loans and resold them to individual investors
or financial institutions.
Freddie Mac operates its business by buying those mortgages that meet the
companys underwriting and product standards from lenders. Then, these
mortgages are packaged into securities guaranteed by Freddie Mac and sold
to investors, like insurances companies and pension funds. More than half
of all new single-family mortgages being currently originated are sold to
secondary market channels.
The proceeds that are acquired from loans that are sold to Freddie Mac are
used by mortgage lenders to fund new loans, continually furnishing the
global pool of funds available for lending to homeowners.
The secondary mortgage market puts private investor capital to work for
home buyers and apartment owners, thus providing a regular flow of
affordable funds for financing their homes.
This process is largely unseen by borrowers and renters. Nonetheless, the

existence of Freddie Mac has given the opportunity to millions of people to
access better home financing options and lower monthly mortgage
payments.
In 2008, the Federal Housing Finance Agency took over the regulation of
both Freddie Mac and Fannie Mae to guarantee its soundness and stability.
ANCILLARY SERVICES
Of the many ancillary services that support the mortgage lending process,
some are given below:
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Real Estate Broker and Real Estate Sales Associate
These are professionals who assist consumers in buying and selling of real
estate. The real estate professional is generally the first point of contact for
the consumer when he decides to purchase a real estate loan. This
professional then refers clients to mortgage specialists.
Title Company
Title companies carry out a title search on the property and issue a title
policy for the lender and the purchaser to confirm that there is a valid
mortgage lien against the property and the title is clear.
Closing Agent
The closing agent assists in the closing of a mortgage loan by acting as a
neutral third party. This closing agent might be an attorney, an escrow
company, or title company agent depending on the region.
Appraiser
The appraiser evaluates the market value of real estate for the buyer and
the lender.
Credit Reporting Agency

These companies research the credit records of consumers and save the
findings in a factual credit report. They have access to databases which have
credit information on most consumers in the country. They also search the
public records for offensive items that may have been filed against a
consumer, such as judgments, bankruptcies, and liens. At times the credit
reporting agencies will research other factors, such as employment place,
banking relationships, and former place of residence.
Private Mortgage Insurance Company (PMI)

Lenders normally require private mortgage insurance when their loan
exceeds 80% of the value of the property. This insurance protects the lender
in case a borrower defaults and a foreclosure becomes necessary. There are
only few companies that provide this insurance. Generally, this insurance is
paid for by borrowers as a part of their monthly payment.
Hazard Insurance Company
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Hazard insurance is required by the lenders, as this covers the outstanding
loan on the property. There are some casualty insurance companies that
provide hazard insurance. In majority of the cases, the lender is the loss
payee on the policy and receives the proceeds on a claim. These proceeds
are used to pay for the repairs.
REAL PROPERTY LOAN LAW
As per the Real Estate Law, anyone who negotiates a loan must have a real
estate license. Previously there have been inappropriate occurrences in the
form of excessive commissions, magnified costs and expenses, negotiation
of short-term loans with large balloon payments, and misrepresentation or
disguising material facts by licensees who negotiate these loans.
Because consumers were receiving unfair treatment from some agents,

legislation to stop these negative occurrences was passed. Thus, the Real
Property Loan Law is now applicable to loans secured by first trust deeds
under $30,000 and by junior trust deeds under $20,000.
According to law, anyone who negotiates a loan must provide a Mortgage

Loan Brokers Statement -- also called a Mortgage Loan Disclosure
Statement -- to a prospective borrower. It should have all the information
concerning the important features of the loan that is being negotiated for
the borrower. The borrower must sign this statement before signing the
loan documents.
Any real estate broker negotiating or making loans that are subject to the
Real Property Loan Law is bound by law for the amount that he may charge
as a commission. On loans $30,000 and over for the first trust deeds, and
$20,000 or more for junior trust deeds, the broker may charge an amount
that is acceptable to the borrower.
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Maximum Commissions Allowed Under Real Property Loan Law
First Trust Deeds
5% of loan amount if the term is less than 3 years,

10% of loan amount if the term is 3 years or more.
Second or Other Junior Trust Deeds
5% of loan amount if term is less than 2 years,

10% of loan amount if term is a minimum of 2 years, but not more than 3 years,
15% of loan amount if term is 3 years or more.
Balloon payments are not allowed for loans on homes occupied by owners
where a broker is involved in the negotiation if the term is six years or less.
This particular requirement is not applicable when a seller carries back a
trust deed as part of the purchase price.
PERSONAL PROPERTY SECURED TRANSACTIONS
A security agreement is an instrument normally used to secure a loan on

personal property, similar to a trust deed that secures a loan on real
property. Some of the personal property that might be used as a security
for a debt may be jewelry, boats, cars, retail inventory and other such bulky,
expensive items. The security agreement is the document used to create a
security interest in personal property.
A financing statement needs to be filed, to protect the interest created by

the security agreement. A security interest is said to be perfected when it
has attached been finalized -- and the financing statement has been
properly recorded in the office of the Secretary of State or the relevant
county recorder.
A security interest attaches when the following requirements are met:
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There is an agreement between the parties involved,
Value has been given, and
The debtor has acquired rights in the collateral.
Note that the financing statement is just the form used to record the debt
and not the actual evidence of the debt. The security agreement has all the
details of the agreement and is the document that describes the obligation.
When the interest created by the security agreement is perfected, the
interest of the secured party is protected against the debtors other
creditors.
CHAPTER SUMMARY
Variable Rate Mortgages enable consumers to borrow at affordable

rates while not tying them to the original rate of interest for the life of
the loan.
In the present day, appreciation in real estate value has beaten the
annual rate of inflation and is the single largest indicator of inflation.
The Federal Reserve Bank is Americas central bank. Its primary

function is to regulate the flow of money and credit to boost economic
development in stable fashion.
The initial source of the funds used to buy mortgage-backed securities

is investors who purchase the securities from the secondary market
agency or company.
A private shareholder-owned company, Fannie Mae, works to

confirm that mortgage money is available for people in communities
across the country.
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Ginnie Mae is a wholly-owned corporation formed in 1968 within the
Department of Housing and Urban Development (HUD).
Freddie Mac is a corporation held by shareholders who wish to fulfill

the dream of every American to own a home of their own. This
objective is achieved by linking Main Street to Wall Street by
purchasing, securitizing, and investing in home mortgages.
A security agreement is an instrument normally used to secure a loan

on personal property, similar to a trust deed that secures a loan on
real property.
A financing statement needs to be filed to protect the interest created

by the security agreement.
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CHAPTER QUIZ
1. The current Fed chairman, confirmed in February 2014, is ______:
a) Ben Bernanke
b) Janet Yellen
c) Paul Volcker
d) William McChesney
2. Under ___________, financial institutions previously restrained in

lending activities are now allowed to compete more freely for profits.
a) Disintermediation
b) Intermediation
c) Deregulation
d) Hypothecation
3. Through the efforts of Treasury Secretary ___________ the

Congress established the First Bank of the United States in 1791.
a) Andrew Jackson
b) J. P. Morgan
c) William McAdoo
d) Alexander Hamilton
4. This Act was passed due to the banking panic of 1907 to provide for
the issuance of emergency currency during financial crises:
a) The National Banking Act
b) The Aldrich-Vreeland Act
c) Federal Reserve Act
d) Glass-Steagall Act
5. The Federal Reserve Act was signed into law by _________.

a) William Jennings Bryan
b) Woodrow Wilson
c) H. Parker Willis
d) William McAdoo
6. Who, after World War I, recognized that gold no longer served as the
major factor in controlling credit?
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a) Carter Glass
b) Woodrow Wilson
c) Benjamin Strong
d) David Houston
7. The Banking Act of 1933 passed to counter the Depression is called:

a) The Glass-Steagall Act
b) The Aldrich-Vreeland Act
c) The Humphrey-Hawkins Act
8. Which banking agency develops national monetary policy and shares

responsibility with 12 member banks for applying that policy and
setting goals for the money supply:
a) Federal Reserve System (the Fed)
b) Housing and Urban Development (HUD)
c) Federal Deposit Insurance Corporation (FDIC)
d) Federal National Mortgage Association (FNMA)
9. Which company was created by the Congress in 1938, after the Great
Depression, to boost the housing industry?
a) Freddie Mac
b) Fannie Mae
c) Ginnie Mae
d) Federal Deposit Insurance Corporation
10. The agency established to ascertain the financial safety and

soundness of Fannie Mae and Freddie Mac is the_______.
a) Federal Reserve System

b) Office of Thrift Supervision
c) Federal Deposit Insurance Company
d) Federal Housing Finance Agency
11. Ginnie Maes most important role today is_________.
a) Guaranteeing mortgage-backed securities payments

b) Originating FHA loans
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c) Buying DVA loans
d) Competing with Fannie Mae
12. Which of the following is not a government agency?
a) Department of Housing and Urban Development

b) Federal Housing Finance Agency
c) Federal National Mortgage Association
d) Government National Mortgage Association
13. Which is NOT used by the Fed as a tool to regulate the economy?
a) Regulation of the secondary money market

b) Discount rate
c) Reserve requirement
d) Open market operations
14. It buys and resells residential conventional mortgage loans:
a) Federal National Mortgage Association

b) Federal Home Loan Mortgage Corporation
c) Government National Mortgage Association
d) Federal Housing Finance Agency
15. The instrument used to secure a loan on personal property is a:
a) Pledge agreement
b) Security agreement
c) Trust deed
d) Financing statement
Answer Key:
1. B 6. C 11. A
2. C 7. A 12. C
3. D 8. A 13. A
4. B 9. B 14. B
5. B 10. D 15. B
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CHAPTER EIGHT
MORTGAGE INSURANCE AND
GOVERNMENTS ROLE IN FINANCE
INTRODUCTION
Insurance is generally supposed to diversify the loss from a particular crisis

over a large insured group. A special form of insurance is the mortgage
default insurance that insures a portion of a mortgage. When a borrower
defaults on a mortgage loan, the lender is insured against the resultant
losses and the loan is foreclosed by the lender. There are three elementary
default insurance plans: Veterans Administration (VA), Federal Housing
Administration (FHA) and Private Mortgage Insurance (PMI). The plans
are different, depending on the eligibility requirements, costs, loan limits,
underwriting procedures, and coverage.
MORTGAGE DEFAULT INSURANCE
There are four types of mortgage default insurance: partial coverage, full
coverage, co-insurance, and self-insurance. If a borrower defaults, the
lender is covered with all these types.
Partial Coverage: The insurer covers losses up to a certain percentage of

the original loan amount. For instance, if the loan amount is $100,000 and
the insurer protects against a 20% loss, then any claims up to $20,000 will
be covered.
Full Coverage: All the losses incurred by the lender are protected.
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Co-insurance: A limit is set on the maximum amount of coverage. The
insurer will pay all losses up to a certain percentage of the amount of the
loan, and any loss in excess of an agreed-upon dollar amount will be shared
in an equal ratio between the lender and the insurer. For instance, if the
loan amount is $100,000 and the insurer protects against a 20% loss, then
any claims up to $20,000 will be covered. But if the loss is $30,000, the
lender will pay the first $20,000 and 20% ($2000) of the remainder.
Self-insurance: The complete risk is held by the lender.
In the majority of cases, the cost to purchase mortgage insurance is not

borne by the lender. The borrower is debited, if the loan is insured by FHA
or is private mortgage insurance (PMI). The federal government bears the
cost if the loan is guaranteed by the VA.
When mortgage default insurance is required, arranging insurance is a

contingency of funding the loan. The costs to the borrower depend on the
agency that issues the loan. With a VA loan, the borrower is required to pay
a funding fee before the loan is processed. On FHA and other loans
requiring PMI, the borrower must pay an up-front fee along with a yearly
premium. In most cases, conventional loans that have a loan-to-value ratio
more than 80% also need private mortgage insurance.
GOVERNMENT INSURANCE
Federal Housing Administration (FHA) and the Veterans Administration

(VA) are the two federal agencies that are the participants in real estate
financing. While the FHA is a fully-covered insurance program that covers
all losses incurred by the lender, the VA is a partial insurance plan that
covers losses up to a certain percentage of the loan amount. These two
agencies make it feasible for the people in this country to buy homes, which
they would never be able to do without the involvement of the government.
The California Farm and Home Purchase Program, or Cal-Vet loan, is a

state program aiming to help eligible veterans in California. Some Cal-Vet
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loans are guaranteed by the United States Department of Veterans Affairs,
while for others the Cal-Vet program purchases private mortgage
insurance. In either case, a loan guaranty fee has to be paid by the
borrower; depending on the down payment, the guaranty fee might be
between 1.25% and 2% of the loan amount. In some instances, the fee may
be added to the loan amount. The guaranty fee is a one-time fee, which does
not affect the interest rate or the monthly installment as long as it is not
financed in the loan. If the down payment is 20% or more, then there is no
guaranty fee.
FEDERAL HOUSING ADMINISTRATION (FHA)
Since 1934, the FHA has been a part of the HUD and is responsible for the
tremendous changes in home mortgage lending in the real estate finance
industry. The FHA was established especially to enhance the construction
and financing of housing.
To make the best of what the program offers, consumers as well as the real
estate licensees should be aware of the operation, functions, and the
positives of the FHA program. There are changes in the regulations from
time-to-time which are usually known to mortgage brokers who specialize
in government insured or guaranteed loans or on the HUD website.
The FHA itself does not make loans; it insures loans made by authorized
lending institutions like banks, savings banks, and independent mortgage
companies. When a borrower defaults, the FHA insures the lender against
losses, provided the loan is funded as per FHA guidelines. In case of a
default by the borrower, the lender may foreclose on the property and the
FHA pays cash up to the set limit of insurance.
Any person may qualify for an FHA loan. An approved lender applies for a
mortgage loan to the FHA on behalf of the borrower. The borrower is
charged a fee for an insurance policy called Mutual Mortgage Insurance;
this protects the lender in case there is a foreclosure. The premium for the
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insurance may be financed as part of the loan or paid in cash when the
escrow closes.
There are various types of loans made by the FHA. Borrowers can qualify
for an FHA loan before a builder even starts construction, allowing both the
parties -- the borrower and the builder -- to be certain the transaction will
be completed. There is a reverse annuity loan that allows borrowers to
convert equity into a monthly income or line of credit. A 3.5% down
payment is required from the borrowers own funds, or from a bona fide
gift, or a loan from a relative or government agency.
A borrower has to be a minimum of 62 years old, should own the property

and occupy it as a principal residence, and also join a special FHA
consumer information session. There is no need for income qualifications
for this type of loan and as long as the borrower occupies the home as his
principle residence, there is no repayment scheduled. This program is
applicable for properties of one-to-four units.
The full amount of the loan is insured by the FHA in the event of a default
and foreclosure. Depending on the location of the property, there are
maximum loan amounts that the FHA will take on, so that the risk of
default can be managed. The FHA scrutinizes the borrowers income, credit
and work history, funds available for settlement and monthly housing
expenses, before it approves the borrowers loan request. FHA loans can be
obtained by any qualified resident of the U.S. provided that the property
will be the principle residence of the borrower and should be located in this
country, although U.S. citizenship is not a prerequisite.
Interest rates are generally set by the market but the lender can negotiate a
rate with the borrower and charge points; 1 point is equal to 1% of the loan
amount. This can be paid either by the buyer or by the seller.
Section 203-B
Under Section 203-B, the FHA offers financing on the purchase or
construction of residences of one-to-four units which should be occupied by
the owner himself. This program offers fixed-rate, fully-amortized
mortgages for a period of 30 years.
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Section 245 GPM
The FHA offers a graduated payment mortgage (GPM) to borrowers who
face difficulty in qualifying for regular loan payments, but who expect that
their incomes will increase. For the initial five years, the payments are low
and cover only a part of the interest due. The unpaid amount is added to
the balance principal amount. After the five-year period the loan is
recalculated and the new payment remains constant for the term of the
loan.
VETERANS ADMINISTRATION (VA)
The Veterans Administration does not make loans; rather, it guarantees

loans made by an approved institutional lender, just like the FHA. The
major difference between the two government programs is that a VA loan
can be obtained by only an eligible veteran and that the VA does not require
a down payment up to a certain loan amount. Both these programs were
meant to assist people buying homes who were unable to procure
conventional loans.
These loans are made by a lender, such as a mortgage company, savings

and loan or bank. The lender is protected by the VAs guaranty on the loan
against losses if the payments are not made. It also encourages lenders to
offer veterans loans with more favorable terms. The amount of guaranty on
the loan depends on two things; the loan amount and whether the veteran
previously used some entitlement.
With the current maximum guaranty, a veteran who has not previously
used the benefit may be able to procure a VA loan up to $240,000 without
any down payment, as per the borrowers income level and the propertys
appraised value. Details on guaranty and entitlement amounts are available
from the local VA office.
Once a veteran decides on the house he wants to purchase, a VA-approved

conventional lender takes the loan application and processes the loan
according to VA guidelines. To qualify for the loan, a veteran must possess a
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Certificate of Eligibility. This Certificate is obtained from the VA, before
applying for a VA loan.
Five Steps to Obtain a VA Loan

1. A veteran must obtain a Certificate of Eligibility by filling out a VA
Form 26-1880, request for a Certificate of Eligibility for VA Home
Loan Benefits, and submitting it to one of the Eligibility Centers. He
or she must include copies of their most recent discharge documents
that cover active military duty since September 16, 1940, which show
active duty dates and type of discharge.
2. The buyer must decide on a home he wishes to buy and sign a

purchase agreement.
3. Apply for a loan to a VA-approved mortgage lender. The lender (i.e.,

bank, savings and loan, mortgage company and so on) gathers credit
and income information, while the appraisal is done. If the VA
authorizes the lender to use automatic processing upon receiving the
VA appraisal, the loan may be approved and closed without waiting
for VA review of the credit application. For loans that need
compulsory approval from the VA, the lender should send the
application to the local VA office, which notifies the lender of its
decision.
4. An appraisal known as Certificate of Reasonable Value (CRV) is

ordered by the lender from VA. A value is fixed by the CRV which a
loan cannot exceed. In most VA regional offices a speed-up
telephone appraisal system is offered.
5. The loan is closed and the veteran moves into the home.
The biggest benefit of a loan guaranteed by the Veterans Administration is

that for some VA loans, no down payment is required. For a no-down-
payment transaction, a maximum loan amount is allowed; there is a
formula to establish the amount of down payment for a larger loan amount.
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If a veteran sells his home, the new buyer gets a new loan which pays off the
old VA loan. The veteran can restore his eligibility and apply for a new VA
loan.
On the other hand, if a veteran sells his home to a buyer subject to the
existing VA loan, the veteran personally remains liable for the loan. In case
of a foreclosure, a VA loan (which is a purchase-money loan) may end up in
a deficiency judgment whereby the original borrower, i.e., the veteran
would be liable for the deficient amount.
Depending on the local economies, the maximum loan amount varies in

different areas of every state. However, there is no limit to the sales price a
veteran may pay.
There are certain guidelines that apply to these loans. All property secured
by a VA loan needs to be owner-occupied. The points charged to the seller,
and interest rates, are both subject to change depending on economic
conditions. There is no prepayment penalty on a VA loan. The loan discount
points are usually paid by the seller, if the loan is not refinanced.
Various types of loans are available which includes fixed-term loans,

adjustable-rate loans and graduated payment loans.
VA Financing a Good Option for Veterans

There are around 29 million veterans and service personnel who are eligible
for VA loans. In spite of the fact that many veterans have already used their
loan benefits, some may still be able to buy homes again with VA financing
using their balance or restored loan entitlement.
Some of the advantages of the VA home loans that veterans should consider
before arranging for a new mortgage to finance a home purchase:
Foremost, there is no down payment required in most transactions.
The loan is up to 100% of the VA-established reasonable value of the

property. The loans mostly dont exceed $240,000 because of the
secondary market requirements.
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Flexibility in interest rate negotiations with the lender.
No paying of the monthly mortgage insurance premium.
Limit on the closing costs for the buyer.
An appraisal informing the buyer of property value.
Thirty-year loans that come with a choice of repayment plans, as

under:
Traditional fixed payment: principal and interest remain

constant; increases or decreases may be seen in property taxes
and homeowners insurance coverage.
Graduated Payment Mortgage (GPM): low initial payments

which gradually rise to a level payment that starts in the sixth
year.
Growing Equity Mortgage (GEM): (in some areas) gradually

growing payments with all the increase applied to principal
which results in an early payoff of the loan.
In almost all loans for new houses, construction is inspected at

necessary stages to ensure that the approved plans are carried out as
planned. A one-year warranty is needed from the builder stating that
the house is built in conformity with the approved plans and
specifications. In cases where the builder is willing to provide an
acceptable 10-year warranty plan, only a final inspection is carried
out.
An assumable mortgage, subject to VA approval of the assumers

credit.
No penalty for prepayment.
VA discharges personal loan servicing and offers financial counseling

to assist veterans from losing their homes when they are undergoing
temporary financial trouble.
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Summary of Facts about VA Loans
Most loans do not require down payment.
Certificate of Eligibility is required.
Loan amount may not exceed the appraised value.
VA appraisal the Certificate of Reasonable Value -- is required.
Property should be owner-occupied.
Seller generally pays discount points.
There is no maximum sales price.
CALIFORNIA VETERAN LOANS (CAL-VET)
The California Department of Veterans Affairs offers the Cal-Vet loan

program to help California veterans buy a home or farm. Contrary to other
government financing, the Cal-Vet program funds and services the loans it
makes. Funds for the loans are obtained by selling the states General
Obligation Bonds.
When the application of the Cal-Vet loan is received and approval of the
borrower and property is given, the Department of Veterans Affairs
purchases the property from the seller, takes title to the property and sells it
to the veteran with a contract of sale. The legal title is held by the
Department, while the veteran holds the equitable title while the loan is not
yet fully paid. The veteran is obliged to apply for life insurance with the
Department of Veterans Affairs as the beneficiary, to pay off the debt if the
veteran dies.
The eligibility of Cal-Vet has been expanded for more veterans, including
those on currently on active duty desiring to buy a home in California.
However, the eligibility is subject to financial qualification and available
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bond funds. Note that there are some restrictions for peacetime-era
veterans.
The advantage with Cal-Vet is that a veteran can save money because of its
low interest rates, low down payments, and easier qualification. Another
good aspect of the program is that it is available to a qualified veteran
without any extra cost to the California tax payers. Given below are some of
the positive aspects of the Cal-Vet loan:
Low interest rate
The rate is even lower for qualified first-time home buyers
Low down payment
Subsequent eligibility, i.e., use the loan again
Home and loan protection plans
Interest Rates
Whenever new loans are made, the interest rates are reviewed so that it is
confirmed they are below the rates offered in the market. Note that interest
rates are subject to change without notice and the existing rates are posted
on the website of Cal-Vet. The rate for the borrower is locked in as of the
date of his application. If the rates go lower while the loan is under process,
the veteran is entitled to receive the lower rate. Although interest rates are
flexible, there is a % cap on increases during the term of the loan.
Low Down Payment

The veterans own investment is minimal as the down payment required is
fairly low. As a down payment a borrower is expected to invest only 2-3% of
the purchase price or appraised value (whichever is less).
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Maximum Loans
This loan is preferred in almost every California market, and is higher than
some other government loan programs. The maximum loan for residential
properties is $250,000; for farm properties, $300,000; and for mobile
homes in rental parks, $70,000. In some counties, home buyers who have
procured this loan for the first time have lower purchase price limits.
Loan Fees
Cal-Vet gets a loan guaranty on all loans. It uses a guaranty from either the
United States Department of Veteran Affairs, or private mortgage
insurance. A borrower has to pay a loan origination fee (chargeable with
almost all types of loans) which is 1% of the loan amount. This fee has to be
paid in escrow.
Private Mortgage Insurance Premium Not Needed

Almost all traditional lenders require a Private Mortgage Insurance (PMI)
premium on loans exceeding an 80% loan-to-value ratio. Cal-Vet helps
veterans by charging a guarantee fee at the close of escrow, eliminating the
monthly PMI premium.
Expanded Eligibility
Almost all veterans are eligible to buy a home in California without any
prior residency requirement. Eligible veterans are expected to meet federal
rules regarding the use of the bond funds.
Peacetime-era veterans have to be first-time homebuyers and meet income

and purchase price limitations. The discharge of the veteran has to be
under honorable conditions and they must provide a copy of their DD-214
or release from active duty. A Statement of Service that verifies qualifying
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dates and character of service has to be provided by a veteran if he is
currently serving on active duty.
Reusable Loans
Each time a veteran desires to purchase a new residence, he might do so by
obtaining a new Cal-Vet loan. Once the previous loan has been paid off, a
Cal-Vet loan can be used again.
Home and Loan Protection Plans

In an attempt to assure that the investment of a veteran is safe and secure,
Cal-Vet provides extensive protection for a veteran and his family. Cal-Vet
is the only lender offering protection against natural disasters. A Cal-Vet
financed home gets full coverage against floods and earthquake damages.
Cal-Vets deductible is just $500 on flood claims, and $500 or 5% of the
coverable loss, whichever is greater, on earthquake and mudslide claims.
Fire and hazard insurance coverage is also included in the Cal-Vet loan.
There is guaranteed replacement cost coverage on the home and premiums
are low with a $250 deductible. A veteran with a Cal-Vet loan receives
limited guaranteed life insurance in an amount to make the principal and
interest payments for one to five years, based on his health status at the
time of originating the loan. The insurance carrier offers optional coverage
that includes additional life insurance for the veteran, life insurance for a
spouse, and disability insurance. The applicant should be under 62 at the
time of funding the loan so as to receive the life insurance coverage.
Loan Processing
A loan may be processed by a veteran through the local Cal-Vet office or
through a Cal-Vet approved mortgage broker. The entire process with Cal-
Vet is coordinated by a real estate agent or broker, just as is done with loans
from other lenders. For timely and uniform processing, the loan procedures
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are centralized. Generally, Cal-Vet closes most loans within 30 days of
receiving the application.
Summary of Facts about Cal-Vet Loans
The Department of Veterans Affairs purchases the home chosen by the veteran
and sells it to him through a contract of sale; a land contract. The state becomes
the vendor and the veteran, the vendee. Until the loan is paid off, title is held by
the California Department of Veterans Affairs.
Residents of California who are qualified veterans are eligible for Cal-Vet loans,
regardless of where they were born or lived when they entered military service. A
veteran who accepted a benefit from another state can also be eligible for a Cal-Vet
loan. A 17-year old California veteran is also eligible, and can sign Cal-Vet
documents.
Once the original loan is paid off, eligibility for a new loan is returned to the
veteran.
Note: One individual could be eligible for a FHA, a VA, and a Cal-Vet loan.
PRIVATE MORTGAGE INSURANCE (PMI)
The extra insurance required by lenders from most homebuyers who obtain
loans that are more than 80% of their new homes value is Private Mortgage
Insurance (PMI). This implies that buyers with less than a 20% down
payment must generally buy PMI.
BENEFITS OF PMI
PMI plays a major role in the mortgage industry as it protects a lender

against loss in case a borrower defaults on a loan while allowing borrowers
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with less cash to have greater access to homeownership. This type of
insurance makes it possible for a borrower to buy a home even with a mere
3%-5% down payment. This means that an individual can purchase a home
without waiting for years to collect funds for a large down payment.
NEW PMI REQUIREMENTS
The Homeowners Protection Act (HPA) of 1998 is a federal law requiring

lenders or service providers to furnish certain disclosures regarding PMI
for loans secured for the consumers primary residence obtained on or after
July 29, 1999. This Act also contains disclosure provisions for mortgage
loans that closed before July 29, 1999. Along with this, the HPA includes
provisions for cancellation requested by the borrower and automatic
termination of PMI.
A CHANGE IN PMI REQUIREMENTS
Previously, the consumers request to drop PMI coverage -- if their loan

balance was paid up to 80% of the value of the property and their payment
history had been good -- was honored by most lenders. Nevertheless,
consumers were the ones responsible for making a cancellation request and
most of them were unaware of such a possibility. A track of the loan balance
had to be kept by the consumer to know if there was sufficient equity, then
the consumer was required to request to the lender to discontinue PMI
coverage requirement. In a lot of cases the consumer did not make this
request even after becoming eligible for it, and continued to pay
unnecessary premiums of about $250 - $1,200 each year for many years.
Accordingly, the new law makes the consumer and lender both responsible
for keeping a track of how long PMI coverage is required.
THE HOMEOWNERS PROTECTION ACT (HPA) OF 1998
The HPA usually applies to residential mortgage transactions acquired on

or after July 29, 1999, along with its requirements for loans obtained before
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that date. The VA and FHA government-guaranteed loans are not covered
under this new law. Plus, the new law also has different requirements for
loans that are classified as high-risk.
Even though the HPA does not set the standards as to what constitutes a
high-risk loan, it allows Fannie Mae and Freddie Mac to issue guidance for
mortgages that conform to secondary market loan limits. The
congressionally-chartered corporations, Fannie Mae and Freddie Mac,
create a constant flow of funds to mortgage lenders so as to support
homeownership. By January 1, 2000, mortgages totaling $252,700 or less
are judged to be conforming loans. The non-conforming mortgages may be
designated by the lender as high-risk.
A transaction can be considered as a residential mortgage transaction if it

fulfills the following four requirements:
1. A mortgage or deed of trust needs to be created or retained.
2. The property securing the loan should be a single-family dwelling.
3. This dwelling must be the primary residence of the borrower.
4. The transaction must be made with a purpose to finance the

procurement, initial construction or refinancing of the dwelling.
CANCELLING OR TERMINATING PMI
Under the Homeowners Protection Act (HPA), a borrower is entitled to

request cancellation of PMI if he has paid down a mortgage up to 80% of
the original purchase price or appraised value of the property when the loan
was made (whichever is less) The borrowers payment history should be
good, too, meaning he has not delayed the mortgage payment for 30 days
within one year of the request or delayed for 60 days within two years. The
lender may need proof that the value of the property has not fallen below its
original value and that the property does not have a second mortgage, such
as a home equity loan.
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Automatic Termination
Under HPA, mortgage lenders or service providers have to automatically
cancel PMI coverage on most loans once a borrower pays the mortgage of
up to 78% of the value, provided the borrower is current on the loan. If the
loan is in default on the date of automatic termination, the lender must
terminate the coverage as soon as the loan again becomes current. Lenders
should terminate the coverage within 30 days of cancellation or the
automatic termination date, and are not allowed to require PMI premiums
later than this date. Unearned premium payments, if any, must be returned
to the borrower within 45 days of the cancellation or termination date.
Where high-risk loans are concerned, mortgage lenders or service providers

must automatically cancel PMI coverage when the mortgage is paid up to
77% of the original value of the property, if the borrower is current on the
loan.
Final Termination
According to HPA, if PMI has not been cancelled or terminated coverage
needs to be removed when the loan reaches the midpoint of the
amortization period. For example, on a 30-year loan where there are 360
monthly payments, the sequential midpoint would come after 180
payments. This provision requires that the borrower must be current on the
payments required by the terms of the mortgage. Final termination must
occur within 30 days of this date.
DISCLOSURES REQUIRED BY THE HPA
For Loans Procured On or After July 29, 1999
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The HPA has fixed three different stages when a lender must notify a
consumer of his rights. These stages are at loan closing, annually, and when
PMI is cancelled or terminated.
The content of the disclosures vary depending on the following:
Whether the PMI is borrower-paid or lender-paid,
Whether the loan is classified as a fixed-rate mortgage or ARM or,
Whether the loan is designated as high-risk or not.
The lenders need to disclose to the borrowers at loan closing:
The right to request cancellation of PMI and the date on which the
request may be made.
The requirement that PMI be automatically terminated and the date

this will happen.
Any exemptions to the right to cancellation or automatic termination.
A written initial amortization schedule, for fixed-rate loans only.
A mortgage loan servicer has to send a written statement to the borrowers

on a yearly basis, disclosing the following:
The right to cancel or terminate PMI
An address and telephone number to contact the loan servicer to find

out when PMI may be cancelled.
When the PMI coverage is cancelled or terminated, a notification needs to

be sent to the consumer stating the following:
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PMI has been terminated, and the borrower does not have PMI
coverage anymore.
No PMI premiums are due anymore.
The servicer of the mortgage is obliged to provide notice of cancellation or

termination.
For Loans Procured Before July 29, 1999
An annual statement has to be sent to the consumers who acquired

mortgages before July 29, 1999. This statement clarifies that under some
circumstances PMI may be cancelled (such as with consent of the
mortgagee). Information should be provided to contact the loan servicer to
find out whether PMI may be cancelled.
The cancellation and the automatic termination rules of the HPA do not
apply to loans made before July 29, 1999.
Even though parts of the new law only apply to loans acquired on or after
July 29, 1999, some lenders make it known that they plan to follow the
requirements of HPA for both new and existing loans. A borrower must
find out from his mortgage loan servicer as to how the law applies to him or
his mortgage.
EFFECT OF INCREASES IN HOME VALUE
Most of the mortgage payments made during the first years are finance
charges. Thus, it may take approximately 10 to 15 years before the paid up
loan reaches 80% of the loan value. Now, if the home prices in the area start
to increase, the property value of the borrower may also increase, and it can
reach the 80% mark much earlier. The increase in property value could also
be a result of home improvements made by the borrower to the home.
If a borrower realizes that the value of the home has increased, he may be
able to cancel PMI on the mortgage. In spite of the fact that the new law
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does not need a mortgage servicer to consider the current property value, a
borrower must find out from the lender if he is willing to do so. The
borrower should also inquire about the documentation that may be
required to show the increase in the property value.
CHAPTER SUMMARY
There are four types of mortgage default insurance: partial coverage,

full coverage, co-insurance, and self-insurance. If a borrower defaults,
the lender is insured with all these types.
Federal Housing Administration (FHA) and the Veterans

Administration (VA) are the two federal agencies that are the main
participants in real estate financing.
The California Farm and Home Purchase Program, or Cal-Vet loan, is

a state program designed to help eligible veterans in California.
The Veterans Administration does not make loans; rather, like the
FHA, it guarantees loans made by an approved institutional lender.
The biggest benefit of a loan guaranteed by the Veterans

Administration is that for some VA loans, no down payment is
required.
PMI plays a major role in the mortgage industry as it protects a

lender against loss in case a borrower defaults on a loan and it allows
borrowers with less cash to have greater access to homeownership.
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The Homeowners Protection Act (HPA) usually applies to residential
mortgage transactions acquired on or after July 29, 1999, along with
its requirements for loans obtained before that date.
Under the HPA, if PMI has not been cancelled or terminated the
requirement for coverage should be removed when the loan reaches
the midpoint of the amortization period.
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CHAPTER QUIZ
1. Which of the following does NOT provide a basic insurance plan.
a) The Veterans Administration (VA)

b) Federal Housing Authority (FHA)
c) Department of Housing and Urban Development (HUD)
d) Private Mortgage Insurance
2. The FHA is a __________

a) Loan guaranty agency
b) Loan insurance agency
c) Secondary market agency
d) Loan origination agency
3. Interest rates on an FHA-insured loan are generally fixed by the:

a) Fed
b) Market
c) FNMA
d) FHA
4. The Veterans Administrations function is to:

a) Guarantee loans
b) Insure loans
c) Underwrite loans
d) Endorse loans
5. The DVA loan guarantee program protects the:

a) Broker
b) Veteran
c) Seller
d) Lender
6. Which of the following statements concerning the FHA is true?

a) The down payment required is generally 25% or more.
b) Secondary financing is not allowed.
c) The borrower generally pays the loan fee.
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d) The maximum loan fee is 10% of the loan amount.
7. A Veterans Administration (VA) appraisal is called a(n) ________.

a) Guarantee of Value (GV)
b) Certificate of Reasonable Value (CRV)
c) Estimate of Value (EV)
d) Instrument of Certain Value (ICV)
8. The Cal-Vet program is administered by the ________.

a) Real Estate Commissioner
b) Department of Housing and Urban Development
c) Veterans Administration
d) California Department of Veterans Affairs
9. Which of the below-mentioned statements is true concerning Cal-Vet

loans?
a) Requires a land contract
b) Are available for only owner-occupied dwellings
c) Are subject to a 1% loan origination fee plus a loan guarantee fee
d) All of the above
10. In order to secure a Cal-Vet loan, a veteran must:
a) Apply for life insurance with the Department of Veterans Affairs as

the beneficiary
b) Have been in combat
c) Be currently enrolled in college or a graduate level program
11. The FHA needs a 3.5% cash investment that must come from the
borrowers own funds, or from:
a) A bona fide gift

b) A loan from a family member
c) A governmental agency or instrumentality
d) Any of the above-mentioned means
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12. FHA loans insure lenders against:
a) Declines in real estate values

b) Late payments by borrowers
c) Loss due to foreclosure
d) Loss incurred due to the borrowers losing their jobs
13. The FHA does _________.
a) Not require a down payment on approved loans

b) Insure loans made by approved lenders
c) Make most of the single-family dwelling loans in the U.S.
d) All of the above
14. Legal title to the property under a Cal-Vet loan is held by:
a) The veteran
b) Veterans Administration
c) Department of Housing and Urban Development
d) California Department of Veterans Affairs
15. Buyers paying less than a ____ % down payment are generally
required to purchase PMI.
a) 5
b) 10
c) 15
d) 20
Answer Key:
1. C 6. C 11. D
2. B 7. B 12. C
3. B 8. D 13. B
4. A 9. D 14. D
5. D 10. A 15. D
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CHAPTER NINE
REAL ESTATE AS AN INVESTMENT
INTRODUCTION
An investment is a disbursement of money with an expectation that it will

generate profits. Almost all individuals, businesses, and institutions invest
an unrestricted portion of their earned money. One choice that they have as
an investment is real estate. Others may include stocks; corporate bonds;
local, state, and U.S. government securities; tangibles, like precious metals,
art and jewelry; savings accounts; certificates of deposits; individual
retirement accounts; and commercial paper. When other sources for
investment do not seem to be productive or profitable, investing in real
estate is usually a reliable and preferred option.
Investing in real estate might have some pitfalls but it may also present
outstanding opportunities. Real estate is a limited, non-liquid investment
option; it is stationary, lasting but sometimes scarce, and physically real. It
could be problematic to own buildings that require regular maintenance,
tenants, and security. The building may be subject to fire, earthquakes,
floods, etc., and there may be advantages and disadvantages of a particular
locality.
As real estate is very susceptible to local conditions, consumers are advised

to invest in real property only if they are aware of the local real estate
values, i.e., the local economy, market conditions, political environment
and building controls. The success or failure of an investment largely
depends on these factors.
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REASONS FOR INVESTING IN REAL ESTATE
Consumers who invest their hard-earned money definitely have some

expectations concerning their financial future. A knowledgeable investor in
real property needs to decide whether the advantages of investing his funds
in a non-liquid asset, such as an apartment building or commercial
shopping center, is as good as investing in other kinds of investments, like
stock market or bank certificates of deposit. Are the returns from a real
estate investment worth taking the extra risk of tying up the money for an
indefinite time period? Local market conditions need to be considered
along with the possibilities of them changing over a period of five, eight, or
10 years. It is without doubt easier, and often safer, to trust the other types
of investment options. For example, investing in certificates of deposits
doesnt require much efforts, is easy to comprehend, and has verifiably
provided conventional but regular returns.
Lack of knowledge has always been the biggest negative factor hindering
the success of an average consumer as a real estate investor. A consumer
must be familiar with other resources of finance and should be tactically
knowledgeable so as to be able to maintain positive investment practices
through the life of the investment project.
Profit is basically the only reason for investing in real estate. Some
investments show profits immediately, but in real estate investment, profits
are apparent only after a certain period of time. However, return of
investment (ROI) in buying real estate is usually much greater than other
investments ROI. The reason for this is that real estate projects offer three
ways in which returns can be made on initial investment. When these three
types of returns are added together they add up to a sizable total. This,
then, mitigates the risks taken with real estate.
TYPES OF ROI
As mentioned above, there are three types of return on investment (ROI):

cash flow, return on taxes, and appreciation.
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Cash Flow
The amount that is returned to an investor in the form of cash after
expenses, which includes mortgage payments, is known as cash flow. This is
the most direct type of return, as this is money seen by the investor
practically immediately.
Return on Taxes
Generally, the investors who fall into the higher tax brackets are not as
concerned with cash return as with the tax advantages of real estate
investment. Property that generates income provides a tax shelter by
permitting the investor to deduct annually the interest on the loan,
property taxes, insurance, management, maintenance and utilities. Loss on
the sale of income property may also be deducted. There is another
advantage of investing in income-generating property; allowed
depreciation. On a personal residence, depreciation may not be taken.
However, investment property has to be depreciated according to the
formula given by IRS.
The investor is rewarded through tax laws for the monetary risk taken from
the investment by permitting the reduction of tax liability, as long as an
investment produces income, as in apartment buildings or commercial
property.
The depreciation allowance is one of the most important tax benefits that
income-generating properties conveys to its owners. A homeowner has an
option of excluding a certain amount of profit from being taxed but the
owner of income property cannot do so. Nevertheless, the investor can
claim depreciation and other deductions which will reduce the tax bill. This
reduction is more than that allowed to a homeowner.
Depreciation for tax purposes is based on the calculated useful life of the
property, and not on actual deterioration. The supposition is that
improvements deteriorate and lose their value, not the land. A building is
perceived to have a definite number of years in which it can generate an
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income and beyond that no longer remains a practical investment. The
investor receives compensation for the loss by being permitted to deduct a
certain dollar amount every year on the basis of the useful life of the
property until the property (on paper at least) does not have any more value
as an investment.
Since the tax laws regarding depreciation keep changing, it is

recommended that current IRS rules be checked for calculating
depreciation.
Straight-line deprecation is the most common method used to determine

the dollar amount each year that will be deducted. The same amount is
deducted each year over the depreciable life of a property. For calculating
depreciation, the value of the improvements is divided by the depreciable
life of the property, to calculate the yearly dollar amount. This amount can
be claimed as depreciation and therefore be deducted.
An example of the depreciation calculation:
Check the current tax law to find out the IRS allowance for the
depreciable life of a residential income property. In this example,
assume it to be 25 years.
Deduct the value of the land from the value of the property to arrive
at the value of the building. To calculate the value of the land, use the
value of similar parcels or the tax assessors bill.
Value of Property $500,000

Value of Land - $200,000
-------------
Value of Building $300,000
========
$300,000 divided by 25 years = $12,000 annual depreciation
allowance.
When an owner sells his income-producing property, the amount

depreciated over the years will be subtracted from their cost basis; this
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will provide the tax liability or capital gain. Besides, once the property is
sold the new owner can begin to depreciate the building as if it were new,
on the basis of the new sales price.
The calculation of the gain on an income-producing property is similar

to that done for a personal residence, apart from any depreciation that is
claimed over the years which should be subtracted from the cost basis.
This implies that the dollar amount deducted for depreciation over the
time the property was owned, after adding the cost of any improvements
to the purchase price, should be subtracted from the cost basis in order
to arrive at the adjusted cost basis. The calculation of the amount of
taxable gain is done by subtracting the adjusted cost basis from the
selling price, minus the expenses of sale (commission).
An example of the calculation of the Amount of Capital Gain

on Income Property is given below:
Purchase Price (cost basis) $500,000

Improvements +100,000
-------------
$600,000
Depreciation claimed - 60,000
--------------
Adjusted cost basis $540,000
Selling price $800,000

Expenses of sale (commission) - $40,000
-------------
Adjusted selling price $760,000
Adjusted cost basis -540,000
-------------
Capital gain (profit) $220,000
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In case of a primary residence, a certain amount of gain may be excluded
from being taxed, but when income-producing property is sold, taxes are
owed on any profit made. Nonetheless, the investor has an option of
legally deferring the gain some time later.
Installment Sale: In an installment sale, a buyer makes payment to

the seller over a period of more than one year. By opting for this method
of payment, the capital gain and the tax payments owed can be spread
out over a period of time. The seller can defer a portion of the tax
liability by taking back a note and trust deed, or an all-inclusive trust
deed or contract of sale, with monthly payments. The amount of gain
collected in the tax year alone is taxable income, while the tax due on the
remaining amount can be deferred until collected. Here again, it is
recommended that current tax laws be checked regarding installment
sales.
Tax-Deferred Exchange (1031 Exchange): This is also called a tax-

free exchange, in which the method of deferring tax liability permits an
investor to exchange a property for a similar property, deferring the gain
until the property is sold off. This is not actually a tax-free exchange but
rather the taxes are just put off, to be paid at a later date.
Almost all real property held as an investment would qualify as like

property. An apartment building, commercial building, business, or raw
land may be classified under this type of property. A residential
property, however, cannot qualify as a like property to be exchanged
with investment property.
To balance the equities in two properties being exchanged, (if they are
not balanced) then money or other valuables such as cars, boats, stocks,
or furniture (but not like-kind property) may be added by the investor
who is trading up to balance the equities. This exchange, which is in the
form of extra cash or non-like property, is known as boot.
To qualify for a tax-deferred exchange, as given in the below example,

Investor X will have to add $50,000 (boot) to the sale to match the
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equities. There will be no tax liabilities on the sale for investor X, while
investor Y would be taxed on the amount of the boot received in the year
of the sale, in case he realizes a gain. However, if the amount of the boot
is more than the amount of the gain, then the tax liability would be
limited to the amount of the gain.
Investor X: Property Value $350,000
Encumbrances - 50,000
-------------
Equity $300,000
Investor Y: Property Value $500,000
Encumbrances - 150,000
-------------
Equity $350,000
When calculating the gain on any property, the cost basis of the property
be exchanged becomes the cost basis of the property that is being
acquired, in case no boot is given or received. The cost basis remains
with the taxpayer through following exchanges or sales. The profit or
taxable gain is found by subtracting the adjusted cost basis from the
exchange value of the property.
Appreciation
The best return on investment is normally by way of appreciation. This is
actually the ongoing increase in the value of a property due to higher
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market value every year. There may be substantial increases in the value
of properties over the years because of various factors, such as increasing
demand, lower rates of interest, inflation, or favorable economic
conditions.
The high ROI based on appreciation is one of the main reasons why
people invest in real property. This return, however, is realized only
when the property is sold. The investor should be in a position to tie up
his money for a prolonged period of time, though. Real estate
investment is not for someone who is looking for a regular and fixed
return on his investment. But for someone who is willing to invest a
large sum of money and wait for the right selling conditions, real estate
investment can be very rewarding.
Points to Consider Before Investing in Real Estate
Location
Financial and political stability of controlling body (city or county)
Redevelopment, zoning or restriction changes, potential general city

plan
Rent control
(Contd. on next page)
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Points to Consider Before Investing in Real Estate
Price: whether cash is necessary
Terms and financing: seller fixes the price, while buyer fixes the terms
Context: find worst building in best district
Condition: look for cosmetic problems rather than structural
Demand: what is the level of competition among buyers?
Competition: the new properties coming in the market; will they improve your
property and increase its value?
Current leases: are they good or bad?
Current operating expenses
Cost to rehabilitation
Replacement cost: compare with new construction
Higher and better use: will the market allow for better cash flow?
Zoning: how restrictive?
Historic tax credit: thought to be frosting on the cake
Intention of seller: why is he selling the property?
Availability of investors: make a feasibility analysis to show them
Economic cycle: is it a good time or a time of downswing?
Appraised value: independent appraisal (not based on insured or assessed

values)
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THE INVESTMENT PROCESS
Understanding the process of investment would be the ideal introduction

for real estate investment. This process is similar to the act of buying a
home, only the commitment is of a different type and there is a need for
increased awareness and assumption of risk. Normally, a home buyer does
not compulsorily see the purchase of a residential home in terms of risk,
which is not even necessary. A consumer purchasing a primary home only
needs to think about qualifying for the loan and making the payments. He
doesnt need to consider the effects of depreciation, cash flow, capitalization
rates, or tenant issues.
To become a successful real estate investor, it should be understood that it

is totally different from buying a personal residence, with sufficient
knowledge and meticulous oversight needed in every stage of the
investment property buying process.
STEPS OF SUCCESSFUL INVESTMENT

Planning and preparation
Securing resources
Choosing the appropriate property
Negotiation process
Closing the deal and acquiring the property
Planning and Preparation
As a rule of thumb, people who fail are those who fail to plan
accordingly. This is the basic rule of successful real estate investment.
Investment in real estate is a business investment and should be treated
this way. Applying the right planning and adequate preparation
minimizes the chances of failure in real estate investment.
235
In order to start the preparation on the right foot, the investor should set
the objective of his or her investment. The individual goals and
objectives have major influence on the decisions taken by the investor.
For example, planning and preparing for an investment with high cash
flow as its primary objective differs completely from preparing for an
investment aiming at higher resale value.
Investment Objectives
Identify objectives
Prepare for the investment
Secure the funds
Develop a solid plan
Realize the investment
Prioritize and set the preferences
Identify Objectives
In any potential investment, setting and identifying the objective is the

initial step. The objective will determine the tactics and strategies used, as
well as the criteria of the property which the investor should look for. These
strategies should not just be thought about, but developed into a written
plan which should include logical questions as well as factors to be
considered.
Is it possible for an investor to acquire a large number of properties in one

year, say 25 or 50 properties? The answer is yes, as long as he or she is able
to secure a good line of credit and stable financing to cover that number of
properties. So, is it easy to pursue that number of properties in such a short
time? The short answer is no; searching for a property that fulfills any given
criteria can take around 3040 hours per week. Of course the ability to
secure stable and solid financing can make the job much easier but,
choosing the right properties is still the bigger challenge. Before deciding
the number of properties to pursue, an investor should analyze his or her
236
abilities and goals in order to set a realistic target for the investment.
Answering a short investment questionnaire can be very helpful at such a
stage; truthful answers will lead to realistic goals. Here are some sample
questions of an investment analysis questionnaire.
Personal Investment Analysis Questionnaire
What is my financial goal after a year from now? What is my long

term financial goal?
Would investing in real estate be helpful to achieve the financial
status I am looking to achieve? How?
Are there any other investment venues that I would like to start in the
near future?
What are my current liabilities and financial obligations, and will they
increase in the near or far future (like tuition fees for children)?
Am I considering real estate investment as the main method to build
my wealth? Or am I considering it as a co-stream of income?
On the priority scale and after my family and basic needs - where
would the real estate investment be?
How much time I can dedicate to my real estate investment per week?
Will real estate investment be my fulltime job? Or will it be a hobby
or a side business?
What is my primary goal from real estate investment? Regular
income, resale gains and profits, or improvement of assets?
In fact, the last question is the one that should be answered first; the
answer will decide the nature of the preparatory stage. For instance, if the
investor is looking for a constant cash flow, then the properties chosen will
have certain criteria different from the properties selected if the investor is
looking for another goal.
Example:
Tia doesnt have a constant income, but her line of credit is excellent so,
she bought four properties in a period of four months with no down
payments or closing costs. She sold the four properties after 12 months for
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a net profit of $120,000. Although Tia was preapproved for 100%
property financing, she waited for about five months before buying her
first property.
The reason for the delay was that she kept forgetting her main objective
and failed to communicate this objective to her real estate agents.
Therefore, the agents were not able to guide her to the suitable properties
that could generate a positive cash flow.
Simply, she told them that she was looking for 2- or 4-unit properties in
specific areas, so the agents printed ALL the 2- and 4-unit properties in
the designated areas regardless of whether they generated a positive
cash flow or not. To make matters worse, Tia let herself fall in love with a
property, even though it was generating a negative cash flow.
Finally, and after repeating her mistake several times, Tia remembered
her main objective and started looking for the appropriate properties that
could serve her goal in the best way. This only happened when she kept
reminding herself of her main goal before viewing a new property.
Preparing for the Investment
In some cases, starting a real estate business is much easier for the
investors who have past experience starting and running their own business
as they are more aware of the mental and emotional mistakes they need to
avoid.
The simple truth is that any given person geared up with the proper
funding, knowledge and experience can do well financially through real
estate investment. If the investor lacks the experience then it would be
more appropriate to spend some time gaining it to prepare themselves for
this new field of investment.
Preparing for the investment, it should initially be noted: It is business, not

pleasure!
238
It is known that investors sometimes involve their emotions as well as
their funds and efforts in their business. But when it comes to
successful investors, they know how to separate their business
decisions from their personal ones. Of course, this does not mean that
any given investor should disregard his morals and ethics when
making business decisions.
Although it is hard to separate the personal and business life of the
investor especially if his or her livelihood is dependent completely
on that business but keeping a distance between the two allows
more room for sound business decisions.
Preparing Business Space
It is not uncommon for beginners to start their investing business from

home. If this is the case, the investor should dedicate a room or a certain
space to conduct business. Investors should refrain from leaving their
business documents scattered throughout their house and keep them
secure and organized in their work space. No matter if the investor sets up
his work space in a separate room or just a desk in the corner of his
bedroom, the only condition is that it should be away from distractions, like
a television set.
Keep it Organized
The real estate business involves filling out lots of paperwork, especially at
the business setup phase. If the investor is managing his own properties
then he needs a filing system to keep up with the different types of
documents he will be using.
Managing the properties involves contracts, checks, forms and property

records, and all need to be kept organized. A good computer system with a
decent package of administrative tools installed can help with this task.
Receipts are among the most important types of documents that investors
deal with, used for assessing the value of the deductibles and tax savings
239
available for real estate investors. The computer will help with automating
certain tasks like sending notifications by the scheduled time, sending and
receiving faxes and emails and keeping maintenance providers data.
Self-Commitment
Commitment is the cornerstone of any successful business. It is the art of

doing the needed task on time without the need of supervision.
Commitment can be learned and developed through good routine. Keeping
a specific time for every task and sticking to this schedule helps develop
self-commitment.
Avoiding Bad Habits
Being disorganized is one of the worst habits for an investor. Maintaining

everything in its right place means that it can be retrieved easily in the
future.
Doing the task on time saves a lot of trouble in the future; keeping an active
to-do list helps with this.
Patience
Business is like fishing; both require patience in order to catch the fish,
(profit). Stress is unhealthy for business; those who are unable to remain
calm under pressure should consider other types of work other than
investing in real estate. Sometimes things go the wrong way but, being
patient is the ideal way to change a bad situation into an opportunity to
lean and develop.
Scope and Goals
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Running the business requires serious and repetitive decision-making.
Keep your ultimate goal in front of you all the time, so that all your daily
decisions are kept in the same perspective.
SECURING THE FUNDS

One of the benefits of real estate investment is that a strong property can
support the weaknesses of the investors income or line of credit. For
example, in case of multipleunit properties, the lender is more concerned
regarding the ability of the property to support itself than about the
investors creditworthiness. Of course, every investor should still be
prepared to demonstrate his financial capability to the lender in order to
secure the needed funds.
Prepare several copies of the following documents
1. Full tax returns for the past three years

2. W-2 forms for the past three years
3. Two most recent bank and asset statements
4. Copies of the Social Security Card and drivers license
5. Any supporting documents for credit issues, if any, such as court
decrees, bankruptcy papers etc.
6. Letter of explanation for any credit problem
7. If you are a renter: landlord contact number to verify rent history.
It is important to know that the investor is just supposed to submit copies;

originals should only be furnished upon specific request. The mortgage
officer will assist with these issues, as well as reviewing the submitted
documents and the mortgage pre-approval.
Developing a Solid Plan
At that point, the real estate investor is on the doorstep of being a

businessman, and nothing benefits a new businessman like a solid business
plan. The initial business plan is not the final plan but the layout that
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describes the main goals of the business as well as its basic approach. The
business plan should include: the available resources, the preferred type of
properties or investment, and the strengths and weaknesses of the investor.
The basic definition of real estate investment is acquiring a property

which is considered a business and either generating constant revenue
from it or selling it for a profit. Deciding which way to follow and taking
the appropriate decisions can help the investor to avoid many problems and
losses.
What to consider when establishing a real estate investment

business
Partners:
The first thing that an investor should decide is whether he will enter
this new business venue alone or accompanied by a partner. If the
investor lacks the funding, experience or time, it would be logical to
consider partnership. The partner should be trustful and that trust
should be memorialized with a well thought-out written partnership
agreement. Partners should complement each other; for example, if
one is a strong financial negotiator, then the other partner should
have good experience in property search and acquisition.
Dedicated phone and mail:
It is important to dedicate a phone line and a cell phone for work

purposes only in order not to mix business and personal calls. The
same goes for the mail box and the email address; a separate one
should be considered for business purposes only.
PRIORITIZE AND SET PREFERENCES
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According to the business plan, the next step is to set the tactics. In other
words, how the investor is going to achieve their goals. For example what
are the properties the investor is going to search for? What are the areas of
interest?
The investors should be prepared to answer logical question as to why they

chose certain properties or neighborhoods of interest. Also, they should be
prepared to choose which properties will serve their goals better; as in,
should they look for a multiunit property close to their residence or say, a
condominium conversion project in the gentrified downtown area.
Although both choices appear to offer good chances for investment and
making profits, each is probably best suited for a specific type of investor.
So, the main question that should be answered truthfully at this point is,
What are my abilities as an investor and what am I looking for?
It is obvious that spending more time on preparations will save time and
effort in the future. Only after completion of the preparation phase, will it
be the proper time for the investor to go shopping for the right properties.
To elaborate more on the importance of the preparation phase: investors

should know that all successful businessmen will carry out detailed
analyses before starting any new venture. The minimum acceptable
analysis is the detailed feasibility study. Be prepared that a large portion of
the projected venture put to study will not get past this point.
Real estate investing business demands a great deal of effort. A good

investor can look at 2025 properties before finding one that fulfills all the
designated criteria before the investor submits an offer to purchase. On top
of this, only one out of every four purchase offers turns into an acquisition.
As the investor builds more experience, however, the ratio between the
properties viewed and properties purchased will improve.
Arrange Resources
An investor should not start his business without gathering the necessary
gear and resources. Before actually starting the business, the investor
should gather the key individuals who can cooperate with the investor to
achieve success. Although the investor will need each individual in a
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specific phase of the process, the investor needs to establish good relation
with all these individual so the cooperation will be easier when that phase
arrives.
Because of the complications of real estate transactions and the

involvement of large amount of money in mortgages, many individuals are
involved in the transaction to minimize the risk of loss of this money.
Common individuals involved in real estate investments are:
Attorneys
Real estate agents
Loan officers
Property inspectors
Insurance agents
Insurance brokers
Appraisers
Closing agents
Escrow agents
Accountants
Auditors
The Real Estate Attorney
Real estate investors have a strong need for experienced attorneys with a
solid background in real estate investment. It also would be much better if
the attorney can help with the business planning. Investors should not
confuse the attorneys who close real estate deals with investment attorneys.
Closing a real estate deal can be performed by most attorneys because it is
highly standardized and comes with detailed regulations but, when it comes
to the investment scope, the situation is completely different.
As a rule of thumb, the greater the experience of the attorney, the more
expensive he is. Although investment attorneys charge higher fees than
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regular attorneys, their experience can translate into savings for the
investor.
Any given investor will try to minimize the closing costs to the minimum
but, wise investors will not try to save money on less experienced legal help.
A good attorney may cost more but may save thousands of dollars in the
same transaction. Savvy investors will consider this as a smart investment.
It might be surprising to learn that having an attorney for closing

residential deals is optional in most states. In some cases, the escrow agent
will represent both parties for closings. In other words, the escrow agent
will play the role of a dual agent in the transaction. This means that in most
cases, the communication between the buyer and the seller is only through
their representatives and not directly.
When the attorney is representing the investor, he is responsible for

protecting his financial and legal rights. The buyers attorney is responsible
for reviewing all legal documents, forms and disclosures before preparing
the closing statement for the transaction.
Also, the attorney is responsible for explaining every document to the buyer
before signing and approving it. The buyers attorney is supposed to
cooperate with the sellers attorney to come up with the appropriate value
for the transaction.
If the escrow agent is closing the deal instead of the attorney, all the phases
are done in the same way and with the same responsibilities of the attorney
allocated to the escrow agent, who may not be prepared for the tasks.
The Real Estate Agent
One of the advantages of using real estate agents is that they are abundant
and available. Investors can take advantage of that availability and benefit
from using experienced real estate agents. Many real estate agents are
trained to locate the profitable properties and that can save a lot of time
and effort for the investor.
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Investors should look for the highly-qualified agents who hold designations
or certificates in investment. Such agents will be a valuable asset for any
ambitious investor.
Agents who hold the CCIM designation (Certified Commercial Investment

Member) have passed rigorous and extended courses in real estate
investment, with the investor reaping the benefits of that training.
Agent vs. Broker
The agent cannot work independently but only through a brokers office.
The agent can be a broker when she passes Brokers Exam, and receives her
license from the state; then, she can work independently. From the clients
point of view the only difference between an agent and a broker is the level
of experience, although this is not always an accurate measure since many
agents are quite experienced in investment matters and can help investors
in the best way.
Buyers Broker
Some buyers will resort to a more dedicated and more experienced broker
who is the buyers broker. The buyers broker is experienced and specialized
in helping the buyers to their best interest. This broker will receive their
fees from the buyer with no fees received from the seller, so they only serve
the interest of the buyer.
Listing agent
The listing agent is the opposite of the buyers agent. He is responsible for
selling the property so they work for the best interest of the seller. The
name suggests the primary task of the agent which is submitting the
property to all the available Multiple Listing Services. When the potential
buyer or the buyers broker finds a suitable property they will approach the
listing agent or broker for going further with the transaction. The listing
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agent and the buyers agent split the commission between them so each
agent will be seeking the best interest of the party he is representing.
It is better for the buyer to use an agent to make the offer of purchase
because the listing agent will be seeking the best interest of the seller and
the buyers interest is not their priority.
Loan officer
The loan officer is typically the lenders agent. Although the buyer may need
to contact the lender or the loan processor directly, it is the responsibility of
the loan officer to pre-qualify the applicant as well as receiving the final
approval from the lender and coordinating the mortgage loan closing
between the applicant and lender. With a great deal of money involved, the
loan officer has the responsibility to provide the borrower with as much
information as possible. On the other hand, the loan officer also has the
responsibility to collect the needed information and documents about the
borrower. Informally, the loan officer will serve as an advisor for the
applicant about the loan type and the most suitable lenders.
Lenders and loan officers are different, but they all have the same goal of
lending money for profit. Banks may lend money and then sell the loan to
the secondary mortgage market in order to replenish their resources and
make profits from the loan initiation fees. The loan broker or the loan
officer usually works with dozens of lenders, giving them the ability to serve
the more challenged applicants who are unable to find an appropriate
lender.
If the applicant can fulfill the standard conditions of the investment loan or
the standard home loan, he can apply to any bank for the loan. However,
when the applicant is not able to fulfill all the standard conditions of
lenders, he will need to work with the loan officer in order to find a more
specialized lender willing to be more flexible on the conditions.
In fact, more lenders are now inclined toward mortgaging onetofour

unit properties instead of larger properties, which usually come with
greater risks.
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Property inspectors
The property inspectors job is different from the appraiser. The inspector is
a valuable option that the buyer can choose to use. In fact, passing on this
option would be a mistake for any smart investor wishing to keep his
money safe.
The job of the property inspector is to conduct a detailed inspection of the

property from all aspects. The inspection will include the heating system,
the cooling system, the plumbing network, the electrical system, and the
building structure itself. If the investor is new to this field, it would be a
good idea to accompany the inspector during his inspection tour through
the property. This tour will give the investor valuable hands n experience
on how to inspect any property. The investor will be able to learn how to
restart a furnace, where the fuse box is located or even how to check a water
valve.
Insurance agent
In any given real estate transaction, the buyer should submit proof of
paying the insurance hazard premium for a full year. In fact, it is a standard
requirement by all typical lenders. It is advisable that the investor use the
services of a good insurance company working in the area of the property in
order to have the insurance agent nearby in case of an accident. The
insurance agent will have to review the property before issuing the policy in
order to approve its acceptable condition. In case of seriously damaged
properties, it would be more difficult to obtain affordable insurance.
Appraisers
The appraisers task is to set the market value of the property through the
analysis of the recorded data of the property as well as the detailed analysis
of the property and its neighborhood. The lender will demand an appraiser
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and the lender carries the responsibility of approving the appraiser. The
buyer still has the right to call for an independent appraiser.
As we discussed before, the role of the appraiser is different from the

property inspector, as the appraiser concentrates more on the monetary
value of the property in the market. Usually, the appraiser assumes that the
property is in normal habitable condition and will visit the property briefly.
During the appraising visit, the appraiser will start by taking the
measurements of the property itself and the lot, as well while taking some
pictures of the property and the neighborhood. The brief visit will give the
appraiser a good idea about the property condition.
The appraiser will not make any adjustments deductions from the market
price except in case of visible damage for the property. Any increase in
price is usually minimal except in cases of extra amenities in the property.
In both cases, the price will oscillate around the neighborhood prices.
Closing agent
The closing agent may be the escrow holder or in some cases the sellers
agent. The closing agent is responsible for getting the buyers signature on
many documents, legal paperwork and disclosures regarding the property.
On the other hand, the seller is only required to sign a few papers and
usually the sellers attorney will represent him. The lender will package all
the documents regarding the loan and send them to the escrow holder.
After signing all the documents, the closing agent will notarize them and
submit them to be recorded by the county. After final confirmation with the
lender, the closing agent will release the funds and split them among the
seller, the attorney, the real estate agents, service providers, lien holders (if
any) and to the buyer as well. This is usually done according to what had
been agreed upon in the escrow instructions signed earlier.
Accountant
When it is time for tax returns, an experienced accountant can be of great

value for the investor. There are many opportunities for the real estate
investor to save money on taxes but the investor needs a well-versed real
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estate accountant to identify these savings. Although there are some
software programs in the market for automating tax returns, using a CPA
(Certified Public Accountant) will help identify the best tax practices that
can add up to a reasonable amount of money. The CPA can also save time
and money through planning ahead to identify the savings as they occur.
Targeting the Right Property
At this point, the investor is ready to proceed with the shopping phase for
the suitable properties. The investor is not tied to any obligations so he
should take advantage of that freedom to keep an open mind for the
opportunities to find the appropriate property.
Steps for identifying the suitable property:
Check the business plan

Get preapproval for the loan
Check the available listed properties
Schedule visits to inspect the potential properties
Prioritize the preferences
Check the Business Plan
The business plan is just a piece of paper until the investor decides to start
applying it. At any point the investor feels that he is going offtrack, then
he should stop and review the business plan once more. During the
shopping phase, it is important to keep reviewing goals and priorities.
As discussed before, the goals will determine which properties match up

with the investor. The plan will help focus on a specific group of properties
instead of checking all the available lists. It is essential for the investor to
share his goals and priorities with his partners and those involved with him
in the transaction. That will help in filtering the properties matching the
goals.
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Obtain Pre-Approval for the Loan
The seller will not consider any potential buyer as a serious or potential
buyer unless the seller is sure that this inquirer has the needed funds to
close the sale. The pre-approval letter indicates the capabilities of the buyer
to pay for the property.
There are two steps in obtaining the needed financing:
1. Pre-qualification: This is a non-binding certificate issued from a

lender that declares the buyer is qualified to get a loan. Although the
pre-qualification certificate is non-binding it usually satisfies most
listing agents and sellers.
2. Pre-approval: This is an agreement between the buyer and the lender
to receive the loan in case the buyer is able to find a property for an
acceptable price. It is issued after processing a full loan application
and it carries more weight than the pre-qualification letter.
If the investor is interested in a small or medium property then obtaining

pre-qualification or even the pre-approval is relatively easy. The investor
will have to fill a short form and send it by mail, e-mail or fax to the lender
in order to attain the pre-qualification which can take a few minutes or a
few hours. The lender will pull the credit record of the buyer and check his
income and the debts, then issue the pre-qualification certificate. In case
the investor is interested in a large property, the lender will need to check
the property and see if it worth the investment and can support itself to pay
for the loan.
Most investors will want to shop around for the loans. Each time the
investor applies for a loan with a lender, the lender will pull the credit
record of the investor for analysis. When he applies again with another
lender the previous pre-qualification will appear in his record and each pre-
qualification will decrease the FICO credit score by 10 to 20 points. This
means that if the buyer applies with several lenders and each application
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deducts 10 to 20 points of his credit score, then he is risking decreasing his
credit score from category A to category B.
The right way to shop for a loan is to pull the investors credit record from
the three main credit reporting bureaus (Trans Union, Experian, and
Equifax). When the investor applies with one lender or more, he will notify
the loan officer not to pull the credit record. When the buyer is ready to
commit with one lender, only then should he ask the lender to pull the
record. This way, the credit report will not show multiple credit report
checks.
Find the Available Listed Properties
Now the investor is set up with a business plan and loan approval, the
actual shopping for the desired properties can start in earnest. The investor
needs to find the right real estate agent, who has the needed experience to
find the properties that match the investors criteria by searching the
Multiple Listing Services (MLS). The real estate agent will print out a list of
the available properties that match the investors wish list. The report will
contain detailed information about each property including the rental
income and operating expenses.
Not all the for sale properties are listed in the MLS as some sellers prefer to
sell their properties directly and save on paying commission to the listing
agent. In order to obtain access to such properties, the investor can
dedicate more effort to canvass the designated area looking for For Sale
signs, or an easier option -- hire a buyers broker.
The investor can also browse the classified ads in the local newspaper to
find the FSBO (for sale by owner) properties and conduct the initial
analysis of the property over the phone before physically visiting it.
Visiting the Property
It is advisable to drive by potential properties at least once before

expressing an interest in viewing it. Before proceeding with property visits,
a smart investor will sit and crunch the numbers for each property. The
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investor will then arrange and prioritize the properties according to their
degree of compatibility with the criteria in the business plan. This will
reduce the time spent in visiting the properties as the investor will only
view the properties that already match his plan.
When visiting properties, the investor should perform this in a professional

way and ask the needed questions to complete an analysis of the property.
It is also helpful to have an inspection checklist and a camera in order to
gather helpful information for further review.
Prioritization Essential
The investor should always prioritize the properties according to how they
comply with his criteria. This should be done continuously, as from time to
time the investor will locate a property that matches his objectives better
than the previous one; so, it should come first in the priority list. Investors
should ask the real estate agent to arrange more visits to the property at
different times. It is essential to see the property at morning and evening in
order to see the characteristics of the property at different times.
In many cases, new investors may get the Buyers Remorse syndrome,
where the buyer regrets purchasing a large item just after its purchase. This
is more common after highvalue acquisitions. Investors can only
overcome such cases of remorse by studying the pros and cons of decisions
very well before making them. If the investor is not able to decide on
whether to buy a property or not, then it is likely they lack the needed
information to close the transaction. The purchase decision should be built
on a completed base of information in order to be worthwhile.
Negotiating Terms
After finding a good property that complies with the investors criteria, it is
time to negotiate the terms of the sale with the seller. The investors goal at
this stage is to reach an agreement with fair conditions and an equitable
price with the other parties. Some investors will look at the shortterm
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goals of trying to get the property at a price much lower than the market
value. Such practices are unworthy and unproductive, though, as it affects
the other aspects of the sale, likely making the seller less willing to
cooperate. It is important to look at building the longterm relationship
with the seller, the agents and the other parties involved in the transaction,
as they will probably be needed in the future for more business. So, such
selfdestructive behavior should be avoided.
One important thing to remember is that the investor should be able to say
NO. In many cases, new investors will be afraid of losing a deal that
appears to be quite good, thinking that they will never find a deal as
profitable as the one in hand. But the investor should always measure the
property according to his business plan and not against the other properties
he has seen. In other words, this property may be the best of what has been
encountered till now but it still might not match the investors goals. So, the
right decision is to review your business plan, and, if warranted, turn down
that property and move forward to viewing other opportunities.
The new investors always fear losing a good deal, thinking that nothing as
favorable will remain in the market. The blunt answer is that opportunities
arise every day. Losing a good deal is much easier than getting stuck in a
bad one.
These decisions are always harder as the investor approaches closing the
deal. The motto that should be followed at this stage is losing a good deal
means having more experience in the future.
Steps for Profitable Deals:
Due diligence
Submit a winning offer
Negotiating terms and price
Review by attorney
Property inspection by professionals
Renew the loan approval
Property insurance
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Set the budget and the operation plan
Due Diligence
When dealing with residential properties, the window for due diligence is
relatively narrow, unlike commercial properties. No matter what property
type the investor is looking for, he should gather as much data as needed to
make an educated decision. Normally, due diligence has three main goals
regardless of the property type or the experience of the investor:
- Calculating the proper value of the property

- Checking the condition of the property, income and running expenses
- Checking that the property complies with the minimum criteria set by
the investor
Investors usually seek the help of real estate professionals at this stage
since they can more quickly collect the needed information from the
county, city and the seller. After gathering this data, the investor should
insert these numbers into a feasibility study. This study should show the
potential profits that can be generated from this property. The key players
in a successful feasibility study are a real estate agent and an accountant.
They will help in calculating the capital investment needed, the income, and
the operating cost of this property.
Before submitting the offer, it is essential for the investor to know the
motive of the seller in selling. The simplest way to find out the motive is to
ask the seller directly.
Submit a Winning Offer
If the analysis indicates that the property is a winner, then the next step is
to submit an offer. When the price proposed by the seller matches the goal
of the investor, he can accept it or start with an offer that is 5 or 10% lower
to give some room for further negotiations. Do not try for a much lower
price unless there is a clear reason for this, or the seller will consider the
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offer and the offeror -- unreasonable. If the due diligence showed that the
property is overpriced, then the offer should include the prices of similar
properties in the neighborhood. Before starting the negotiations, the
investor should know the price that he is willing to accept and act
accordingly.
Negotiations have no definite rules; it is a skillful art rather than a solid

science. Investors will develop this particular skill while they build their
experience in the real estate market.
Negotiating Terms and Price
If the seller considers the offer submitted by the investor as a serious offer,
then he will likely reply with a counter-offer. Both parties will exchange
counter-offers until they can reach an offer acceptable to both. It is
important to remember that counter-offers do not only contain price
adjustments but, also usually include other different terms in the
transaction. A shrewd investor will know that he can accept a price that is
little higher than what he intended to pay in exchange for some concessions
on other terms. For example, the seller will add some appliances to be
included in the sale or perhaps the seller will agree to pay the closing costs.
Review by Attorney
After reaching an offer with terms acceptable to both parties, it is advisable

that the buyer have an experienced attorney review the entire contract to
confirm that it is written in the proper way. The buyer should have a
window of time to request a review by the attorney.
Property Inspection by Professionals
After signing the contract, the buyer will have several days to get a
professional inspector to inspect and check the economic, structural and
functional condition of the property. If the inspector finds any major issues
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with the property that is not cited in the contract, the buyer can ask for
maintenance by the seller or even cancellation of the contract. Usually, the
contract will have a clause that declares the right of the investor to cancel
the contract during specific number of days if the inspector finds a giant
flaw.
Renew the Loan Approval
After the inspection, the investor should notify the loan officer of the
contract signing and request completion of the loan processing. In most
cases, the lender will request several up-to0date documents and the
investor should be ready to furnish these in order to close the loan deal and
prompt the disbursement of the loan money. The loan officer will guide the
investor through this step and specify the needed documents.
Property Insurance
Usually, lenders will request one year of property insurance paid before
closing the loan deal. Even if the lender does not request a property
insurance policy, it is recommended that the investor take the extra step
since it is a sensible expenditure. The insurance agent is able to issue the
policy in just couple of hours in most cases. In the case of larger properties,
it may take a bit longer to issue the policy.
Set the Budget and the Operation Plan
The budget plan should be built on the facts included in the appraisal and
the inspection report. It should also comply with the goals identified in the
business plan of the investor. The operation plan is the tool that will help
the investor play the role of a new landlord. It will contain the lease
contracts, the notice forms, and a dedicated bank account.
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Closing the Deal and Acquisition of the Property
This is the final step in the deal where the investor will receive the keys to
the property as a sign of taking it over. This may happen in the escrow
holders office, the title company or at the attorneys.
STEPS OF A SUCCESSFUL PURCHASE
Prepare Smartly
There are many tasks that the investor can do before closing the deal which
can make the period after closing the deal more fruitful and profitable. For
example, if the investor is planning for some decorations or maintenance
then setting those tasks up in accordance with any issues identified in the
inspection and/or appraisal report should save time after taking over the
property.
Calm Down
Closing real estate deals can be very stressful because of the tight deadlines
and the crucial decisions that need to be made on the spot. Investors should
be prepared for this stress, consider it part of the job requirements and try
to deal with the situation calmly in order to be able to make the right
choices at the right time. Indeed, sometimes deals will turn wrong and be
cancelled; investors should be prepared for such an eventuality and view it
as a chance to boost their experience and learn from past mistakes.
Listen to the Closing Instructions
The closing agent should inform the investor about how to finish the
transaction and what the investor should bring to the closing session. If
there is an additional deposit to be paid, the investor should bring the full
amount in the form of a cashiers check.
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Closing the Deal
A clean closing will take one or two hours, but sometimes might go far
longer. Investors should be prepared to sign documents, a large number of
forms and the trust deed itself.
Acquisition
The end of the closing session is the handing over of the property keys.
When the investor receives the keys, he is in full control of the property and
all the preclosing work should pay off at this point. Preplanning for
maintenance, rehab or decoration of the property will allow the investor to
start directly after taking over the property.
REAL ESTATE ANALYSIS TOOLS

The measuring of the profitability of a property depends on the party
conducting the analysis. What is the best way for the buyer not to be
swayed by the effect of the marketing information put forward by the seller
and his representative? When it comes to lenders, they focus mainly on the
chances of the property being able to support itself financially or what is
known as the debt service ratio. There is little difference with larger,
commercial properties as the lender will focus more on the anticipated ROI
and the capitalization rate. The aspiring investor should do his best to
understand the key financial terms and analysis expressions involved in the
real estate business.
Fortunately, these terms are clear and can be easily understood. These
terms and tools were developed especially to help the investor to measure
the chances of the property to make profit. Some fresh investors may
initially feel confused by the language used in these reports but discover
that most of the terminology relies on common sense.
INVESTMENT TOOLS
Operating expenses
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Carrying costs
Net operating concepts
Debt service ratio
Return over investment
Market development cycle
Operating Expenses
The name says it all; operating expenses include all the regular and
repetitive expenses incurred in the operation of the property. This includes
but is not limited to: trash collection, maintenance, management fees,
utilities, service contracts, supplies, taxes, insurance premiums and vacant
property advertisement.
It is important that the investor know how to identify the operating

expenses and the non-operating expenses. Seeing the difference between
these two types of spending will save money every year in tax deductions.
One of the misconceptions that confuse beginner investors is believing that

mortgage payments are considered operating expenses; actually, mortgage
expenses are counted as acquisition costs. The following table differentiates
between operating and non-operating costs.
Operating expenses Non-operating expenses

Maintenance Closing costs
Janitorial Mortgage and debt servicing
Service contracts Capital improvement fees
Supplies Equipment and fixtures
Trash collection Marketing costs
Management fees Selling costs
Accounting fees
Administrative fees
Advertising services
Insurance premiums
Real estate and corporate taxes
Governmental fees
Utilities
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As shown in the table, capital improvements -- unlike maintenance
expenses -- are separated from the operating expenses. The maintenance
expenses are considered operating expenses because they are spent to
maintain the current value of the property, while the capital improvements
are used to increase the value of the property.
Example: Major improvements, the installation of alarm systems and the

construction of annexes and extensions are considered as capital
improvements since they increase property value. Understanding how to
distinguish between the two types of expenses is important when
calculating capital gains for tax purposes.
Being informed as to the accurate value of operating expenses is a crucial

step in knowing the exact value of the operating income of the property.
Extra care should be taken in identifying the exact value of the operational
costs in order to find the monthly income of the property.
In order to increase property income, the investor can go in either of two

directions: decrease the operating expenses, or somehow increase the
income collected from the property.
Depreciation costs also have a role in this process, as the property structure
and the fixtures go through regular depreciation.
Example for Maximizing the Depreciation Deductions
Kathy has a fourunit property that breaks even (breaking even means
that the operating costs equals the operating income). Kathy is actually
not unhappy about this; the property is gaining in appreciation and
increasing in value, while Kathy can earn more through her depreciation
deductions. On top of those earnings, breaking even means that Kathy
does not need to pay income taxes.
Carrying Costs
Real estate investors who are looking at buying a certain property and
selling it after a period of time for a profit should be concerned about the
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carrying costs. These are the costs spent after buying a property and until
selling it again. The carrying costs exclude the purchase price and the
deduction of the net income generated by the property.
Inexperienced investors may think that a property bought for $150,000 and
sold after three months for $200,000 is a good investment opportunity, but
it would turn into a fiasco if the investor discovers after the purchase --
that the carrying costs will be $60,000.
Experienced investors will look at the carrying costs as a major component

of the deal as well as the purchase price itself. The carrying costs include
the purchase price, the mortgage payments, the closing costs, the capital
improvement costs and the selling costs.
Example: At first glance, an investor sees an underestimated property

bought for $100,000 and sold later for $120,000 as a nice investment. But
after a closer look at the carrying costs, he changed his mind,
Purchase price $100,000

Closing costs of the deal $4000
Cleaning service and redecoration $3000
Mortgage payments at 8% $3600
Real estate taxes $1000
Insurance $300
Utilities $600
Supplies $300
Real estate agent commission $6000
Resale closing costs $2500
Total of the 6 month carry costs $21,000
Total investment $121,300
Resale price $120,000
Net profit/loss - $1300
The table shows a potential loss of $1,300 in this transaction. Take into
consideration that the example did not calculate a possible tax gain
incurred, the bank interest lost through a cash withdrawal for the down
payment, and the investors time lost in this process.
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In a typical buy and quickresale transaction, the investor should know
that he needs to sell the property for at least 11% more than the purchase
price just to break even. The investor will pay around 3% for the closing
costs after the purchase, around 2% for the resale closing costs and around
6% for the real estate commissions (without calculating the lost time and
effort of the investor or any possible taxes that may be incurred during the
process). Also the example assumes that the investor will resell the
property on the same day of purchase but, in real time, every day the
property remains in the hands of the investor means additional running
costs incurred.
Net Operating Income
Net operating income is used as one of the common methods to calculate

the value of an income-generating property. In this approach, the current
value of the property is measured through its ability to generate this income
in the future.
The process of calculating the current value of a property through its

capability for generating a specific amount of money in the future is called
capitalization. In other words, this tool will use the future generated
income of a property to calculate how much it is worth at the present time.
This means calculating the future expected income stream as well as the
expected spending in the same period of time.
However, the investor should be asking, how long should can this future
income be expected to last and how reliable is this expectation? Here are
some fundamental points used in calculating the current value of property:
1. Calculate the annual gross income:

The gross income is the total annual income of a property with the
deduction of any vacant units or any rental losses. The income
includes the rental income, facilities fees (parking lot fees, laundry
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room fees, etc.) The deduction of the gross income is the rental value
of any vacant unit and is calculated as the vacancy factor.
Market rent: the rent expected for the property in open market.
Contract rent: the actual agreed-upon rent generated from the

property.
2. Calculate the operating expenses:

These expenses are classified into two categories
Fixed: property taxes, insurance.
Variable: management, maintenance, and utilities expenses.
3. Calculate the net operating income:

To attain an accurate calculation of the net operating income, the
investor should be able to calculate the total gross income and the net
operating costs accurately.
Example for Calculating Net Operating Income
Rental income $24000

Laundry income $4000
Penalties and late fees $300
Storage rooms and parking fees $2700
Interest income $50
Gross operating income $31,050
Maintenance and repair fees $2500

Supplies and janitorial $1800
trash collection $1400
Utilities $2800
Advertising fees $500
Administrative fees $5000
Taxes and license $300
Insurance $700
Operating expenses $15,000
Net Operating Income (NOI) $16,050
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As earlier discussed, the net operating income does not factor into its
calculations the amounts paid for the mortgage nor the amounts paid for
capital improvements. It only concentrates on the difference between what
the property generates and what the investor pays to keep the property
running.
Selection of capitalization rate (cap rate):
The capitalization rate or cap rate is a simple tool that helps the investor
choose the type of property to go after. For example, should he try to buy a
shopping mall or an office building; a farm or a car wash? The cap rate is a
simple tool that uses two factors: the purchase price and the net operating
income (NOI).
Cap Rate = NOI / purchase price
The cap rate is considered as the interest rate returned on the amount of
investment put into the property. It is usually used as one of the tools in
determining whether the property has a good potential profit or not. It can
also be defined as the yield rate that can entice an investor to proceed with
the acquisition of a property. When comparing the investment in a property
against an investment in land, the depreciation should be taken in
consideration. The cap rate is utilized to show the rate of regaining the
initial capital investment in a property and thus provide an incentive for the
investor to acquire this property.
The greater the risk of returning the invested money, the higher the cap
rate should be. All these factors should be taken in consideration when
determining the price that should be paid for the property in question.
Example:
A property in downtown Chicago is for sale, the land leased for a 50-
year contract of $1.2 million per year. The land owner has a running
expense of $200,000 (the property tax incurred annually). The
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developer leasing the property has an office building which will revert
to the owner at the end of the lease. The ROI in this case will be $1.2
million $ 200,000 = $1 million per year.
The landowner is willing to sell it for $20 million dollars and this
makes the cap rate = 5%
For most investors a 5% cap rate will be very low but, the cap rate is
not usually the major index in such deals. Usually, the cap rate is used
for the income producing properties. In the current example, the 5%
cap rate may be acceptable for the investor looking for a long-term
resale value. For example, this land will be purchased for $20 million
and then sold for $100 million after 10 years.
Another example:
Office building with an annual income of $200,000 (when fully
occupied)
The usual occupancy rate is 90%
The operational cost per year is $100,000
The seller is looking for $1 million as the sale price.
So, the cap rate is:

Actual rent =$200000 * 0.9 = $180,000
Annual expenses = $100000
The net income is $ 80,000

The cap rate is: $80000/$1000000 = 8%
The question now is, how much should be the cap rate be in order to
consider the property as a profitable investment?
Informally, the investors think that a 10% cap rate is the median or the
acceptable cap rate. According to the last example, the fair price should
drop to $800,000. Of course the fair price is more dependent on the
market itself. In some locales, a lower cap is normal and accepted by most
investors.
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Investors will try to determine the appropriate cap rate of the property
during the period of investigation and inspection of the property. The
following is a step-by-step walkthrough in order to verify the cap rate of the
property
a) Check and confirm the rental rates of the property

b) Confirm the vacancy rate of the property
c) Check the other sources of income
d) Review the cap rate of similar properties
e) Calculate the total operating expenses after deducting the vacancy
rate
f) Check the past operating expenses rates
g) Review the maintenance expenses during the past period
h) Calculate the NOI
i) Calculate the capitalization rate
Define the market value by dividing the net income by the capitalization
rate:
After finishing the calculations of the annual total income, and identifying
the operating expenses, and finding out the net operating income of the
property, and realizing the cap rate -- the investor will be able to determine
the acceptable market price of the property through dividing the net income
of the property by the cap rate.
Debt Service Ratio
This is the preferred index for the lender; it measures the propertys
capability to cover the mortgage payments rather than measuring the
ability of the investor himself to pay for the mortgage. Some types of
investment loans allow the lender to intervene and start collecting the
tenants monthly payments to cover the mortgage payments in case the
investor (the borrower) defaults on the loan payments. In some loans, this
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could be done just after the default, with no need to wait for a complete
foreclosure to step in. Therefore, the Debt Service Ratio (DSR) is
considered an accurate tool for the lender to assess the possibilities of the
property generating enough income to pay for its own mortgage.
The DSR is calculated through two factors: the NOI (Net Operating
Income) and the payments of the loan itself.
DSR = NOI / Loan Payment (debt servicing)
Example:
Total operating income = $31,050
Total operating expenses= $15,000
Net operating income = $16,050
Loan payment = $13,000
The DSR = 1.23%
Most lenders will accept DSRs 1.2% and up. This means that the
income can cover the whole value of the monthly payment and still
have 20% remaining as the buffer amount. If the DSR is lower than
the required 1.2% then the lender will decrease the loan value until
the monthly payment divided by the net income is at least 1.2%.
The investor will have to go one of two ways to compensate for the
decrease of the DSR. The first way is to go with lowering the loan and
compensate for the decreased amount by increasing the deposit paid.
The other way is to improve the DSR by increasing the net income of
the property.
Increasing the total income or decreasing the operating expenses will

result directly in increasing the net operating income.
Return On Investment (ROI)
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ROI is the tool which investors use in order to determine the
propertys accurate gains. This tool makes an accurate comparison
between what the investor has actually paid or invested into the
property and the amount it returns. ROI is a good analysis method to
attain a bigger picture of the potential profits of a specific property.
ROI determines how well the money is invested
ROI can be used to analyze any type of investment. For example, a

savvy investor can use the ROI to compare the profitability of a real
estate property and a stock market investment.
The simple calculation of ROI is the division of the net income by the
capital investment made in the property.
Calculating ROI (annually):
Annual net income of the property: $30,000

Deducting the loan service value: $20,000
Increase in property appreciation: $25,000
Total return of the project: ($30,000 $20,000 + $25,000) =
$35,000
Paid capital investment and other cash payments =$400,000
ROI $35,000/$400,000 = 8.75%
Note that the capital investment is not the purchase price but what
the investor had paid until the property started operating. This
includes the purchase price, any rehabilitation done on the property
or any other type of capital investment in the property.
Example:
Peter is about to buy a carwash with a down payment of $45,000 and
closing costs $5000 with a total investment of $50,000. The net
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income of this carwash is $5,000 so the ROI will be $5000/$50,000
= 10 %.
But he is planning to sell the carwash after one year from purchase
with a profit of $10,000. The total return is now $15,000, which
increases the ROI to 30%.
This ROI is considered very well when compared to those of bonds

and the S&P which can return a maximum of 10%.
Unfortunately, not all the investment opportunities have an

optimistic scenario. Some real estate properties turn into a
problematic business that needs continual capital investment. A lucky
investor may be able to walk away with a small, bearable loss, while
another investor may get stuck and lose quite a bit in such cases.
When that happens, a certificate of deposit with a return of 4.5%
doesnt seem like a bad idea.
There are several other ways to measure ROI, such as the internal
rate of return and the equity dividend rate. Another factor that should
be taken in consideration is the period of time spent before the
investor can take back his money. As a rule of thumb, the shorter the
period, the safer the investment.
When an investor is looking at a potential investment, its ROI should

be compared to other types of investment. The best practice is to look
at a more conservative investment category, such as bonds, and
contrast it with the potential real estate investment. Here are some
points of comparison to be taken into consideration:
1. Liquidity: It is important to know the time and cost needed to

liquidate the investment. Real estate is a hard asset which usually
cannot be sold quickly without impacting its price. When it comes
to certificates of deposit or stock shares, they can be liquidated in
minutes by contacting a banker or broker. Therefore, ROI should
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be adjusted with these factors in mind to include the time and cost
consumed in liquidating the assets.
2. Management: This means time spent with the investment. Some

investors fail to determine the fair compensation for the time spent
managing an investment. The ROI of a savings bond may be 3-4%,
but it requires little management or work exerted. So, if an
investor is spending 20 hours per week in managing a real estate
investment which is generating 10% ROI, he should consider how
much he might earn by investing these 20 hours in a part-time job.
So, such time management issues should be taken into
consideration when comparing real estate investment.
3. Risk: this is an intangible factor because no one can definitively

predict the amount of risk in any investment. On one hand,
savings bonds have no risk at all while the risk of bad investments
may be higher with real estate. It is important to take care when
measuring the risks involved with the investment.
ROI Risk
Natalie is considering a real estate investment with a base ROI of 16%. It is

a good opportunity but she wants to compare it to her regular saving
account that is generating 4.75 % ROI.
1. Liquidity: The subject property is an old office building in a

residential neighborhood, meaning that it is harder to liquidate. For
that, Natalie subtracts 5% of the ROI.
2. Management: The office building is fairly old, so Natalie will have

to be involved in its management to ensure a proper return. She
estimated that she would spend four hours per week doing this, with
the annual cost of these hours expended lowering her estimated ROI
another 4%.
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3. Risk: Although the office building has a good track record by its
occupants, Natalie is aware she is new to management and will
require a learning curve; this increases the risk of losing some
tenants which she estimates should deduct another 4% of ROI.
The ROI after the adjustment will be % 3 (16 5 4- 4 = % 3). So, in this
particular case, sticking with a savings account is the safer choice.
Of course there are many other factors that should be taken into account
like tax deductions, grants and property appreciation. These factors will
affect the ROI and should be calculated when adjusting the ROI of the
investment. Experienced investors will look over the entire process that
starts from the acquisition of the property until its final resale in order to
accurately estimate the ROI.
Market Development Cycle
Successful real estate investment depends on good timing. Studies of real

estate markets show that each market has a clear pattern or cycle which
regulates it, assuming that the market is exposed to the normal conditions.
It is essential for the investor to understand such cycles in order to make

the best choices suitable for his investment. The market faces different
stages in the development cycle with these stages differing from one market
to another according to severity, shape and duration. The experienced
investor is able to differentiate between the four main stages of the market
development.
Absorption: This is the first stage that comes after the down phase
of the development cycle. In the absorption stage, construction slows
down, which boosts occupancy rates of the existing units in the
market. When occupancy rates increase, rents prices will follow.
New Constructions: Although many developers are unable to

anticipate the periods of future high demand in the market, they can
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recognize when those periods have begun. When rents increase, the
market demands more units to cope with the increasing demand.
Saturation: This is the stage that follows the increase in

construction rates. It starts when the construction rate (supply)
outweighs the number of tenants and buyers (demand). At this point,
the market inclines toward being a buyers market. This is an
unfavorable point for the investor to start a new project, because it
will only increase the gap between supply and the demand.
Down: Although there is no distinct border between the saturation

phase and the down phase an investor will know it when facing a
down stage. In simple terms, the down phase arrives when the gap
between supply and demand strongly widens. This will compel
developers and investors to stop new projects.
Thus, investors and developers should recognize the market stage of the
target area before deciding whether to begin a project or postpone. Even if
demand seems apparent, if there are many projects underway then prices
may stagnate or drop if the demand did not increase at the same rate.
DEVELOPMENT CYCLE IN PRACTICE

The downtown area of Orange City is maintaining a balance between supply
and the demand in the area for office space but still has significant
vacancies in the market. This means that downtown Orange City is still in
the absorption stage of the market development cycle.
Community leaders lead an initiative to develop the city and induce

commercial growth in the area which attracts many hightech companies
and cutting edge businesses to move to downtown. So, the supply should
increase through developing more office buildings of different sizes and
amenities to cope with this expected increase in the demand. Now, the area
is moving out of the absorption stage into the new construction stage where
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more development will hit the market, bringing potential opportunities for
good investments.
In the last stage, the demand curve is rising while the supply curve also
surges to cope with this increase. When the demand curve starts to level off,
the amount of newly-built office buildings will provide all the necessary
new business space. This means that the market in the downtown area will
be entering the saturation stage.
Usually, developers start to realize that the demand is tapering off while
they are still constructing new buildings so construction starts its slowdown
well after the decrease of the demand. Rental rates start to go down with
the increase of the vacancy rate in office space. This means that the market
is in the down stage.
It is important for investors who are interested in entering the real estate
market to understand how to read the market status to detect the stage the
market is facing and react accordingly.
If the investor is looking for investment opportunities that will generate a

good running income then the best time to do this is in the new
construction phase or at the first part of the saturation stage.
On the other hand, if the investor is looking for investment opportunities to

generate appreciation profit then she should be seeking to enter markets in
the latter part of a downstage or in the early absorption stages. If the
investor is looking for a long-term investment, though, the stage of the
market should not be the first priority.
Investors with a sharp eye for details can spot underperforming properties
that can generate more profit no matter what stage the market is in. That
discernment enables some investors to enter market while facing the down
stage because they can see upside potential in a specific property.
REAL ESTATE INVESTMENT TACTICS
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What is the difference between successful investors and others who lose
large sums in the real estate market? Some investors would say that luck is
the main reason but the real answer is that successful longterm investors
obtain the needed knowledge and required data before investing. There are
many different ways that investors can generate profit from the real estate
market. Some of these ways are familiar to most investors, but there are
also unbeaten paths to take for generating better profits. No one can claim
to know all the ways to make money in real estate; investors come up with
new successful ideas every day.
This section discusses some of common, as well as some uncommon profit-

generating methods and tactics in the real estate market.
Collateral
Income stream
Value appreciation
Subdivision
Development
Options
Master lease
Tax shelter
Tax free exchange
Of course, not all the methods mentioned, above, are suitable for the
properties in the market. It is also possible to combine more than one
method in one property at the same time. The successful investor is one
who can check a property and know exactly which methods are applicable
to produce the best profit.
One tip applicable to all projects and potential properties: Do not fall in
love with the property. This can cause potential loses or at least decrease
the profit substantially. Choosing the right tactics depend mainly on the
property itself and real estate investment requires objective, rational
decision-making. The problem is that some beginner investors become
infatuated enough with a property to influence their perspective. The best
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approach is following the plan to achieve the desired objective by searching
for the property that can fulfill this objective; not the opposite. The biggest
mistake is to start by finding a property, then trying to accommodate a plan
that fits.
Collateral
Collateral is one of the most common investment tactics that investors use.
The aim of this investment is to build a portfolio of collaterals for future
investments in the market. Lenders prefer borrowers who hold the deeds to
real estate properties more than other type of borrowers, because real
estate collaterals are highly useful and profitable for the lenders.
For many individuals, the main purpose of purchasing a real estate

property is to provide a home for their families. The truth is that a home
can offer much more than just a safe shelter.
Americans who own their homes have a wide array of opportunities

available to them, unlike renters who have no access to these opportunities.
The obvious reason is that real estate provides collateral. Even if the
property is highly mortgaged, it is can still be utilized as good collateral for
future investments.
Many commercial banks and lenders are willing to offer loans to investors
and enterprises with borderline credit if they are able to put up their real
estate properties as collateral for the loan.
Example: Mary is running a business (a caf) and it is going well; the next
logical step is to expand. She contacted a bank for a business loan but they
have restrictions on giving her the needed funds since she has a couple of
late payments in the near past. The bank offered her a loan if she agrees to
put a lien against her own home.
Of course if the business fails, this means that the bank will hold that
secondary loan against her own residential property. If she doesnt own her
own property she wont be able to get the business loan she is looking for.
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Also, if she holds any other property, she can choose to put the lien against
this property instead of her residence.
Real estate can serve as collateral even if it is highly mortgaged. Equity is

not the only measure for a propertys suitability as collateral, other factors
can be considered, too. For example, the regular income generated by a
property is usually included when it is considered as collateral.
For example, Mark owns a farm, with a local farmer as a tenant. The lender
will take the farm as collateral for a business loan, so in case Mark defaults
the lender will step in and be able to collect the rent in order to cover the
loan payments.
Another use of the collateral is to generate a chain of multiple acquisitions

of several properties in turn.
Example: Sam purchased a duplex as a residential property for $100,000.

He added some decorations and improvements for the duplex and it was
appraised for $150,000. Sam used a new loan of $50,000 to buy two small
units where he made similar enhancements to the property and then used
those units to take a loan for the difference in their appraisal after the work
was done. This chain keeps going until Sam has 15 properties in his
portfolio. He then used all the properties with its generated income in
order to obtain a $500,000 loan. He used this as a down payment for a
large office building property.
When property is considered as collateral for a loan, the main responsibility

of the investor is to manage the property and keep up its value as collateral.
The main way this is done is through performing all needed maintenance.
In addition to this, the investor should stay up to date with new projects in
the area and the market overall. The development of the area, crime level in
the neighborhood, and tax issues are some other factors that will affect the
propertys value.
Income stream
A considerable amount of investors will go into the real estate investment

seeking a side line of income. The measure of success for these investors is
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obtaining a positive cash flow from the investment. In most cases, this is
easier theoretically than in real life.
If generating a positive cash flow is the goal of the investor then the
following four points should be taken in consideration for a successful
investment.
Understanding the cash flow

How to improve the cash flow
How to recognize the profitgenerating profits
Finding the properties with potential for income increase
Understanding the Cash Flow
In order to have a positive cash flow, the property income and any other
associated revenue should exceed the running expenses and the debt
servicing value of the property. The common mistake that many investors
fall into is failing to differentiate between two types of cash flow:
- Pre-tax cash flow is the cash flow of the property before calculating
the incurred taxes on the property.
- Post-tax profit is the net profit generated from a property after paying
the taxes due.
Many investors fail to pay the taxes due on their investments because taxes
are not sent to them in bill form like other operating expenses. The tax
statement will eventually come; the investor must take the needed steps to
pay the due taxes on time to keep the tax implications to a minimum.
It is important to concentrate on the posttax profit as the main

measurement of the propertys profitability. Depending on how well the
investor understands the due taxes, the post-tax profit is maximized and is
closer to the pre-tax income.
When the investor tends to analyze the true cash flow of a property, it is
important to look into the complete picture through calculating the
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operating costs, the net income, the return over investment, and the
capitalization rate.
The veteran investors will not take the sellers estimates for granted. They
know that the sellers are trying to put out the best possible numbers for
their properties in order to make a purchase more attractive.
The safest move is to insist on getting all the documentation for the
numbers claimed before making the final decision about the property.
P&L statement or the profit and loss statement: This document is the
final statement the owner calculates for their properties every year,
which explains the profits and losses of the property. It is usual
practice to provide them for large buildings but not so common for
the smaller ones. The investor should request the previous year P&L
statement as well as a year-to-date P&L statement.
Lease Roll: The P&L statement will have some figures for the
income of the property, these figures should be supported by the
property document (lease roll) and the lease contracts with the
deposit receipts included. If there are no leases available, the investor
can confirm the status of the tenants through instructing the attorney
to get the tenants to sign estoppels statements to confirm their lease
status. The investor should do his best to confirm the past vacancy
rate of the building and the history of occupancy of all the units of the
property.
Service contracts: These contracts are common factors in the

running of any property. This includes the trash pick-up service
contract, elevator maintenance and some leasing services.
Utility bills: This is one of the regular payments in the operational

expenses. The seller should provide copies of the utility bills paid by
the landlord for the last year. The mean value of these bills should be
factored in the operating costs.
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Appraisal reports: When the investor applies for a loan to
purchase a specific property, the lender will commission a
professional appraiser to appraise the property. The investor should
request a copy of this report in order to confirm the price of the
property as well as knowing the overall rate of similar properties in
the area.
Professional inspection: The investor is allowed to send his

professional inspector to check the property. An experienced
inspector can point out problems related to the maintenance or the
systems of the property that may arise in the future.
How to Improve Cash Flow
Knowing the current situation of the cash flow is essential for the investor.
It will help him to be aware of operating expenses and property income and
show possible ways on how to maintain and improve that cash flow
through:
Decreasing expenses: Reducing the amounts spent on the

property is a quick method to improve cash flow. This can be done
through bulk purchases of the regularly-used materials, and through
negotiating the service contracts or obtaining new providers for
needed services.
Increasing the gross income: Although it is harder than

decreasing expenses it is just as important. For most properties,
raising income means the blunt increases of the rent, while lowering
the vacancy rate to the minimum. It also includes creating side
incomes like fees for parking spaces or storage rooms.
When the investor increases the cash flow of the property, its appreciation
will increase automatically. The value of the property varies proportionally
with the income it generates.
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Cash flow, Example 1:
Sunny purchased a 10unit apartment building. The net operating income

(NOI) is $20,000 per year and its sale price is $200,000 (cap rate 10%).
Sunny made the proper decisions in order to decrease operating expenses
and increase the revenue. The result was a higher NOI that reached
$25,000. Because of successful management by Sunny, she can expect an
increase of the property value to be $250,000, assuming the cap rate
remains the same.
Sometimes the investor can increase the propertys value without

improving the cash flow.
Cash Flow, Example 2:
Randy is running a four-unit property in Chicago in the gentrifying

Lakeview neighborhood; he inherited the property from his late mother.
Randy only does the very basic maintenance required for the property, so
he was not able to increase the income higher than its usual $15,000. The
property was appraised 10 years ago for $150,000 with the same ROI.
Currently, this property screaming for a rehab now attract offers for around
$450,000 because of the neighborhood and not because of the successful
property management.
Although investors cannot include the increase in the equity in the cash
flow, it is still tangible. Sometimes, investors focus mainly and solely on the
income stream of the property and they disregard the appreciation value of
the property. In some cases, the property may produce a low monthly
income and it seems not worth the investment for novice investors. A
second look reveals, though, when the appreciation rate in the area
increases, this property will become much more valuable.
If the investor is looking for positive cash flow from the property, the best
move is to closely manage it through direct management or hiring a
property manager and supervising him closely. When the investor is
running the property for monthly or annual cash flow, he will judge any
expense against the costbenefit equation. In other words, the investor will
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refrain from making any payment unless it is clearly necessary to keep the
property running or if it will generate a profit in the future.
For small investors, the investment in cash-generating properties may be

difficult but it is still feasible in many cases. When it comes to large
investors, the situation is much more in their favor as management costs
decrease per unit because of the economies of the scale. This should not
prove discouraging for the small investors -- even the large investors
started small. All thats needed is a proper management and good
preparation before starting the investment. Indeed, perhaps this is the most
important question that the investor should ask himself before starting
such an investment: do I have the needed management skills to make this
venture a success?
How to Recognize Profit-Generating Investments
Some speculators and investors wont love the next fact: only a few of the
available two- and four-unit properties in this country can be considered as
profit-generating investments. Most of the units listed for sale now are just
covering their operating expenses and debt servicing costs. On top of this, a
large percentage of these units are located in unfavorable neighborhoods.
The good news is that the situation is much better with larger properties.
It is obvious that the rent rates did not increase proportionally with the
increase in the real estate expenses. Even so, there are still some good
investment opportunities available for those willing to exert some effort in
searching for them. The crucial point is to find those properties able to
generate a positive cash flow, after paying the debt services. It is the sole
responsibility of the investor to search and find these properties. In order to
locate them, the investor should be knowledgeable about the whole process
from start to finish.
Knowing how to find these properties is the main factor in this process.
After finding the property the investor should trust his experience and
conclusions about it and proceed with making an offer of purchase. Below
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are some of the tips and tricks to help the investor to detect good and bad
investment opportunities:
- The 1% rule: This is a simple rule used by many investors, they

calculate the monthly income of the property to be at least 1% of the
suggested sale price. New investors should know that this tool is not
the proper one to make a final decision about a property but is used to
primarily filter the large number of properties available in the market.
After that, the investor will concentrate more on getting the right
figures for the operating expenses and average sale price of similar
properties on the market.
- Focusing on the NOI: The net operating income is a more accurate

tool used only for the properties that passed through the previous
filter (1% rule). As stated above, after the investor obtains the correct
numbers for operating expenses, that leads to finding out the net
income of this property.
- Cap rate: Knowing the accurate NOI will lead the investor to the cap
rate. If looking for positive cash flow, then investors should stay away
from those properties with single digit cap rates. Ten percent is the
minimum cap rate for those looking for a positive cash flow. Lower
cap rates should only be considered if the investor is looking for value
appreciation.
Finding the Properties with Potential for Income Increase
Assuming that the investor knows how to find the properties with potential
positive cash flow, the real test is to actually find such properties. Because
of the technological improvement and the dynamic markets in the U.S., it is
now easier to find these properties. Here are some tips.
- Low rents: The undeniable fact in the real estate market is that
location is the main factor in real estate investment (location,
location, location!) In order to detect the properties with low rents,
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the investor needs to check the median rent in a specific area. The
trick here is to search by town and not by properties. In other words,
do not conduct your search for two-unit properties all over the city,
instead pick those asking low rents because they will probably be
situated in unfavorable areas. The best course is to search for two-
unit properties in specific neighborhoods and check these properties
that are asking for lower than the going median rent. These
properties may have the potential for a quick increase in cash flow.
- Below median price: The same advice goes for those who are
looking for a resale profit gain. It is important to start a search by
area and not by property type. Once the median price of a specific
property type in a specific area is detected, start looking for those
properties asking for a lower-than-median price which can more
easily generate a profit in a short period with some retouches and
quick fixes.
- Poor management: This can prove the difference between a good

and bad investment. If the investor has the needed skills and
experience to manage properties, she can do wonders with an
underperforming property. If this is the case, the investor should look
at properties in aspiring and promising areas that appear to be
unkempt or ill-managed. These properties can turn profitable with
the right management.
- Distress: Many sellers are willing to slash their asking prices

because they are in stress mode and need a quick sale. If the seller is
facing personal circumstances, bankruptcy, foreclosure or similar
situation he might be willing to accept a much lower price in
exchange for a fast close. The lower the purchase price for the
investor, the higher the cap rate can be. The only condition is that the
investor should be ready to close the sale right away.
- Aggressive advertising: If an owner is doing his own selling, that

will put the investor in an advantageous position. Savvy investors can
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use flyers or classified ads with phrases like Investor looking for a
property in order to attract distressed sellers. Responding to such
ads means that the seller is very serious about co-operating to finish
the sale. Spread the word that you are looking for deals and be ready
to close the sale immediately, this will help finding properties with
lower than median prices.
- Spreadsheet listings: Use the power of the computer to get much

of the work done. The Multiple Listing Services (MLS) are now
allowing the download of properties and their data. Putting such data
in a spreadsheet and programming the computer to calculate the NOI
and the cap rate will help filter out many properties and let the
investor concentrate only on the potential opportunities.
- Value appreciation: Some investors are not looking primarily for

steady income from a property; this can be because of many reasons.
The first is that they know that they do not have the needed time or
the required experience for the proper management of the property in
order to get the desired regular income. Another reason is that some
investors are not prepared to spend more money on carrying costs of
and are only looking for a resale with higher value. The third reason is
that some investors are bidding on the increase of the appreciation
rates in a specific area because of potential developments or increases
in population. No matter what the reason, the real estate market in
this country consistently shows prices on a steady increase over time,
even if this is interspersed with periods of decrease. These troughs
rarely last long before the curve flips upward again.
Shrewd investors do not sit and wait for the appreciation value of
their property to increase just due to the market but will take the
needed steps to move it up themselves. Some investors will take a
large parcel and divide it into smaller plots. Some will take this a step
further and start developing the land.
Subdivision: Everyone knows that half plus half equal one. This
may be the case in mathematics but not in real estate. Most of the
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case studies claim that dividing or subdividing a piece of land may
generate profits more than selling it as a whole lot.
The basic theory of subdivision is that the investor will purchase a

large parcel of land and cut it down to several smaller parcels, aimed
at selling these pieces for a sum higher than the acquisition price and
the carrying costs.
This theory or principal has been at work in the market for a long
time, happening whenever cities and towns begin to expand. It will
continue happening in the future, of course, because of the increase in
population. Investors ca acquire a large piece of raw land, plot it into
several smaller pieces and aim at selling it to people willing to build
homes on it. Usually, this process involves the following steps:
Survey: The property survey is a graphical survey. Its aim is to find

out the boundaries of each parcel of property after dividing the raw
land. The goal of this step is to know the final number of pieces of
land after subdivision, its square footage and its boundaries.
Easements: This is another factor to be considered when dividing a

piece of land into smaller pieces. Each subdivided plot should have
access to a road and should not be landlocked. The plot should
include roads, sidewalks, and easements for utilities and other access
requirements for each division of land.
Legalization of the subdivision: In order to proceed legally with

selling these subdivisions, the plot should be approved, legalized, and
recorded by the local authorities. Subdivision is usually restricted
and heavily controlled in order not to result in uncontrolled and
unplanned growth of cities and communities. Each municipality will
require a minimum requirement for the utilities of the new plot, as
well as areas dedicated for special uses, before approving the new
plot.
Usually, the developer willing to divide a piece of land will undertake

the process of building roads, sidewalks and utilities infrastructure,
while the owner of each parcel will be responsible for developing his
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own piece of land and improving it. In some cases, especially in large
rural areas, the landlord will only be responsible for building a dirt
road that connects the entrances of the subdivided land pieces.
Another example of subdivisions is what happens in the urban areas.

The developers tend to separate a condominium project into
individually-owned units. This will help the developer avoid the heavy
restrictions of subdividing a piece of land and tends only to subdivide
the internal space area of the project.
Subdivision is a highly profitable investment if the investor is able to

do it in the right way.
Development
The big profits in the real estate investment are always associated with
development -- and big losses, too. The simple definition of development is
the creation or evolvement of an already-existing real estate project in order
to achieve a bigger market value. The development may include the
subdivision or focus more on developing the property and building on it.
Some developmental investments aim at developing a project and selling it

immediately after completion, or it may aim at long-term investment of
developing a project and keeping it for regular profit generation.
Currently, there are different types of developers in the market:
Converters: This type of developer avoids the huge from-scratch

projects and will focus more on changing the shape or use of the
property. For example, the converter developer will be interested in
rehabilitation of an old factory and changing it into an office building,
or modifying apartment building into condominiums.
Hired developers: Sometimes, the developers do not own the land

they are developing but are hired by the landlord to develop, market
and manage the property. In such cases, the developer is not risking
his own money but he is managing the resources of the land owner.
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Land developers: This type of developers will focus more on
developing the land rather than developing the buildings on the land.
They will focus on building roads, implementing infrastructure and
utilities, and other related work. In most cases, these developers will
go through the subdivision of the land before developing it. After
preparing the lands, they will be sold to individual buyers. The
individual buyers will be responsible for the development for their
own piece of land.
Merchant builders: These developers are trying to minimize their

risks through developing the project only when they have a
committed buyer for the resale after the completion of development.
For example, the builder will start customizing and developing a set
of land parcels only when the buyer makes a firm commitment
through getting the purchase loan approval.
Renovators: This is another example of the diversity of converter

developers. Renovators will seek to renovate or rehab, improve and
modify a property in order to maximize its use and its revenue. The
prevalent kind of renovators are those who seek out cheap properties,
renovate them and aim at selling them for a good profit.
Speculative developers: These are the developers willing to take

the risk of developing a project without any commitment from a
buyer, on the chance of maximizing their profit. These developers
usually speculate that the area is undergoing a boom and that
appreciation value will drastically rise.
In order to avoid tremendous losses, novice investors and developers

should avoid major projects unless they have the needed experience to
navigate the tricky areas of such businesses.
PURCHASE OPTIONS
The option tactic or tool is an uncommonly-used method that can be very
helpful to secure a good profit for beginner investors. The option to
purchase is a commitment to buy for a fixed period of time at a fixed price.
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If the price goes up then the buyer will be able to make a profit from the
difference between the two prices.
Maintaining the price for a period of time is the main benefit for novice
investors because it minimizes the risk of losing money if prices go down.
Example:
Marley found a property that she thinks is underestimated. The seller is

willing to sell but he is not getting any takers for his asking price. Marley
decides to offer the seller $5000 for an option to buy the property for
$100,000 while fixing the price for the next three years. If Marley wants to
buy the property now, she will get 80% LTV loan ($80,000). Or, if after a
year or two the property is appraised for $140,000, Marley can get a loan
for 80% ($112,000). Then, she can obtain the property without paying
anything, leaving some cash for the rehab.
Master Lease
This is a smart way to obtain a profit without actually buying the property.
The investor leases the property for a while and uses it to generate profit for
a fixed period of time.
Example:
Eddie leases an office building from Bill for a monthly payment of $2000.
Eddie will sublease the offices individually with a gross monthly income of
$4500. Although the title is still under Bills name, Eddie has full control
over the building and has the right to market and lease all its offices.
The master lease should be legally recorded, and it should be clear that
Eddie cannot able to sell the property although he has full control over it.
The master lease may come with an option to buy the property in the
future.
Tax Shelters
Clearly, real estate investments do not offer the number of tax shelters for
institutional investors like they did before. Before the1980s, the tax code
allowed institutional investors to offset some of their tax liability through
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the paper losses of some real estate properties they have in possession. The
changes that occurred in the tax law after that time stopped these
institutional investors from receiving these benefits. On the other hand,
there are some tax benefits that are still available for the real estate
investors, such as:
- Operating losses
- Capital gains
- Depreciation
Operating Losses
Running, managing or operating a real estate property is considered

practically and legally running a business. Due to this, the real estate
investment that finishes a year with a profit gets taxed while those with no
profit are not; additionally, investors may use their losses to offset some
profits in other investments.
Current tax laws now differentiate between passive and active profits, as
well as between passive and active losses. Losses generated from a passive
investment can be used by the investor to deduct some tax gains from other
passive investments, only. They cannot be used to offset taxes incurred on
primary active investments.
This does not work for the betterment for new investors, since most of their
investments produce active gains and losses. So, these investors can use the
declared losses of one investment to deduct some taxes on other profitable
investments of theirs.
Capital Gains
When any investor or businessman tends to sell an investment property,

such as bonds, stocks, or real estate, they have to pay capital gains taxes on
the profit they achieved from the sale. However, there are some ways that
investors can decrease or overcome these capital gain taxes.
Any investor who plans to work mainly with real estate investments should
know exactly how the capital gains taxes can affect their business. As a
golden rule about all investments goes: it is not about how much you make
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from your business, it is all about how much you can (legally) keep what
you make.
Generally, landlords only pay capital gain taxes for the sales related to the
investment properties, not on properties considered their primary
residence. If the property sold is considered a primary residence -- the
owner has lived in this property for at least two out of the last five years --
then the sale value is exempted from the capital gain. The exemption for
solely-owned properties is $250,000. If the property has joint owners then
the exemption level mounts to $500,000 on their primary residence. Due
to the last changes to the tax code, all homeowners are qualified for this
deferred tax once every two years.
Depreciation
Any experienced investor in the field of real estate should know that the
depreciation deduction is considered one of the most important tax
deductions of all. If the investor is able to well understand the depreciation
concept, then he can turn a property achieving small profit into a property
that is breaking even. In addition to this, even if the property is
appreciating in its value, the owner can make it appear to be losing money
through the process of depreciation.
It is important to know that depreciation does not stop the appreciation.

The incredible fact is that even though the investor is claiming depreciation
deductions every year, the property is still appreciating over the same
period.
The only drawback for making depreciation deductions is that the seller will
have to add these deductions to the base price adjustment which will
increase the capital gain, but that effect is diminished because of these
factors:
Value of money over time: The value of money for the type of
depreciation deduction is completely different from the value of the
paper money that should be added back to the cost basis later.
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Depreciation tax rate vs capital gains tax: Consider that
currently, capital gains taxes are calculated at 20% of the capital gain,
while the depreciation tax is calculated at 28%. So, in the worst case
scenario, the investor is still ahead with an 8% difference.
Deferring capital gains: By selling the property through a trade or

exchange sale, the investor can defer the capital gains tax in the
future.
One of the best ways to turn a good profit from depreciation deductions is
that the investor can take the profits resulting from the depreciation
deductions and invest them back in high-yield certificates of deposit. When
the property is sold, the capital gains tax incurred will be covered through
the revenue of the CDs, which will neutralize the effect of the capital gain
taxes on the investors income.
Tax-Deferred Exchanges
As discussed above, capital gains taxes are only incurred when the investor
sells a property for a profit. It should be noted that the capital gains taxes
will be applied to a significant part of the profit. However, some investors
try to evade these capital gains taxes completely through selling their real
estate properties through trade transactions. The tax authorities will only
apply the capital gains tax only on the sold properties against cash.
Through the tax code, an investors can defer capital gains taxes by selling
their properties through trade transactions with likekind properties,
instead of selling them. The authorities treat the term likekind rather
loosely so almost any property type can be exchanged for another property
type and treated as likekind, the only condition being that both properties
are considered real estate investments.
The seller/exchanger should identify the target property within 45 days of

selling the currently-held property. The seller can target up to three real
estate property with no limitation on their values. In addition to this, the
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seller or exchanger should hold the title of the target property within 180
days of selling the original property.
CHAPTER SUMMARY
Real estate investment is one of the most sought after types of
investment; there are several reasons for this:
- Investment in real estate can generate strong revenue and be an
effective method to build wealth in a reasonable time period.
- There are many ways and tactics to invest in the real estate
business, which can suit different types of investors regardless
of their credit history, assets, and income.
- Novice investors who lose money in the real estate business
may not be victims of lack of experience but usually victims of
lack of knowledge.
Depreciation is the deduction allowed from the property value due to

the time spent from its depreciable life. The depreciable life of
residential property is 27 years; 39 years for commercial buildings.
Land value is not included when calculating depreciation.
Depreciation is calculated through deducting the price of land from

the gross value of the property. The remaining value is divided by the
depreciable life of the property in order to calculate the annual
depreciation of the property.
Stages of the investment process

- Preparation and planning
- Identifying the resources
- Finding the property
- Negotiating the contract
- Closing and acquisition of the property
Goals of investment
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- Identify the goals
- Preparation of the investment
- Secure the funds
- Realize a solid plan
- Start the business
- Prioritize and make preferences
Documents needed for business preparation

- Tax statements for the last three years
- W-2 documents for the last three years
- Last two bank statements and asset statements
- Copies of drivers license and Social Security number
- Explanation for credit problems, if any
- Supporting documents for any credit problems
Real estate investments necessitate an understanding of the common

terms and concepts involved in this field:
- Operating expenses
- Carrying costs
- Net operating income
- Debt service ratio
- Return on investment
- Developments market cycle.
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CHAPTER QUIZ
1. All the following are examples of the return on investment in the real
estate business, except:
a) Cash flow
b) Return on taxes
c) Depreciation
d) Appreciation
2. Depreciation deductions for tax purposes are based on:

a) The pre-calculated useful lifespan of a property
b) The actual life of the property
c) The future market rent rate
d) The future contract rent of property
3. All the following properties face capital gain taxes, except:

a) Apartment buildings
b) Personal residences, with some exceptions
c) Land
d) Commercial buildings
4. Operating expenses include:

a) Debt service
b) Capital improvements
c) Equipment and fixtures
d) Taxes
5. What is excluded from depreciation?

a) Land
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b) Fixtures
c) Improvements
d) Equipment
6. The gross income of a property is calculated by:

a) The total income minus the vacancy or rental expenses
b) Annual income less the expenses
c) The net income without the debt service
d) Net income after deducting improvements
7. Net operating income is calculated by:

a) Subtracting the debt service from the gross annual income
b) Subtracting the operating expenses and debt service from the
annual gross income
c) Subtracting the operating expenses from the annual gross income
d) Subtracting the vacancy loss from the annual gross income
8. Which of the following is used to improve cash flow?

a) Increase expenses
b) Decrease expenses
c) Refinancing the property with higher interest rate
d) Get a partner
9. Condominium conversions definition is:

a) Subdivide a propertys internal space
b) Subdivide a propertys total space
c) Subdivide a propertys tax base
d) Subdivide a propertys common area
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10. When investors sell a property, they have to pay:
a) Installment taxes
b) Capital gain taxes
c) Real property taxes
d) Deferred taxes
11. When calculating the depreciation rate for a residential property, the
price is divided by:
a) 50 years
b) The same period of the loan
c) 27 years
d) 39 years
12. When calculating depreciation, the value of the land is:

a) Included completely in the formula
b) Excluded completely
c) Multiplied by a factor of appreciation
13. A commonly-applied investment strategy holds that a propertys

monthly income should be at least _______ of the suggested sale
price.
a) 1%
b) 5%
c) 10%
d) 50%
14. An investor can defer capital gains taxes by selling a property through
a(n):
a) Trade
b) Exchange sale
c) Either A & B
d) Neither A or B
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15. Delivering the keys of the property is evidence of the acquisition,
usually taking place at:
a) The title company
b) The accountants office
c) The property
d) The tax office
Answer Key:
1. C 6. A 11. C
2. A 7. C 12. B
3. B 8. B 13. A
4. D 9. A 14. C
5. A 10. B 15. A
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CHAPTER TEN
SHOPPING FOR A LENDER
INTRODUCTION
Imagine being a first-time property buyer who finds the property they are
looking for, and then discovering that was just the easy part of the process;
they still have to undergo the rigorous process of obtaining the needed
financing for purchasing this property. It is not uncommon that lenders will
daze borrowers with many confusing terms and expressions like FICO
score, debt-to-income ratio, loan-to-value ratio, disclosure statement, and
fair-lending notices.
Additionally, the lender still must struggle with the costs to be covered
during the loan approval process, including -- but not limited to -- escrow
fees, loan points, flood policy, and tax stamps. This is the reason why many
borrowers feel stress during the process of loan approval.
The role of the mortgage loan officer is to help the borrower to complete her
loan application, and explain to the borrower what the documents are
needed to support this application. These documents may include credit
card information, employment letters, tax statements, or bank account
statements. Many applicants are likely to be first-timers, so they need more
time and effort from the loan officer to explain and clear the terms and the
procedures involved with the loan approval. Good brokers seeking long-
term client relationships will exert more effort and be more patient, helpful
and respectful toward these novice loan applicants.
Completing a loan application is the starting point of the loan approval

process or loan initiation. At any given time, there are a specific number of
potential borrowers waiting for approval, depending on the economic status
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of the market, the cost and the availability of the funds, the ratio between
the potential borrowers and the differing available lenders.
It is crucial to build a trustful relationship between the potential borrower

and the lender; this is the main reason that lenders will offer to meet with
the potential borrower, the customer, at his own convenience. Often, the
loan officer will try to meet the borrower for the first time at the borrowers
own residence. This will make the borrower more relaxed and comfortable
with the loan process and negotiations. The borrower probably thinks that
his transaction is the most important thing happening for him, and even
if not the case -- also believes that his transaction is a main issue for the
loan officer and the lender as well. The experienced loan officer will show
extra care in an effort to demonstrate that he will provide his new client
with the attention they are looking for.
Because of the tremendous strides in business communication, the client is

now able to make a loan application through the phone. The lender can pull
the credit score and the income of the applicant instantly and gives a
preliminary approval within minutes. After the preliminary approval, the
borrower will receive a hard copy of the paperwork and the disclosures
associated with the loan, as well as the verifications and other documents
required for the loan process. All these copies will be sent back through fax
or email for the convenience of the customer.
CHOOSING A LENDER
A borrower can choose a specific lender because of many reasons. From the
lenders perspective, there are some individual requirements that the
borrower must fulfill. On the other hand, each lender should have some
basic attributes of their own in order to attract customers or borrowers.
The channel that attracts the majority of customers to a given lender is

through referral by a real estate agent. In most cases, the real property
buyer does not have a direct relationship with a mortgage officer when they
start looking for a new property. The successful real estate sales agent will
maintain strong connections with several loan officers who are available,
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reliable, trustworthy, and offer a selection of different loan types through
various lenders to suit most buyers requirements.
The simple definition of a good loan officer one who is able to build a
professional, yet friendly relationship with buyers. In most cases, the
customer will rely on the real estate agent and the associated loan officer
who works with the agent in order to close the transaction and obtain the
needed fund for it. A successful partnership between a good real estate
agent and an informed loan officer will return a great benefit for the buyer,
the real estate agent himself and the broker, as well.
No doubt, every buyer is interested in saving some money on the purchase

of the property in question. The buyers tend to attempt to do this by
choosing a real estate agent who offers a lower commission rate or they will
seek to save on loan costs. There are several ways borrowers can try to
spend less money on procuring a loan. The first and easiest way is to shop
around for a loan with fewer fees or less loan points. Borrowers will look for
the best interest rate. This is the main reason that lenders who are offering
lower interest rates will attract more buyers and borrowers.
Performances That Match Promises
Lenders reputations are founded on how well they uphold the promises
claimed in their advertisements. This is a key point, as important as the
interest rate. The reputation of a lender is founded on delivering the
advertised interest rate when the borrower is shopping around for the best
loan offer. Of course, there are other points that affect the selection of the
lender, mostly negative ones: the dubious and vague practices of some
lenders, the lack of mortgage agents and lack of resources. These negatives
can lead borrowers into choosing the well-known lenders even though they
may be more expensive.
Choosing a lender is a critical decision; borrowers want to feel welcomed

and that the mortgage agent is on their side. If a mortgage officer wishes to
build a network of long-term clients and benefit from a solid base of
referrals, then he should smile, be cheerful, helpful and welcoming to his
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customers. On the other hand, the loan officer who demonstrates little
interest in putting his clients at ease or getting to know them is likely to
have a shrinking group of customers and soon be out of business.
One of the important reasons that a borrower will select a certain lender is
that he has enjoyed a positive experience with the same lending institution
previously. That experience may include the clients satisfaction with the
loan product itself, or with the personnel that worked with him.
The large lending institutions in the market allocate huge budgets for
advertisement in order to attract more borrowers. Business names like
Wells Fargo, Bank of America, Citibank and Chase sound familiar, the
reason being, of course, is that they are so well advertised on television,
radio, billboards, online, direct mailing pieces and brochures. A
considerable number of borrowers prefer these well-known lenders simply
because of their cant-be-missed presence on all the communication venues
in daily life coupled with the institutions long-time duration in the
marketplace.
Loan Products
Because of the nature of the loan market today, lenders find themselves
obliged to offer a variety of loan types or what is called loan products.
Three decades earlier, when asking for a loan, the lender could provide a
standard 30-year fixed rate loan and not much else. If the borrower could
not fulfill the requirements then there was no loan. As a result, though, of
market needs and changing law in the 1980s, the banks started offering
new types of different loans. To be a key player, a lender must be able to
offer a variety of lending solutions for funding a loan.
Easing the application submission process is another decisive factor for

many borrowers. The lender who is able to offer its customers the option of
meeting at their own residence or at their place of business, or even to
submit the application over the phone will possess a big advantage over
other lenders in the business.
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HOW LOANS ARE ORIGINATED
Usually the lenders will offer the mortgage loans directly to their
customers, with the lender taking care of the process of application
submission and loan processing. This is called a retail loan operation.
Alternatively, a middleman will be involved in the process a loan broker
who will work for a fee to match the borrower with an appropriate lender
who, in turn, will issue the loan on a wholesale basis without ever having
direct contact with the borrower.
RETAIL LOAN ORIGINATION

Commonly, when a borrower starts looking for a loan, he will start the
search at his own bank or a bank near his home or workplace. Most
probably, these bank locations will deal with borrowers directly, without a
loan broker, and will carry out all the loan processing inside the bank. This
is called retail loan origination and is usually adopted by the smaller banks
and small-scale lenders. On the other hand, the larger lending facilities will
use different methods to offer their loan products.
Another prominent type of mortgage lenders are those facilities that issue
loans and tend to keep them until the loan maturity, instead of selling them
on the secondary market after a period of time. Such lenders need to have
the necessary assets and funds in order to keep these loans for such long
periods. These lenders tend to filter their borrowers and only choose those
with a flawless financial history and impeccable credit scores in order to
avoid loan defaults and minimize risk. Usually this type of retail will seek
qualified borrowers through analyzing the information found through the
credit report agencies like Equifax, Experian, and Trans Union. The chosen
customers will be pre-approved before being contacted for the loan offered,
because they have been already selected according to the lenders criteria.
As noted above, most borrowers will not search for their own mortgage
lenders but rely on their real estate agents for recommendations. The real
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estate agent is considered the main source of information when it comes to
connecting the borrower and the lender. The main reason for this is that the
real estate agent builds a trustworthy relationship with the buyer before he
starts to shop around for the loan. Lenders will target real estate agents
when they are launching a new product since the agents are best able to
convey the benefits of these products to potential borrowers, and lead these
borrowers to the most suitable lender.
However, as discussed, lenders will close deals with potential borrowers

and increase their market share only by being helpful, courteous,
knowledgeable, efficient, and above all, capable of implementing
competitive loan programs and funding solutions suited to the client. In
other words, being connected to busy and prominent brokers might secure
a good flow of potential borrowers, but turning them into customers is a
direct result of the service level offered by the lender itself. In addition, if
the lender successfully converts a reasonable percentage of prospective
borrowers referred by the real estate broker into clients, this will encourage
the broker to continue making these referrals as a means to smoother
transactions and faster commission for the broker.
Any retail mortgage lender will employ loan officers and loan
representatives. The loan officers remain at the lenders establishment to
process the loans and market loan solutions for the customers, while the
loan reps go out to build active relationships with local real estate brokers
and efficiently attract a flow of potential borrowers.
Any given loan originator who works in the retail loan field is usually paid a
commission of 1% of the total loan amount; this amount only being payable
when the loan is funded. It is called the loan origination fee. This is the
case if the loan originator is dealing with the lender on a per-loan basis. In
other cases, the loan originator will deal with the lender on a quota basis,
where the lender pays a smaller percentage per loan until a certain quota is
reached and the commission goes up. On the other hand, some lenders will
employ the loan originator to generate as many customers as possible and
pay a fixed salary on monthly basis.
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BORROWER S EXPECTATIONS
The potential borrower should expect to work with the retail lender to
complete the following during the process of loan origination:
Fill and complete the application with the lender

Request all the verifications, employment certificates, proof of
income, and deposit verifications
Order a professional appraisal for the property in question
Order the credit report of the potential borrower
Prepare the loan for underwriting
Underwrite the loan application
Issue the approval or rejection of the loan application
Close and find the loan application after its approval or sell it to
another lender.
WHOLESALE LOAN ORIGINATION

Since the 1980s, the mortgage business has changed a great deal. More
options is the main difference; the single, one-size-fits-all solution of a 30-
year fixed-rate loans gave way to an array of more flexible mortgage
products. Although the mortgage business was considered a highly
conservative business that resisted alteration, these changes took place in a
relatively short time. In spite of these new loan solutions, though, the basics
of the mortgage lending industry remains constant. The changes occurred
only in some areas that contributed to giving the mortgage lending a new
look.
The factors of change in the mortgage business
One of the major differences in the mortgage market is the instability

and ever-shifting interest rates. In 1978 it reached 9%, jumped to 18%
in 1982, then went below 7% in 1993; reached a little over 8% at the
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end of the 1990s; and by the beginning of the new century fell to
unprecedentedly low rates.
The origination fees of loans change drastically from one year to

another, leading to a somewhat unstable outlook for the lenders. Even
experts cannot predict the future of the business as a result of these
fast-moving indicators.
Because of the unpredictable cycle of loan originations in some parts

of the country, mortgage lenders are not able to commit to long-term
plans about where and when they will need the mortgage funds.
The increasing competition between the traditional and non

traditional lenders forced both to implement new ideas and to react
with the market in a more dynamic way; this resulted in more
benefits and new products for consumers.
With the implementation of new technology and computers in the

mortgage lending process, the business became less expensive and
more sophisticated, providing mortgage lenders with the ability to
qualify potential borrowers within minutes rather than days.
Loan servicing became an independent sub-industry of the loan

mortgaging business. With the exponential growth in the amount of
mortgage money available, servicing these loans has become a very
profitable business for many corporations. The servicing business
includes payment collection, keeping records of due dates, payoffs or
any particular incident of an individual loan.
These factors have impelled the mortgage business to mutate into a giant
industry that is more dynamic and responsive to its customers - much
more so than two decades earlier. Because of growing demand from
borrowers, wholesale loan processing changed into a more efficient process,
with more variety and flexible loan solutions. One of the major
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characteristics of wholesale loans is the emergence of the third-party
origination or what is better known as TPO where the mortgage brokers,
and mortgage correspondents will originate the loan and then sell it to the
wholesale lending institution.
Mortgage Loan Professionals

The simple definition of the wholesale mortgage lending is that a loan
professional will originate and process a loan then, after it has been
processed, sell it to another lender. The main reason behind the emergence
of this business is that it is easier and less expensive for the lender to buy
the processed loan instead of originating and processing it inside the
institution. The loan professional will undertake the whole process of
origination, underwriting, processing and funding the loan, then will sell it
to another, larger wholesale lender.
The mortgage professional acting as the originating lender can be a

mortgage broker or a mortgage correspondent. The main difference is that
a loan broker will only originate the loan and will sell it directly to the
wholesale lending institution, while the loan correspondent will continue
with the processing and fund the loan, then proceed to sell it to the
wholesale lender. In most cases, the loan broker will fill out the application
with the borrower, and order the needed verifications like the employment
evidence, bank statements and any other required documents before
handing it over to the wholesale lender. The rest of the underwriting and
the funding steps of the loan will be completed after the wholesale lending
institution acquires the loan.
Because of the fact that the loan correspondent is funding the loan before
selling it to a wholesale lender, he will be eager to have the underwriting
decision on the lender made as soon as possible. If the loan was declined for
some reason, the loan correspondent will return to the borrower for further
negotiation about the issues with the application.
Every loan professional has her own role in this complicated market. If the
loan professional chooses to be the originator part of the process then sells
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the loan immediately afterward, then she is willing to take a smaller share
of the profit in exchange for not bearing any risk regarding the loan itself.
When it comes to the loan correspondent, the situation is a little different;
the correspondent will communicate with the wholesale lender in synch
with his communication with the borrower in order to obtain an interest
rate commitment for the loan before proceeding with the funding.
The profit of the loan originator comes from the loan application fees that
are paid by the prospective applicant, in addition to another 1% of the loan
amount. This rate is either paid to the loan originator by the wholesale
lender or by the customer, according to the terms and the conditions of the
loan.
After the loan is transferred to the portfolio of the wholesale lender, the
loan originator has nothing more to do with the loan; the only one with
further responsibility for administering the loan is the wholesale lender. No
matter if the wholesale lender acquires the loan before or after funding, the
result is still the same. The wholesale lender will decide later if he will keep
the loan in his portfolio until maturity or, he will resell it on the secondary
mortgage market.
WHOLESALE LENDING AS A SOLUTION
Of course, there are pros and cons for wholesale lending. From the
wholesalers perspective, the biggest advantage of wholesale lending is that
there mortgage broker is the one originating large numbers of loans
through his office, which can then be acquired by the wholesale lender. The
expenses of originating these loans through the mortgage broker are much
less than originating them by the wholesale lender would be. In fact, there
is no need for the wholesale lender to employ and manage a large personnel
staff to conduct the originations, and the lender can simply acquire the
ready-made loan from the mortgage broker with greater profit.
Another benefit for the wholesale lender is great flexibility. For example, if
the loan market is weak in one city but strong in another, then the
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wholesale lender can choose to work with a mortgage broker located in the
city with the more robust loan demand without having to relocate
employees or opening a new branch there. It is easy for the wholesale
lender to refrain from buying more loans from declining neighborhoods
and begin accepting loan applications from more profitable locations.
The servicing income is the larger portion of the cake that the wholesale
lender is looking for. Once the wholesale lender acquires a loan from the
mortgage broker, it will try to sell it in the secondary mortgage market
while still keeping the servicing rights. This means that the greater the
number of loans, the greater the amount of profit from the servicing
income.
Loan quality is directly related to the quality of the originator broker. This
means that if a loan broker is doing poorly with loan verifications and other
issues, then the wholesale lender can expect similar problems in the future
with loans originating from this source. Wholesale lenders will not want to
enter a vicious circle like that so they tend to deal just with those
originators with a good view of the local market, well-established and
proficient at loan processing.
Along those lines, the mortgage broker should take extra care while
originating the loan, double check the documents and verify all the
information included.
CHAPTER SUMMARY
Loan customers are now able to make applications over the phone
and by computer. The lender can pull the credit score and the income
of the applicant instantly and provide a preliminary approval within
minutes.
The channel that attracts the majority of customers of any given

lender is through referrals by the real estate agent.
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Because of the nature of the loan market today, lenders are obliged to
offer a variety of loan types or what is called loan products.
Usually, lenders will offer the mortgage loans directly to their

customers, with the lender taking care of the process of application
submission and loan processing. This method is called the retail loan
operation.
Any given loan originator who works in the retail loan field is usually
paid a commission of 1% of the total loan amount; this amount is only
payable when the loan is funded. This is called the origination fee of
the loan.
One of the major characteristics of wholesale loans is the emergence

of the third-party origination, known as TPO, by which mortgage
brokers, and mortgage correspondents will originate the loan and
then sell it to the acquiring wholesale lending institution.
Loan quality is directly proportional with the quality of the originator

broker.
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CHAPTER QUIZ
1. The retail loan origination is the approach used by ______ to

originate mortgage loans:
a) Small banks
b) Large lending institutions
c) Fannie Mae
d) Ginnie Mae
2. The wholesale loan origination is the approach used by ______ to

originate mortgage loans:
a) Small banks
b) Large lending institutions
c) Fannie Mae
d) Ginnie Mae
3. The originating party of the mortgage loan is paid a fee, ______ of

the loan amount; this amount is only payable after funding the loan.
a) 8%
b) 5%
c) 3%
d) 1%
4. Which of the following is considered one of the major factors of

change of the lending mortgage market in the 1980s?
a) The quick turnover in bank staff
b) Election results
c) Stability of interest rates
d) The instability of interest rates
5. The unexpected changes in the economic market conditions in some

areas of the U.S. prevented mortgage lenders from:
a) Working on definite hours
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b) Charging loan points to originate loans
c) Making long-term plans and estimates
d) Raising interest rates
6. Who is considered a third-party originator in case of wholesale

lending processes?
a) Applicant
b) Mortgage correspondent
c) Fannie Mae
d) HUD
7. Which is considered a secondary mortgage market for mortgage

loans?
a) Loan applicants
b) Mortgage correspondents
c) Fannie Mae
d) HUD
8. When a lending institution acquires a loan originated by another loan

professional, this process is called the:
a) Retail mortgage lending process
b) Consumer mortgage lending process
c) Wholesale mortgage lending process
d) Passthrough mortgage lending process
9. When a lending institution deals directly with their customers,

originates and funds its own loans, this process is called the:
a) Retail mortgage lending process
b) Consumer mortgage lending process
c) Wholesale mortgage lending process
d) Passthrough mortgage lending process
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10. What will happen to a mortgage loan acquired by a wholesale
lending institution from a mortgage professional originator, either
before or after the funding of the loan?
a) The loan will be kept in the wholesale lenders portfolio or sold on

the secondary market
b) There is a probation period of 6 months before the wholesale
lender can sell it on the secondary market.
c) It is processed by the wholesale lender
d) It is conveyed by the wholesale lender
11. Wholesale lenders derive their greatest profit from:
a) Origination fees
b) Loan points
c) Servicing fees
d) Interest rates
12. How does the originator broker get paid his commission for finishing
a loan application?
a) Through an application fee and percentage of the loan

b) By the mortgage loan servicer
c) By the lender
d) On installments associated with the monthly payments
13. What is considered one of the biggest advantages for the wholesale
lender?
a) Building a close relationship with the borrower

b) The availability of large number of loans able to be acquired
c) Being only able to concentrate in a market section
d) Being able to approve new loans
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14. Which of the following is considered a negative factor affecting the
wholesale lender:
a) Too many loans sold to wholesale lending institutions

b) Flexibility in the marketplace
c) Servicing loans does not generate income
d) Quality of new loans
15. Increases in competition between lenders leads to:
a) Appearance of new products

b) Appearance of new lending institutions
c) Disappearance of mortgage brokers
d) Disappearance of service fees
Answer Key:
1. A 6. B 11. C
2. B 7. C 12. A
3. D 8. C 13. B
4. D 9. A 14. D
5. C 10. A 15. A
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CHAPTER ELEVEN
APPRAISAL
INTRODUCTION
It goes without saying that the most common question in the real estate
market is How much do you think my property is worth? On a daily basis,
any real estate agent will meet a client interested in finding the right price
to sell or rent out their property. The real estate agent should be prepared
with the needed knowledge to answer this question after inspecting the
property.
In fact, not only are the buyer or the seller of a property interested in
knowing its fair value. The mortgage lender also wants to know the value of
a property before approving a loan or applying the loan-to-value ratio and
becoming involved in the risks of marketing this property in case of default.
The information regarding the price of the property is as important to the
mortgage lender as the information about the capability of the buyer to pay
the loan installments. The next two chapters will discuss in details the
subject of processing, underwriting and closing the loan.
One important aspect of loan processing is obtaining the needed

information from a professional appraiser about the value of the property
to be used as collateral for the loan involved. This appraisal can be carried
out by an appraiser working solely for the mortgage lender or a private-fee
appraiser working under contract for several mortgage lenders.
The role of the appraiser and the methods followed to answer the question
regarding property value is essential to the loan process.
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DEFINITION OF APPRAISAL
The simple and straightforward definition of appraisal is the fair estimate

or opinion about the value of a property on a given date. The word value
itself has another definition which is the present worth of rights to future
benefits that come from property acquisition. The opinion of the appraiser
is expressed in a written form called the appraisal report. This appraisal
report will include the conclusions reached by the appraiser after analyzing
and researching all the relevant data and information about the subject
property.
In most cases, in addition to the buyers and sellers perspective, a third

opinion is indispensable in determining the real and fair value of a given
property. Because of his experience, ethics and training, the professional
appraiser is best prepared to provide an unbiased opinion about the
property to his clients after researching the property in detail. In such
situations, the appraiser has a serious responsibility toward his clients to
offer a fair and unbiased value of the property, without allowing any other
external factors to interfere with his work in any way. The appraiser should
always stay neutral toward the parties, taking into account only the factors
affecting the value of the property, and discounting any other influences on
the fairness of his judgment.
What are the main reasons for choosing to rely on an appraisal to

determine the value of a property?
In fact, there are several reasons that impel people to use the professional
services of an appraiser to determine the value of a property, such as:
1. The transfer of ownership of the property

2. Financing, loan approval, and credit issues
3. Taxation and tax assessments
4. Condemnation
5. Insurance
The estimate of value for the same property can differ according to the
reason for the appraisal. This means that an appraisal of a property for
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insurance purposes can come out with a different value than if the
appraising is for condemnation, and appraising for market value is also
different from appraising for taxation. A professional appraiser will know
the difference between these different types of appraising and be prepared
to calculate the correct value of the property according to the needed
appraisal purpose requested.
FAIR MARKET VALUE
In real estate, the value of land includes its price and anything that gets else
involved with it, including development, the rights, or the interests. The
price a property can bring on the open market, based on what a
knowledgeable, willing, and unpressured buyer would probably pay to a
knowledgeable, willing, and unpressured seller, is known as the fair market
value of the property.
When the property is offered for sale in the case of circumstances like
default, foreclosure, bankruptcy, divorce, death, it is not considered to be
freely and openly offered on the market; consequently the sale price of such
property is not considered a fair market price. In such situations, the
professional appraiser will not use the sale price of these properties as valid
comparables in the process of determining the fair market price of another
similar property because of the unusual circumstances involved with the
sale. On the other hand, the following cases can be considered as a fair
market sale.
1. The seller and the buyer are pursuing their own interests.
2. The property is listed on the open market for a reasonable period of

time.
3. The transaction is closed for cash, trade or financed specifically.
4. The buyer used the normal type of financing for a qualified borrower.
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DEFINING THE PRICE, COST, AND VALUE
The main difference between the market price and the market value is that
the market price is the actual price that the property has sold for, while
market value is the price that the property should have sold for.
In some cases, the price, or cost, as well as the value are all the same but
not all sales are like this. The specific circumstances of the buyer or the
seller can differ from one transaction to another and that gives each sale its
own value even if two properties are in the same parcel. It is the job of the
professional appraiser to determine the special factors affecting the sale
and estimate the value of the property according to these factors.
1. Price is the amount of money, or its equivalent, paid to purchase

something.
2. Cost is the summation of all expenses, including labor, materials,
money or personal sacrifice made to acquire something. The cost is
not an essential factor in determining the value.
3. Value is a combination between the present and the future worthiness
of something according to the anticipated interest, profit or desire.
The value of a real estate property can be determined in different ways and
methods. There is the utility value, or the value estimated according to the
usefulness of the property. This is called a subjective method of estimation,
because the value provided by this method depends on personal reasons.
For example, a swimming pool can be a very important amenity for one
family but of much less importance for another. The utility value can be
applied for the majority of amenities that fall in the same category.
Another example is a property with four bedrooms offered to a couple;

whether these four bedrooms could be of use depends on whether they have
children and how many, frequent visitors, etc. Or, for instance, a house
located in the citys farther suburbs would not be useful for someone whose
job is downtown.
The market value is defined as the amount of money which a property can
be sold for in the current market conditions at a given time. This is usually
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called the objective value of the property because it depends on data and
not on personal factors.
FOUR ELEMENTS OF VALUE

There are four main elements that must be taken in consideration when
calculating the worthiness of a property. These four the pillars of value --
are demand, utility, scarcity and transferability.
Demand: The power to pay for a property and its availability on the market.
Utility: The usefulness of the property.
Scarcity: The scarcer the property is, the more valuable it is.
Transferability: The property title should be clear, unclouded and
marketable.
It is the appraisers job to evaluate each of these four pillars of value in

order to gain the final estimate for the market value of the property.
Demand can be attributed to unique characteristics, or simply because
there is an overall desire for home-ownership, or both. In addition, the
market participants must have purchasing power.
Is the property useable for its primarily-intended purpose? This means, for
instance, that the residential property can accommodate a family.
Additionally, the appraiser should try to decide the degree of scarcity of this
property by being informed of the number of other similar developments in
the area. The fewer the number of developments the more valuable the
property is.
Finally, the appraiser will check the transferability of the property by

checking if the title is clear, and whether the seller can easily transfer the
ownership to the buyer or there are any reasons that may hinder such a
transaction. As can be seen, all these factors are important in determining
the value of the property. The appraiser must evaluates each of these
factors in order to figure out the most accurate estimate of the market value
of the property.
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Change is the essence of life, and real estate business is not immune to this
potent element. The value of any given real estate property is created,
maintained, and destroyed because of the relationship between the
following major influences.
Environmental and physical characteristics:
These characteristics include the quality and the availability of schools and
their proximity, shopping facilities, public transportation, houses of
worship, and the similarity of use of the land. The environmental factors
will also include the type and nature of the soil, topography, climate, oceans
and water bodies, and mountains.
Social ideals and standards:
This includes patterns of population growth or decline, the rates of

marriage, divorce, births and deaths. All the factors mentioned above
influence the social patterns of the area and affect the value of its
properties.
Economic factors and forces:
Some of the economic factors affecting value are natural resources,

industrial and commercial trends of the market, employment rates and
trends, salary rates, availability of funding and credit, interest rates, price
level in the area, taxation, economic base of the area and the region, new
developments in the area, and rental and purchase prices and rates.
Political and governmental laws and regulations:
Some of the political factors that may affect the value of a property are new
building codes, zoning laws, public health measures, fire laws and
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regulations, rent controls, environmental legislations and laws, as well as
the community economic base.
Directional growth:
This factor determines if the area is growing. The value of the property will
definitely increase if the area is still in growth mode.
Location of the property:
This, of course, is a major determinant in establishing the value of the

property.
Utility:
The suitability of the property to be used in the same purpose it was

intended for. The presence of building restrictions and new zoning
regulations affect the utility of the property.
Size:
The use of the property is influenced by the width and the depth of the land.
Corner influence:
When it comes to commercial properties, extra exposure can be crucial. On

the other hand, more exposure for residential properties means less privacy
and significantly increases the maintenance costs of the larger frontage.
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Shape of the plot:
Irregular-shaped plots of land are more expensive and harder to develop

than regularshaped lots.
The surrounding conditions:
The degree of congestion of the streets leading to the area, the width and
quality of the street where the property sits, and the condition of the
pavements will affect the value of the property.
Exposure:
The west and south sides of any business street will be preferred by
experienced storeowners; they know that people seek the shady side of the
street to go window shopping. Also, the orientation of these properties will
influence how sunrays hitting store windows might damage products.
Business climate:
The proximity of shopping facilities, wholesale outlets, industrial areas,

offices and medical suites are influential factors in deciding the value of the
property.
The plottage of the area (or assemblage):
Plottage is the adjoining of several adjacent lots of land into one larger
property. Usually, the value of the bigger lot is much more than the sum of
the value of the individual parcels.
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Topography of the land:
The topographical nature of the lot affects the cost and desirability of the
property in different ways. Bad and unusual topography make it harder for
workers to develop the area.
Obsolescence (antiquity):
This may be caused by several reasons like external changes or economic

changes in the area itself. These changes decrease the usefulness of the
property or may result in complete deterioration.
Building restrictions and zoning laws:
These factors can affect the price of the property if governmental bodies
decide what it can be used for is altered.
BASIC PRINCIPLES FOR ESTIMATING VALUE

Any good real estate agent or professional appraiser should know these
basic principles of estimating the value of a property before proceeding
with the actual process of estimation.
The Principle of Conformity: The value of the property can increase

significantly when lots in the neighborhood are similar in size and the
houses built on them are nearly identical in shape and size.
The Principle of Change: Changes is a constant in neighborhoods and

cities as a whole, reflected in the properties located there. Expert appraisers
should know the trends that affect the value of the real estate because of
these changes, which can be caused by the environment, the government,
or by the society. All these changes are dynamic and can affect the value of
the property significantly.
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The Principle of Substitution: This is the foundation of the valuation
process. To explain it simply, the property should have a price similar to the
price of another property with the same characteristics. No buyer is likely to
pay more for a property more than what he can pay for a similar property
under similar conditions.
The Principle of Supply and Demand: Increasing supply coupled with

decreasing or stagnating of demand will result in higher properties to
buyers ratio, and the conclusion will be a decrease in price. Decreasing the
supply with increasing or the stagnating demand will lead to a lower
properties to buyers ratio, and an increase in price. The more available
properties, the lower the price will be.
The Principle of Highest and Best Use: This principle is based on

measuring the highest net return of a property or a piece of land through
the reasonable use of this property at the time of appraisal. Estimating the
best use of the property includes assessing the reasons of the buyers for
purchasing the property, the current use of the property, the allowable use
of the property, zoning laws, the benefits of ownership, market trends,
community behavior, and environmental factors.
The Principle of Progression: It states that a property with less value

may be worth more when it is nearby a property with a higher value.
The Principle of Regression: The corollary to the progression principal,

holding that a property with a higher value may be worth less if near to a
property of lesser value.
The Principle of Contribution: The value of the improvement added to

any piece of land or any real estate property is measured by the value added
to the total market price of the property, regardless of the cost of this
improvement itself. For example, redecorating the attic may be costly but
not be reflected in a rise in the property price, while building a family room
may be factored into the price by doubling what the building cost. This
principle is very important for those who are thinking of adding some
improvements to their houses without considering the nature of the
neighborhood itself. As noted above, the neighborhood may, in effect, have
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a limit on the maximum price of properties; those wishing to develop their
property in the hopes of raising its potential sale price should consider that
their properties may turn out to be overbuilt for the neighborhood. Thus,
some improvements made without considering the limits of the
neighborhood may not have any effect on the price of the property.
The Principle of Anticipation: the anticipated or expected benefits of a

given property in the future may reflect on its price on the current market.
The appraiser estimated the current value of the future benefits of a
property when he or she assigns a value for the property according to this
principle.
The Principle of Competition: When demand is higher than supply, the

selling prices of the properties in the area will go up, generating better rates
of profit for the developer. This can attract more developers to enter the
competition for profit who start building more properties. This
competition, in turn, could decrease those selling prices, leading to a
significant decrease in profit. So, continual increases in competition can
cause an unprofitable effect compelling builders to lose interest in the area,
interrupting the supply chain of properties to the area. Impeding the supply
then leads into another phase of increase in demand followed by an
increase of price. Because of these constant cycle of the market, the
appraiser should be aware of the current phase in order to anticipate the
value of the property in the future.
The Principle of Balance: When the neighborhood is in balance then

property values increase. The neighborhood that has varying kinds of
property with all needed facilities and utilities will have higher property
values than those properties available in areas with under-development or
over-development.
The Principle of the Three-Stage Cycle: Each neighborhood passes

through changes. It starts with a dynamic, young and quickly-developing
neighborhood, then transforms into an older neighborhood. The properties
into any neighborhood pass through a three-stage cycle with distinctive
phases.
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The three stages of property changes:
1. Development
2. Maturity
3. Old age
The growth and disintegration of properties and neighborhoods is

completely normal and natural. It happens continually, as a cycle, so when
a neighborhood reaches the final stage, it can be restored to its first stage
again. For example, a lovely neighborhood that was developed thirty years
ago may have some deteriorated properties and considered to be an old
neighborhood. However, young families may be interested in these
properties because of their moderate prices with plans to remodel the
property they purchase. This might bring the neighborhood back to the
development stage once more.
THE APPRAISAL PROCESS
After finishing the appraisal, the appraiser or the real estate agent should
be ready to answer two questions:
1. What is the best and highest use of this property, and
2. What is the value of the property through this specific use?
Professional appraisers have constructed a systematic and schematic

method known as the appraisal process in order to arrive at the proper
estimate of value for the subject property. Although not all the steps of the
process are performed on every property, the checklist will aid the
appraiser evaluate the value of the property in an organized and efficient
manner.
The four main steps of the appraisal process:
1. State the problem

2. Gather the data (general data and specific data)
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3. Select the appraisal method to be used
4. Reconcile and process the data in order to arrive at a final value
estimate
State the problem:
The appraiser must first know the reason or the motive for the appraisal
itself. Is the property for sale and a mortgage loan needed, or is there some
other purpose? The appraiser must first describe the property and identify
it precisely with a clear indication for the reason of the appraisal. After this,
the extent of ownership to be appraised must be identified.
The rights of ownership affect the value of the property because they can
limit the uses of the property, so the appraiser should know the type of
ownership in order to identify the value of those rights. Through a fee paid
to the recorders office, the appraiser can determine it is a life estate, or a
co-ownership; are there are any restrictions on its use?
The possible purposes of appraisal:
1. Defining the market value for sale

2. Defining the value for mortgage loan purposes
3. Defining the value for property insurance purposes
4. Defining the value for the condemnation process
5. Defining the value for inheritance
6. Defining the value for income tax purposes
7. Defining the value for the property tax purposes
After determining the purpose of the appraisal needed for the property, the
appraiser can move to the second step of the appraisal process.
Gather the data:
In the beginning, the appraiser should start with a general survey of the
neighborhood and the site of the property to determine the highest and best
use of the property. The type of the property itself will determine the type of
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data to be collected. For example, appraising a singlefamily residency will
require collecting data about similar owneroccupied single family
properties, while appraising a residential-income property will require data
about the income and expenses of similar apartment buildings. So, the first
step is to collect the general data needed on the region, the city, and the
neighborhood where the property is located. Then, the appraiser can delve
more deeply for more specific information about the location, the particular
lot and the improvements.
The information collected for appraisal:
General information:
1. Region
2. City
3. Neighborhood
Specific information:
1. Location
2. Lot
3. Improvements
The supply and demand on the market in this area, as well as the
purchasing power will affect the value of the property. The appraiser should
collect data about population trends in the neighborhood, income levels,
and employment opportunities.
Sources of Information:
1. The general data can be collected from the government

publications, magazines and newspapers
2. When collecting regional data about metropolitan areas like the San
Francisco Bay Area, Southern California, or Central Coast, an
appraiser can utilize monthly banking summaries, the regional
planning commissions, or the governmental agencies.
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3. On collecting community data (city or town) an appraiser can
consult information from the Chamber of Commerce, the city
planning commission, local government agencies, banks or the real
estate board.
4. Neighborhood data can be collected through inspecting the
neighborhood in person, other real estate agents, or area builders.
The personal inspection will help the appraiser personally check the
age and appearance of the neighborhood. Any evidence on bad or
good characteristics of the neighborhood can affect the value of the
property, like the crime rate, presence of rundown buildings,
evidence of future development, proximity to schools, business
centers, recreational facilities and transportation.
The data collected in these ways should include the listing prices and the
final sale prices of the similar properties in the area. All closed-sale
information can be obtained through sale assessors records, county
records, title insurance companies, property owners in the area, or through
the appraisers own data base. The age of the improvements and the other
information regarding development can be collected from the sale
assessors office, city building department, or, as stated, through the
personal inspection of the property.
Site Analysis
In the site analysis step, appraisers usually depend on the information

collected from listings, offers, leases and sales reports as the basis of their
appraisal method.
Even though the city and the location of the neighborhood is first
considered in the analysis of a particular site, the exact location of the plot
of land probably the most important factor in determining the exact value
of the property. Some locations are more desirable than others and this
should be evaluated separately from the development itself as well as the
evaluation of the highest and best use.
The location and types of lots:
Cul-De-Sac
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The literal translation of this expression is bottom of the bag -- it means a
dead-end street, with only one way and the same way out. This may be a
desirable location for a residential property because of the privacy it
conveys to the property, but the lot may be oddlyshaped if it is at the exact
end of the dead end street
Corner Lot
A corner lot is the one occupying the corner of an intersection between two
streets. It may be considered a desirable location because of its
accessibility, but some buyers will not like it because of higher maintenance
costs resulting from its bigger frontage.
Key Lot
The key lot is given this name because it is surrounded by the backyards of
other properties like a key fitting into a lock. This is an undesirable location
because of its lack of privacy.
TIntersection Lot
This type of lot is the one located at the head of T with a headson
frontage overlooking the longer street. There will be noise and headlight
glare which is a disadvantage, but the lot may be considered desirable
because of the open view it commands.
Interior Lot
The interior lot is the most common type of lot. It is surrounded by other
lots from three sides, and a frontage on a street. This site may be desirable
or not according to other factors.
Flag Lot
The flag name is derived from the shape of the lot resembling a flag on a
pole. The pole is usually at the corridor or the entrance of the lot, while the
lot is completely located behind another lot overlooking the street.
The appraiser should remember to evaluate all the correlated legal data of
the lot such as:
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1. Legal description of the lot
2. Taxes incurred
3. Zoning and the general plan
4. Restrictions and easements
5. Determination of other interests in the property
The appraiser should also consider the following physical factors of the
property:
1. Shape of the lot

2. The topography of the site and nature of the soil
3. Corner influence
4. Relation of the site to the surroundings
5. Availability of the public utilities at the lot
6. Encroachments and violations
7. Landscaping and the subsurface land improvements
Buildings and Other Permanent Developments
When the appraiser starts to consider the building on the property, she will
consider all the permanent developments such as fences, swimming pools,
builtin hot tubs, or any other type of permanent construction on the lot.
Any real estate property is divided into the land and the construction itself,
and each of the two adds a specific portion to the full value of the property.
Improvements are significant, both on-site and off.
Types of improvements:
On-site improvements: These are the structures that are permanently

attached to the land: buildings, swimming pools, fences, etc.
Off-site improvements: The areas bordering and surrounding the lot that
have being improved by adding street lights, sidewalks, curbs and
greenbelts.
The basics of construction:
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It is essential for the appraiser and the real estate agent to have a good idea
about the basics of construction in order to properly to evaluate the
property.
A list of the common terms used in the building construction includes:
Anchor bolt: It attaches the mud sill to the foundation; the bolt is
embedded in the concrete foundation.
Bracing: The diagonal board nailed across the wall framing to prevent
the sway of the frame.
Building paper: The waterproof layer of paper located between the

sheathing and the roof covering.
Closed sheathing: The foundation layer of the exterior siding, it is the

boards nailed to the studding.
Crawl space: The area between the floor the ground under the building.
Cripple: The stud above or below a window opening or above the

doorway.
Eaves: The part of the roof that hangs freely outside the exterior walls.
Fire stop: The boards nailed horizontally between the studs to block the
spread of fire in the walls.
Flashing: Metal sheeting that keeps water out of the house.
Foundation: The base part of the house that extends under the entire
house plan. It is usually made from concrete.
Header: The board over a doorway or window opening.
Joists: The boards supporting the floors or ceilings (the board that
supports them is called the girder).
Mud sill: A redwood board that is fastened with open bolts to the
foundation.
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Open sheathing: Boards nailed to rafters to form the foundation of the
roof.
Rafters: Slanted boards that support the roof boards and shingles.
Ridge board: The highest board of a frame building.
Sill: The board below the window or door opening.
Sole plate: The plate that supports the studs.
Studs: Vertical 2 by 4 boards in the walls with 16-inch spacing in

between
Other terms and definitions of building construction:
Backfill: The soil used to fill in holes and support the foundation.
Bearing wall: The wall that supports a vertical wall over it as well as
supporting its own weight.
Board foot: Equaling 144 cubic inches, it is the same cubic area of a
standard board measuring 12 x 12 x 1. It is the measurement used for
lumber.
BTU (British thermal unit): One measurement of heat. The amount of

heat needed to increase the temperature one degree Fahrenheit of one
pound of water.
Compaction: The extra amount of soil compressed to fill in the gaps of

the foundation or to increase the level of the lot; also used when the soil
is unstable.
Conduit: A flexible type of pipe, in which the electrical wirings are

installed.
Deciduous: Type of trees that lose their leaves seasonally.
Drywall: Gypsum panels used instead of wet plaster in order to finish

interior walls.
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Elevation sheet: It shows the front and the side exterior views of the
finished building in the blueprint stage.
Energy efficient ratio (EER): A measurement of home appliances energy

efficiency.
Hoskold tables: Method used to value the annuity that is based on

reinvesting capital immediately. Usually used by appraisers to evaluate
the income property.
Insulation: The resistance of insulation to heat is measured by the factor

R. When the R value is higher, the insulation is better.
Inwood tables: Used by appraisers to evaluate income properties, the

method where the income stream is converted into present value.
Kiosk: Free-standing sales
Minimum residential ceiling height: 7.5 feet.
Normal residential ceiling height: 8 feet.
Percolating water: Underground water not flowing in a specific channel.
Percolation test: Test applied by construction builders to define the

ability of the soil to absorb and drain water.
Potable water: Water that is safe to drink.
Setback: Pre-determined distance that the building should be set back

from the street, as decided by the local building code.
Shopping center: In order to make building a neighborhood shopping

center feasible, a population of 5,00010,000 people is needed; for a
major shopping center, 50,000 100,000 is required.
Wainscoting: the bottom part of the wall that is covered with wall siding
the upper wall is treated with another material.
Water table: Natural level at which water can be found, either below or
above the surface of the ground.
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Water pressure: It can be tested by turning all the water tabs of the
building and flushing all the toilets at once.
Roof Types
The types of the roof are determined by the direction, steepness and the
number of roof plans into:
1. Single dormers
2. Gambrel
3. Mansard
4. Pyramid
5. Dust pan or shed dormer
6. Gable
7. Flat
House Styles
It is important to know how to determine the type of the house through its
style:
1. Cape Cod
2. Colonial
3. Contemporary
4. English Tudor
5. Mediterranean
6. Ranch
7. Split level
8. Townhouse
9. Victorian
THREE APPROACHES FOR APPRAISING PROPERTIES

There are three main approaches for the valuation of real estate properties:
1. Sales or market comparison approach
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The recent sales and listings of properties still on the market, from
the same area, are all collected to form an opinion about the value
of the subject property.
2. Cost approach
This approach estimates the value of the vacant lot of land, then
adds the depreciated cost of developments and improvements in
order to determine a proper estimate of value for the entire
property.
3. Income capitalization (income approach)

The potential net income of the property is calculated and then
capitalized into a present value.
In many cases, the appraiser will use a combination of the three methods in
order to calculate the proper value of the property. The appraiser will use
each method order to make an estimate, then each value is given a weight
according to its compatibility and similarity with the subject property in
order to find the correct amount. This process is called the reconciliation or
correlation.
Sales or Market Comparison Approach
This is the easiest and most commonly-used method by real estate agents. It
is most suitable for appraising single-family homes, condominiums and
vacant lots since the sales information is readily available. Another reason
for using this method is that it is relatively easy to learn and use. The market
comparison relies mostly on the principle of substitution to compare similar
properties.
As noted earlier, the principle of substitution states that the buyer is not
prepared to pay more for a property than the price of another similar
property. The market comparison approach takes the selling price of the
similar property and adjusts it for any differences from the subject property
in order to arrive at the market value of the subject property.
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The appraiser will collect the needed data regarding the similar properties
to the subject properties (these properties are called the comparables).
These points of similarity should be present in comparables:
Neighborhood location
Size of the house (number of rooms, bedrooms, bathrooms and
square footage)
Age
Building style
Financing terms of the sale
General price range
The market comparison approach is based on the idea that the propertys
value is equal to what it would sell for without any stress applied in the
process, and if a reasonable time is given for the buyer to appear. Because
of this idea, the appraiser researches comparables to discover if any were
sold according to special circumstances that influenced the sale. The
properties considered for the comparison should be those sold in normal
circumstances; those who sold under special or unusual circumstances
should be excluded from the comparison. Normal conditions include the
property being on the market for a reasonable amount of time, the seller is
approved, the transaction is on the open market, and the property had been
listed for a reasonable time. Additionally, the properties should have been
sold within the last 6 months. If the comparables are sold later than that, it
should be excluded from comparison.
Features in either the property or the sale transaction itself are the
elements that influence the variation of the estimate
The elements influencing the estimate include:
Financing terms
Date of sale
Sale conditions ( Arms length relationship)
Location and site
Physical features
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Income of the property (if applicable)
Therefore, a price should be calculated for the comparable property which

reflects its current value on the date it was sold. As noted, properties that
are not considered as proper comparables should be excluded, and those
who most resemble the subject property given more weight.
The pros of the sales comparison approach:
The easiest method to understand for the evaluation purposes,

most commonly-used by real estate agents.
Easily and properly applied for singlefamily properties.
The cons of the sales comparison approach:
The difficulty of finding similar properties that had been recently

sold recently on the market
Making the needed adjustments for the comparable price in an
accurate way
Because of changes in economic conditions, older sales are
considered unreliable.
Difficulty in confirming transaction details.
The procedure:
1. Start by finding similar properties that can be used as comparables,

then verify the relevant data for these properties.
2. Select the appropriate elements of comparison, then adjust the sale
price of each comparable (the adjustments should be only made to
the price of the comparable properties, not to the subject property).
3. Adjust the sale price of the comparables by deducting the value (if the
subject property lacks some amenities present in the comparable
property) or by adding to the value (if the subject property has
amenities that the comparable does not).
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4. Use the sales comparison approach as the best method available to
estimate the value of single-family residences, condominiums or
vacant lots.
Cost Approach
The cost approach concentrates on the value of the appraised property as a

combination of two elements: the value of the land (disregarding any
developments on it) and the cost of rebuilding the same development
(while deducting the depreciation costs).
The formula used to estimate the value using the cost approach:
Value of the land + the cost to build the same structure the applicable
depreciation = Value of the property
According to the principle of substitution a buyer will not pay more for a
substitute property if he can obtain the subject property for a lower price.
In the cost approach, the substitute in this formula will be the
reconstruction of the same building on the same vacant land. The cost
approach is intended to set the maximum limit of value of the property; in
other words, the highest price the property can cost if it was built today.
The procedure:
1. Consider the land is vacant and start by estimating its price as a

vacant lot, by using comparable vacant land sales (principle of
substitution).
2. Evaluate the existing construction and then consider the cost to
construct it today, in order to calculate the cost of rebuilding it on the
appraisal date.
3. Estimate the amount of depreciation applied to the building.
4. Deduct the amount of depreciation from the rebuilding cost, to
estimate the value of the development on the land currently.
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5. Add the value calculated in the previous step to the value of the
vacant land. The result will be the final estimate of value for the
subject property.
The cost approach is usually used to appraise new constructions and special
purpose buildings. Estimating the depreciation of new buildings is
relatively easier than doing the same process with older buildings, as the
depreciation can be difficult to calculate on those old structures. The cost
approach is used with the unique or custom-built structures because it is
unlikely to find proper comparables for such properties, such as fire
stations, churches, or hospitals.
In some cases, the cost approach is the only applicable method of value
estimation an appraiser can employ. This usually occurs in cases of
recession or in case of high-loan interest rates, as finding suitable, recently-
sold comparables is relatively hard. Also, if the building appraised is not an
income-producing property, then using the income approach is
inapplicable. In such cases, the appraisers and real estate agents will rely on
the cost approach as a best method to estimate the value of the property.
Estimating the cost of new buildings:
Square-foot method:
This is considered the most common method used by appraisers and real
estate agents to estimate the cost of a new building. The size of the subject
property is measured in square feet and compared to other constructions
with the same square footage. The building under appraisal is compared to
the most similar property and the square foot price of the comparable is
applied to the subject property. This is considered the quickest way to apply
the cost method to estimate the value of the property. Cost services
companies specialize in this kind of appraisal for new construction.
Cubic-foot method:
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This method resembles the squarefoot method, except that this approach
includes height into the formula instead of depending on the area alone. In
this method, the cubic volume of the building is the point of comparison
with the similar comparables instead of depending on square area.
Quantity survey method:
This is a detailed method which depends on calculating the amount of labor

and material needed to construct the building. Items like overhead costs,
insurance and the profit margin of the builders are also taken into
consideration in order to arrive to the total cost of rebuilding. Although this
method is time consuming it is considered very accurate.
Unit-in-place cost method:
The cost of every unit installed in the building is surveyed and added to the
cost of rebuilding the structure itself. The total cost of walls, heating units,
roof cladding and all other units are added together to form the total cost of
the building. It is considered the most detailed method and among the most
accurate, as well.
Depreciation
The simple definition of depreciation is the loss of value due to any cause. It
is commonly measured as the difference between the cost of reconstructing
the same building as of the date of appraisal and the estimated value of the
property at the time of appraisal also.
The opposite of depreciation is appreciation, or what is defined as the

increase in value of the property. In most cases, appreciation is attributable
to inflation or the influence of the supply and demand ratio related to the
property.
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All the factors that contribute to decreasing the value of the property below
its cost as a new building are included in the definition of depreciation
The three main types of depreciation:
Physical Deterioration
This type of depreciation is the result of wear and tear, neglected

maintenance, damages caused by dry rot, termites or severe changes in
climate. Physical deterioration may or may not be reversible.
Functional obsolescence
Poor architectural design and style can contribute to functional aging, or

obsolescence, as well as a lack of modern facilities, outdated equipment,
changes in construction styles, or changes in utility demand. This
functional aging also may or may not be reversible.
Economic Obsolescence
This type of depreciation occurs to the property because of outer factors

that affect the value of the property. They include changes in the economic
or social nature of the neighborhood, zoning changes, over-supply of
properties, under-supply of buyers, recession or legislative restrictions
these can all cause economic obsolescence. In most cases, these changes are
irreversible.
Depreciation for calculating the tax income is book depreciation; in other

words, it is a mathematical linear depreciation or deduction from the
owners original purchase price (cost basis). This steady depreciation allows
the owner to return his investment in the property over the period of its
useful life span. This type of depreciation is calculated annually and
deducted from the gross income of the owner.
In many cases, this deduction changes the gross income into a negative
value on paper. Apparently, the building is losing its value and providing
the owner with a loss. This paper loss is considered as a tax shelter, and this
is why some people invest in income properties.
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Book Value
Book value is the current value (for accounting purposes) of a building. This
book value is calculated through adding the original acquisition cost and
the cost of capital improvements with the deduction of the accumulated
depreciation. This type of depreciation is only a book value for accounting
purposes, and not the actual value of depreciation. The depreciation is only
applied on the building or the improvements, not the land itself. The
depreciation for taxation and accounting purposes is a mathematical way to
view improvements over steady steps.
It is essential to remember that the book value and book depreciation are
only methods to estimate income tax, and are not relevant to the appraiser.
Acquisition cost + development costs applied depreciation = book value
It is important to know that the depreciation calculated by an accountant as

book depreciation is not the same of the depreciation estimated by the
appraiser. The main difference is that the appraiser does not consider the
original costs paid by the owner but depends instead on calculating the
costs of reconstructing a new building at the current prices, by using the
cost method. The appraiser will deduct the accumulated actual depreciation
(not the book depreciation) of the building from the cost of building a new
one.
When using the cost method, as mentioned before, the value of the land
and the value of the improvements are estimated separately, and then
added to each other to calculate the final appraised value of the property.
So, the appraiser calculates the actual depreciation value of the building
and deducts it from the cost for rebuilding the same construction on the
date of appraisal.
The next step is to add the result of the previous step to the value of the
land. The value of the land is concluded from the value of other similar
properties sold recently (using the principle of substitution). Both values
will figure into the estimated value of the whole lot. There are several ways
to calculate the actual depreciation; however, most appraisers concentrate
on the most important method: the straight line or the agelife method.
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This is the most common methods used by appraisers and real estate agents
because it is easy to use, easy to understand and also preferred by the IRS.
Through adopting the straight-line method to determine accumulated

depreciation, the appraiser will assume that a building loses the same
amount of its value each year until depleting its initial value completely. For
example, if the useful life of a building is estimated to be 50 years then it
will lose 2% of its initial value every year (2% * 50 = 100% depreciation at
the end of the 50 years). Using this method of calculation for the
accumulated depreciation, the appraiser will probably not use the actual
age of the building. Instead, he will rely on the effective age of the building
based on its condition at the date of appraisal, not on the number of years
since it was built.
Actual Age is the real age of the building, while the effective age is
determined by the condition and the usefulness of the building. The
economic life of the building is the period of years that the building can be
profitable for the owner. For example, a property was constructed 25 years
ago but it is well-maintained and appears to be similar to the buildings built
20 years ago. So, it will have an actual age of 25 years and effective age of
20 years.
Income Approach (Income Capitalization)
The income approach evaluates the current value of the future benefits that
will come from the ownership of the property. The value of the property is
mainly based on its potential to continue producing income in the future.
This method is used to analyze the value of income-producing properties
(rental properties). In most cases, it is employed in combination with one
or both of the other methods. The process of calculating the present value
of the property through its ability to produce an income in the future is
called capitalization. This appraisal method is based on three principles:
substitution, comparison, and anticipation.
Using the income approach:
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The value of the property is based mainly on its ability to maintain the
production of income in the future. This approach depends mainly on
converting the income stream anticipated in the future into an indicator of
the current value of the property. The appraiser will anticipate the expenses
of the potential income of the property as a component of her estimation of
the current value of the property.
The formula used by the appraiser to define the value of an income

property:
The net income divided by the capitalization rate (cap rate) equals the
current value of the property.
Net Income/cap rate = current value
The appraiser should decide the amount of income, and how long this
income will last. There are five basic steps in order to arrive at these
answers:
1. Calculate the effective yearly gross income of the property:

The effective gross income is the total yearly income of the property
after deducting the vacancy and rental losses. The gross income
includes the rental income and any side income like laundry room,
parking lot or any other side income generated by the property. The
loss of income because of a vacant unit is called the vacancy factor.
The current rental rates of the property are used to determine the
losses from the vacancy factor. The market rent is the proper rent that
the property can bring in an open and fair market. The contract rent
is the actual rent paid by the tenants after negotiations. The market
rent is the rent used for the calculations.
Example:
The annual gross income is $36,000
The vacancy factor is 10% = $3,600
The effective gross income is $32,400
2. Calculating the operating expenses:
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Expenses are usually defined under two categories, fixed and variable.
Fixed expenses: property taxes and insurance

Variable expenses: maintenance, management and utilities
3. Calculate the net operating income:

Taxes $1920
Insurance $480
Management $2400
Maintenance $1000
Utilities $800
Reserves $800
Total expenses = $ 7400
The net operating income = gross income operating expenses =

$32,400 - $ 7400 = $ 25,000
4. Selecting the cap rate:

The cap rate stands for the return of the invested capital plus the
return over the investment. The rate is mainly dependent on the
return requested by the buyer before investing money in the property.
The greater the risk of recapturing the investment money, the higher
the cap rate and the lower the price. When the risk is low, the rate is
low, and the price of the property is higher.
Simply put, higher risk of making a profit increases the cap rate and
consequently decreases the price of the property. Lower risk of
making profit decreases the cap rate and consequently increases the
price.
Selecting the right cap rate is the hardest step for all appraisers using
the income approach. Commonly, real estate agent will need
thorough studying in order to use this method to estimate the value of
income properties. Capitalization rate is usually determined by a
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detailed market analysis of the similar income properties in the area
using the same capitalization rate to determine their sale value. There
are other methods of determining the capital rates which agents may
be able to utilize through more studying of the appraisal process.
5. Divide the net income by the chosen cap rate to obtain the market
value.
Net income/cap rate = market value
Example:
Net income = $ 25000
Cap rate = 8%
25000/8 = $312, 500
Gross Rent Multiplier:

The gross rent multiplier is used by real estate agents and appraisers
as a quick method to convert the gross rent to the market value. It is
an easy way for calculating the value of income-producing properties
and to estimate the value of the rental units.
Gross rent is income (it may be calculated monthly or annually)

received before any deduction for the expenses. A gross rent
multiplier of the total annual rents will provide a rough estimate of
the property value that can be compared with other similar income
producing properties. Usually, the gross rent multiplier will be
anywhere between five to ten times according to the market, the
condition and the location of the property.
In other words, a property producing a gross income of $36,000 and

with a gross multiplier of 10 would lead to a guess that the price is
$360,000. Some properties will have a gross multiplier of five or
seven or nine and because of this variance, the outcome is only
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considered as a rough estimate and cannot substitute for a formal
appraisal.
A real estate agent can reverse the process to calculate the gross
multiplier, instead of the market value. The reason for doing this is to
check the pricing of a property to find if it matches the general price
in the market or not. Normally, the incomeproducing properties are
sold for eight times the gross income, so divide the market value of
the property by the annual gross income and check if the answer is
eight.
Example:
Market price, $360,000
Gross income, $36,000
The multiplier is 10 in this case.
The gross rent multipliers of several properties can be compared after

this, using the market comparison method to estimate their value. A
gross rent multiplier can be stated on either an annual or monthly
basis.
Correlate and Reconcile
This is the final step of the appraisal process, where the appraiser
correlates between the different market values derived from the
different methods and decides which one to use, to find the most
appropriate price for the subject property. Then the appraiser uses
that figure to determine the final estimate for the subject property.
Single-family residences: The market comparison approach is the

most appropriate.
New and unusual properties: The cost approach is the most suitable.
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Rental and income-producing properties: The income approach is
the most appropriate.
THE APPRAISAL REPORT
Any prepared appraisal report should be delivered in one of the three

following forms:
Self-contained appraisal report
Summary appraisal report
Restricted-use appraisal report
When the intended recipients of the appraisal report include parties other
than clients, then the Summary Appraisal report or the Self-Contained
report (the most detailed) should be employed. However, when the
recipients do not include non-clients then the appraiser can utilize the
Restricted Use Appraisal Report. The differences between the three types of
the appraisal reports are the content and the level of the information
provided in each of them.
Choosing which type of appraisal report to use is a significant decision by

the appraiser. Each kind of report has standard minimum requirements for
its content and level of information.
The report includes the name of the client and his identity, as well as any
intended recipients (each should be mentioned by name and type). The
report should also include the intended use of this appraisal report, the
identity of the subject property, the real property interest appraised, the
purpose of the appraisal, the specific date of appraisal and the date of its
issue. The report should also cover the type of work done to produce it, the
assumptions used and limiting conditions applied, the information that was
analyzed, the procedures followed, and the reasons that support the
conclusion of the report. The report should also show the current use of the
real estate property and the use reflected through the appraisal.
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The appraisal report will also contain the reasons that support the
appraisers opinion about the highest and best use of the property, as well
as any deviations from standard conclusions. The report should also
include a signed certification.
The summary appraisal report contains the same information included in

the full appraisal report. The only difference between both types is that the
full report includes detailed description of the case, while the summary
appraisal report will only include concise summaries about the same points.
The Restricted Use appraisal report contains the same categories included
in the other two types of appraisal reports, but with a few differences. The
clients identity is the only one mentioned on the report as this report is
restricted for her use only. Additionally, the report will mention that if any
additional information about this report is desired, the client should refer
to the appraisers work file.
APPRAISAL LICENSING STANDARDS

The Appraisal Foundation was established in 1987, as a nonprofit
educational organization founded in response to the catastrophic problem
of the savings and loan industry that occurred in the early 1980s. Because
of that crisis, it was decided that all appraisals should meet well-established
and known standards, free from external pressures or influence.
The Appraisers Qualifications Board was the primary component in the

structure of this foundation set up to establish these requirements, called
the Uniform Standards of Professional Appraisal Practice (USPAP). It also
designed the educational and experience requirements for licensing and
qualifying appraisers in all the states. These standards put forward by the
USPAP are known nationwide and every professional appraiser should
abide by them through his practice.
In California in 1990, the Office of Real Estate Appraisers (OREA) was

established to be responsible for licensing the states professional
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appraisers. Since then, OREA has overseen licenses for more than 20,000
professional and qualified appraisers.
The four different types of appraisal licenses:
Trainee license
Residential license
Certified Residential license
Certified General License
To pass each level of the license accreditation, the real estate appraiser
should have the needed level of experience and education and pass the state
exam at the intended level. The holders of trainee license should be working
under the supervision of a licensed appraiser. The types of property that a
licensee is qualified to appraise are specified for each level. Regular
continuation education is required for maintaining the license.
Professional Appraisal Organizations
The main goal of these organizations is to confirm that those working in the
appraisal industry are well educated and well informed about their
profession, according to the standard code of ethics and the standards of
professional appraisal practice.
The main nationwide appraisal organization is the Appraisal Institute (AI).

The members of this organization hold the title Member Appraisal Institute
(MAI) or a Senior Residential Appraiser (SRA)
Appraisal Institute designations:
1. Member Appraisal Institute (MAI)

2. Senior Residential Appraiser (SRA)
3. Senior Real Property Appraiser (SRPA)
4. Senior real Estate Analyst (SREA)
5. Residential Member (RM)
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CHAPTER SUMMARY
The reasons for an appraisal include:
Transfer of property ownership

Financing and loans
Tax purposes
Condemnation
Insurance purposes
The fair market sales:
Buyers and sellers are working for their own interest

Buyers and sellers are well-informed about their transaction and
making their decisions accordingly
The property has been listed on the market for a reasonable period
of time
The sale is made for cash or specifically financed
Financing is conventional made for qualified, approved borrowers
The price, cost, and value:
Price: What is paid for something

Cost: The total expenditure in money, labor, materials and time to
produce or acquire something
Value: The worth of something according to its present value, as
well as its future benefits and profits
The four elements of value:
Demand , Utility, Scarcity and Transferability
Factors influencing value:
Environmental and physical characteristics

Social ideals and standards
Economic factors
Political and governmental regulations
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Three stages of property change:
Development, maturity, and old age
The four steps of the appraisal process:
State the problem

Gather data
Decide the appraisal method
Correlate and reconcile
Three approaches for appraising property:
Sales comparison approach

Cost approach
Income approach, capitalization
Formula for determining value based on cost approach:
Land value + building cost new accrued depreciation = value
Three types of depreciation:
Physical deterioration
Functional aging
Economic obsolescence
Book value formula:
Original cost + developments accrued depreciation = book value
Estimating the value of income property:
Net income/cap rate = value of property
Three types of appraisal reports:
Self-contained appraisal report

Summary appraisal report
Restricted use appraisal report
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CHAPTER QUIZ
1. The most appropriate use of the income approach to appraisal is

designed for:
a) New residences
b) Old residences
c) Rental property
d) Religious edifices
2. The most detailed appraisal report is:

a) Self-contained appraisal report
b) Summary appraisal report
c) Detailed appraisal report
d) Restricted use appraisal report
3. The most appropriate use of the cost approach to appraisal is

generally for:
a) Newly constructed properties
b) Old residences
c) Rental properties
d) Religious edifices
4. The most appropriate use of the sales comparison approach is meant

for:
a) Single-family homes
b) Condominiums
c) Vacant lots
d) All of the above
5. In estimating land value, what is the least important factor?

a) Size
b) Sale price of similar land
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c) Cost to build on it
d) Price asked
6. An apartment building which overloads its utilities supply solely

because it lacks power to operate all the residents computers, high-
definition televisions and other modern electronic devices is an
example of:
a) Functional obsolescence
b) Social obsolescence
c) Economic obsolescence
d) Physical deterioration
7. The first step in the appraisal procedure is:

a) Arrange and categorize the data
b) Make an appraisal plan
c) Define the problem
d) Separate the data
8. Which is the least desirable lot type?

a) Flag lot
b) Corner lot
c) Key lot
d) Cul de sac lot
9. What does the highest and best use means:

a) Highest net return
b) Highest population
c) Highest gross return
d) Highest elevation
10. The stages of property change include the following:
a) Development
b) Maturity
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c) Old age
d) All of the above
11. The following are the elements of value, except:
a) Scarcity
b) Demand
c) Utility
d) Plottage
12. Which is used with the cap rate in the capitalization approach:
a) Adjusted cost
b) Sales price
c) Net income
d) Gross income
13. The following are types of housing styles all found in California,
except:
a) Cape Cod
b) Tudor
c) St. Martin
d) Mediterranean
14. OREA was established in:
a) The Nineties
b) The Eighties
c) The Seventies
d) The Sixties
15. The holder of the MAI title is a member of the:
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a) Appraisal Foundation
b) OREA
c) Appraisal Institute
d) Estate office
Answer Key:
1. C 6. A 11. D
2. A 7. C 12. C
3. A 8. C 13. C
4. D 9. A 14. A
5. D 10. D 15. C
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CHAPTER TWELVE
PROCESSING LOANS
INTRODUCTION
Since the moment of deciding to get a property loan and until the loan is
funded, there are many steps taken in order to reach the desired result:
obtaining the funds needed to buy the property.
First, the loan application is submitted by the borrower; then it reaches the
underwriter whose job is to decide whether the application meets required
standards. After the underwriter, the application must pass several more
tests. The careful, lawful and professional handling and processing of the
application is crucial for the mortgage lender as well as the borrower in
order to arrive at the funding of the real estate property.
Loan processing is considered the lengthiest part of the loan procedure, and
the most important as well. A great deal of information is collected and
evaluated in order to determine if the loan application fits standard
guidelines. Additionally, the loan application will undergo a risk analysis in
order to evaluate the potential risk to investors. This chapter discusses loan
processing key position in the mortgage lending industry.
LOAN PROCESS OVERVIEW

In the past, when someone was looking for a property loan, he would go to
the nearest neighboring bank or S&L. If the bank or thrift had adequate
funds, then it would evaluate the creditworthiness of the customer. If he
qualified as a good credit risk, then the institution would provide the loan
from its funds.
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In more recent times, of course, the process isnt that simple anymore. The
funding money for most the real estate property loans comes from one of
three major sources:
Fannie Mae (FNMA) Federal National Mortgage Association

Freddie Mac (FHLMC) Federal Home Loan Mortgage Corporation
Ginnie Mae (GNMA) Government National Mortgage Association
The prospective borrower will shop around for loans with different lenders
then apply to one of them. The mortgage lender will perform the needed
verifications and decide if the borrower will receive the needed funds to buy
the property, with monthly loan payments scheduled for a certain period of
time. The borrower may be end up making these monthly loan payments
directly to the company which originated the loan, or to another lender who
buys the processed loan.
In most cases, the company that receives these loan payments is not the
loan owner but the loan servicer. In other words, the company collecting
the payments is servicing the loan for the institution that actually owns it.
What actually happens in the back-end operation is that individual loans

are pooled with a package of loans and then sold to one of the large loan
institutions. The servicer company collects the monthly payments for the
individual loans, and receives a servicing fee for its work of payment
collection and administering the loan. The regular fee of payment collection
is usually 0.375% but the amount is enhanced when collecting several
loans.
In fact, mortgage servicing is the most profitable aspect of mortgage

lending an area where generates good returns. The entire loan processing
system is designed so that the loans eventually arrive in the portfolio of the
servicing company after other parties have taken their share of the profit.
Once the loan is processed, the lender will pool and package it with other
loans to Fannie Mae, Freddie Mac, Ginnie Mae or other institutional
investors. Selling the loans to these institutions allows the lender to use the
money generated from the sale to fund more loans, then pool those, and so
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on. This cycle enables lenders to generate a continuous supply of loans
through selling the old loans to the secondary market.
THE LOAN PROCEDURE

The process starts with the application which contains detailed information
about the borrower such as employment record, income, debts -- as well
as detailed information about the subject property including its address.
The aim of collecting this information is to measure the capability and the
willingness of the borrower to repay the loan.
The loan processor will consult with credit bureaus to see whether the
borrower is paying his bills on time. The lender has the right to reject the
loan application if the credit file shows a poor credit history. Therefore, the
borrower should check his own credit history before even applying for a
loan. The borrower has the right to confirm all the information displayed in
his report and have a credit bureau employee explain it to him.
In order to determine the monthly payment, the lender will first try to
gauge the loan value. This value depends on the value of the property itself
as well as the financial condition of the borrower. The lender usually asks a
professional appraiser to appraise the property and calculate a proper price.
The appraisal value is an important factor in determining whether the
borrower will qualify for the needed loan or not.
Usually, the lender will only fund a certain percent of the value of the
property. In most cases, the value of the loan is 80% to 90% of the
appraised value of the property. A down payment of the difference between
the value of the property and the value of the loan is expected to be paid by
the borrower. If the appraisal value is lower than the asking price, then the
loan value added to the down payment will not be enough to cover the
asking price of the property. In this instance, the lender will suggest that
the borrower make a larger down payment in order to cover the difference
or the seller may agree to decrease the asking price to match the appraised
value.
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Debt to Income Ratios
In order to estimate the maximum mortgage amount that the borrower can
afford, the lender will use some guidelines called the debt to income ratio.
Its simple definition is the percentage of the monthly income of the
borrower that can be used to pay his debts. There are two different
calculations for this ratio: the front ratio and the back ratio.
The front ratio is the percentage of the gross monthly income of the
borrower (before taxes) that can be utilized to pay the housing costs,
including the principal amount, interest, taxes, insurance premium,
mortgage insurance and home owner's association fees (if applicable). The
back ratio is the same but also takes into account the consumer debts of the
borrower. These consumer debts can include car payments, credit card
payments, installment loans and similar expenses. Auto insurance and life
insurance premiums are not considered consumer debts.
Common guidelines for the debt to income ratio is 33/38. This means that
the housing costs alone cannot exceed 33% of the gross monthly income of
the borrower, while if adding the consumer debt to the monthly obligations,
they cannot exceed 38% of that gross monthly income.
However, if the borrower is willing to make a larger down payment, then

the guidelines become more flexible; a smaller down payment, though,
renders them more rigid. The same goes with borrowers with marginal
credit scores as the guidelines become stricter for them. These ratio rules
also change according to the loan program itself; in case of FHA loans, the
qualifying values are 29/41. With VA loan programs, the guidelines do not
have a front ratio but the back ratio should not exceed 41.
The borrower needs to able to demonstrate his income history to the

lender. This is done through W-2s of the previous years and pay stubs for
the year to date. The borrower should also be able to disclose his debts,
including the account number(s), outstanding balance(s), and the address
of creditor(s), as well as the purchase contract for the desired property.
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If the loan application is refused for any reason, federal law obliges the
lender to express the reasons for refusal to the would-be borrower in
writing. The factors that may affect loan approval or disapproval can
include the following:
Credit history:
If the credit level of the borrower or the level of debt is too high then it is
doubtful that the borrower can repay the loan or commit to a new monthly
payment.
Appraisal:
If the value of the mortgage required is overly high in respect to the

appraised value of the property, then the application most likely will be
rejected. Also, if similar properties in the same neighborhood have recently
sold for considerably less, then the amount of the down payment should be
raised, the selling price reduced, or the application will likely be turned
down.
LOAN APPLICATION PACKAGE

This usually includes:
1. The loan request: This is the actual formal application that contains
the borrower's name, the requested loan amount, the terms of the
loan, the purpose of the loan and how and when it will be repaid.
2. The borrower's information: This section helps the lender to evaluate

the borrower's capability and willingness to repay the loan
The purpose of the loan (property sale, property refinance).
The type of employment and its duration. If the applicant had
spent less than two years with his current employer then the
lender will request more information concerning past jobs.
The amounts of any other incomes like royalties, annuities, or
rents collected.
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The number of the applicants dependents and how long they will
continue to receive support.
The nature of the living expenses of the applicant, and the amount
remaining from her gross income after making the loan payments,
taxes, and insurance. What are the other debt obligations of the
applicant?
What was the previous experience of the lender with this particular
applicant, if any?
How is the debt repayment record of the applicant? What
references credit and otherwise can he present?
If the applicant owns another real estate property, the lender will
need to know the type, value, location, repayment obligations and
any encumbrances for this property.
Other assets the applicant may have, such as bank accounts, saving
accounts, or personal properties.
3. Property Information: Being the sole security for the loan, the
subject property has great importance for the lender in case the
borrower defaults on the loan. The decision of the lender about
whether to fund the loan depends equally on the value of the property
as well as the ability of the borrower to repay the loan. Since the
lender will set the loan value to a percentage of the property value, the
lender will need to know the exact value of this property. This
particular part of the loan package requires the following
information:
Specific and detailed information about the property including its
legal description and the common address (street address of the
property)
Detailed information about the property title including vesting,
claims, encumbrances, liens, and mortgages.
Detailed description on the land lot and the type of improvements
on it, including all work done on it during the last 90 days that
might be subject to mechanic's liens.
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The agreed-on purchase price and the terms of sale, including the
date of purchase, taxes, zoning, and assessments. Commonly, the
lender will request an original copy of the offer to purchase form if
the sale is contingent on the approval of the loan.
If the subject property is an income property (apartment or
commercial building), the lender will request detailed information
about the operating expenses of the property, the gross income of
the past years, as well as how any negative cash flow will be
covered.
The present value of the property, which may be different in some
cases from the purchase price.
4. Credit Analysis: The lender will estimate the willingness and the
ability of the applicant to repay the loan based on the following
points:
Detailed analysis of the submitted information in the loan
application and the supporting documents.
Information received by the lender from the credit bureau about
the credit history of the borrower.
Verification of the information submitted by the borrower in the
loan application form.
5. Decision of the Lender: The decision of the lender to assign the loan
approval to someone whose job is to assess and approve the
borrower, or to send it to the loan committee, is usually based on the
borrowers conformity with the lender's loan guidelines.
6. Processing Check List: The lender will use a check list of several
steps, actions and documentations needed to close the loan after the
approval decision is given.
STEPS FOR OBTAINING A REAL ESTATE LOAN
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The information should be collected about the borrower through the loan
application. Then this information should be analyzed financially, and the
personal data of the prospective borrower verified. The lender will finally
decide whether this candidate is qualified to get the loan or not. After
approval is provided by the lender's underwriter, the paperwork should be
processed and finally the loan can be closed.
The four general steps of obtaining a real estate loan:
1. Application
2. Processing
3. Underwriting (risk analysis)
4. Loan closing
APPLICATION
In an earlier era, everything used to happen in the close community of the

applicant, where the bank was located in the neighborhood, and the banker
responsible for the loans knew every person in town. At that time, anyone
who needed a real estate loan would go and ask the banker, who would
decide whether to provide the loan based on his life-long relationship with
the borrower and his family. Sometimes, the loan was funded and the
repayment guaranteed on the basis of a handshake and a great deal of trust.
Over the years, distances and relationship patterns between banker and
borrowers changed, along with the level of sophistication, and the process
of getting a real estate loan changed accordingly. Lenders started to request
the borrower-to-be to submit a written application requesting a loan and a
written promise to repay that loan on time.
At the beginning stages of applying this system, when there were still no
standard guidelines, the forms, data required on each of them, and
approval requirements varied from one lender to another. Because of the
fact that each lender was asking different questions to qualify a potential
borrower, it was reasonable that one borrower with the same background
might be accepted by one lender and refused by another.
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Currently, of course there is a standardized form for residential loan
applications used by all lenders: form 1003, the Uniform Residential Loan
Application. The standardized form makes it possible and easier for the
lenders to sell their loans on the secondary market (FNMA, FHLMC, and
GNMA) because the approval guidelines are common and consistent. The
HUD (Housing and Urban Development departments) and the VA
(Veterans Affairs) also approve this form and use it for the loans offered
through their programs. Even lenders who keep the loans in-house also use
the uniform loan application in order to make sure that their loans conform
to the secondary market requirements.
Also, because the information submitted by borrowers to every lender is

always the same, lenders can judge the trustworthiness of the borrower and
assess the risk involved according to standard analysis of the common loan
application.
Uniform Residential Loan Application (FHLMC/FNMA 1003)
This commonly used application form requests the following detailed

information from each potential borrower:
Type of mortgage and terms of loan

Property information and the purpose of the loan
Borrowers personal information
Employment verification
Regular monthly income and housing expenses of the borrower
Assets and debts of the borrower
Details of the transaction
Declarations and disclosures
Acknowledgements and agreements
Information for government monitoring purposes
Type of Mortgage and Terms of Loan

This is the first section of the loan application, which is a request for the
specific type of loan mortgage requested by the applicant, along with the
amount and terms of the loan.
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Property Information and the Purpose of the Loan
This section of the application form lists the detailed street address and
legal description of the subject property, how the title will be held, and
the source of the down payment.
Borrower/Co-borrower Information
The detailed information about the borrower helps the lender gauge his
qualifications and ability to repay the loan. In this section, the lender
requests the borrowers name, social security number, marital status,
number of dependents, address and the former addresses of the
borrower and the co-borrower(s).
Employment Verification
In this section the borrower shows evidence that he can repay the loan
by stating his employment information. The borrower submits his
employers name, address, the borrowers job description and the
duration of employment.
Monthly Income and Housing Expenses

Here, the borrower describes his monthly income, with how much of it is
allocated for his current housing expenses.
Assets and Debts

The assets of the borrower include any checking or savings accounts,
stocks and bonds, life insurance policies, real estate owned, retirement
funds, the net worth of any business owned, vehicles owned and any
other valuable items in his possession. Debts and liabilities are listed,
such as credit card accounts, pledged assets, alimony or child support,
any job-related or other amounts that may be owed.
Transaction Details
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This section will include detailed information about the transaction
including the purchase price, total loan amount, as well as any other
costs included in the deal.
Declaration and Disclosure

This section includes a list of declarations to be answered by the
borrower regarding any judgments, previous bankruptcy, foreclosures,
lawsuits, or any other voluntary or involuntary legal obligations.
Acknowledgement and Agreement

This section includes the final declaration by the applicant regarding the
integrity of the stated information, as well as an acknowledgment of the
borrower's awareness of the obligations incurred by this loan. The
borrower and co-borrower (if any), should sign and date this section.
Information for Government Monitoring Purposes:

This section is optional for the applicant. It includes the disclosure that
the lender is following the fair housing laws and guidelines as well as
home mortgage disclosure laws.
REQUIRED DISCLOSURES UPON APPLICATION FOR

A LOAN (RESPA)
The abbreviation RESPA stands for the Real Estate Settlement Procedures
Act, which is a consumer protection law. It was first passed in 1974 and its
initial purposes were:
To help consumers become better shoppers for settlement services
To eliminate kickbacks and referral fees that unnecessarily increase
the costs of certain settlement services.
SPECIAL INFORMATION BOOKLET
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According to RESPA, the mortgage broker or the lender must provide a
special information booklet to the loan applicant. This booklet contains
consumer information regarding various real estate settlement services
required for a transaction.
The first part of the booklet describes the settlement process and the nature
of charges. It also suggests the questions that borrowers should ask lenders,
attorneys and others to clarify what services each of them will provide in
return for their stated charges. It also highlights the borrower's rights and
remedies made available by RESPA and notifies the borrower about illegal
and unfair practices.
The second portion of the booklet is an itemized explanation of settlement

services and charges, with sample forms and worksheets that can aid the
borrower to make the required comparisons for costs and charges.
Part I
What happens when
Shopping for services
The role of the broker
Negotiating the sales contract
Selecting the appropriate attorney
Selecting the lender
Selecting the settlement agent
Securing title services
Home buyer's rights
Special information booklet
Good faith estimate
Lender designation of settlement service providers
Disclosure of settlement costs one day before closing and delivery
Escrow closing
Truth in lending
Protection against unfair practices
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Kickbacks
Title companies
Fair credit reporting
Equal credit opportunity
The right to file complaints
Home buyer's obligations
Part II
Specific settlement services
HUD1 settlement statement
Settlement costs worksheet
Comparing lender costs
Calculating the borrower's transaction
Reserve accounts
GOOD FAITH ESTIMATES (GFE)

Borrowers should be given a Good Faith Estimate of the settlement
(closing) costs within three days of submitting the loan application. This is
only an estimate of the total costs, while the actual costs may differ. The
goal of the good faith estimate is to provide the borrower with a proper idea
about the approximate charges and costs owed before the settlement or the
closing. The estimation is based on the common practice in the
neighborhood.
An accurate estimate of the good faith estimate is essential for the borrower
to make an informed decision. Giving the borrower a clear picture about
what he will have to pay for this loan should enable him to shop for a loan
more effectively.
MORTGAGE SERVICING DISCLOSURE STATEMENT

This form discloses to the borrower whether the lender will keep the loan in
his portfolio and service it by itself or transfer the loan to another lender. It
also provides information about complaint resolution.
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If the lender is not provide these documents to the borrower at the time of
the application, then he should send them to the borrower by mail within
three days. However, RESPA does not require the lender to send these
documents.
In fact, the RESPA law does not provide a clear penalty either failure to
provide the special information booklet, or the good faith estimate.
However, bank regulators may choose to impose penalties on lenders who
fail to comply with this federal law.
RESPA is designed to protect borrowers applying for residential mortgage

loans meant to fund purchasing of one- to four-unit family properties,
including houses, condominiums, and co-operative apartment units,
manufactured homes on a land lot. It also cover lots upon which a house
will be built, or a manufactured house placed, immediately after the
settlement. RESPA does not apply to home refinancing. RESPA is also not
responsible for setting the prices of closing services. On the other hand, as
noted, it provides the borrower with the information that clarifies the prices
of the settlement services enabling the applicant borrower to make a more
educated choices.
AFFILIATED BUSINESS ARRANGEMENT (AfBA) DISCLOSURE
The affiliated business arrangement disclosure (AfBA) is required if a

closing service provider offering a RESPA-covered transaction refers the
consumer to a provider with whom the referring party has an ownership or
other beneficial interest.
The referring party must submit the business arrangement disclosure to the
borrower at or before the time of referral. The disclosure form clearly
describes the business arrangement that exists between the two providers
and conveys to the borrower an estimate of the second provider's costs or
charges.
With the exception of referring a borrower to an attorney, credit reporting

agency or real estate appraiser to represent the lender's interest in the
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transaction, the referring party may not require the borrower to use the
particular provider being referred.
TRUTH IN LENDING ACT (TILA)
Title I of the Consumer Credit Protection Act is aimed at promoting the

educated use of consumer credit by requiring disclosures about its terms
and costs.
TILA requires lenders to make certain disclosures on loans subject to

RESPA within three business days after receiving the written application of
the loan. This prior disclosure statement is partially based on the initial
information provided by the borrower. Another final disclosure statement
is provided at the time of the loan closing. This disclosure is required to be
in a certain format and include the following information:
Truth in Lending Disclosure Requirements:
Name and address of creditor

Amount of the loan
Itemized amount of funds (optional, if good faith estimate is
provided)
Finance charges
APR (Annual Percentage Rate)
Variable Rate Information
Payment pattern
Total number of payments
Demand feature
Total sale price
Prepayment policy
Late payment policy
Security interest
Insurance requirements
Certain security interest charges
Contract reference
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Assumption policy
Required deposit information
ANNUAL PERCENTAGE RATE (APR)
When comparing two loans of any type -- a fixed-rate loan to another fixed-
rate loan, or a fixed-rate loan to an adjustable-rate loan (ARM) -- there is
one major point of comparison whether they are the same kind of loan or of
different types.
Annual Percentage Rates or APRs are designed to make this possible. The
simple definition of the APR is that it is a way to calculate the annual cost of
the loan, while taking in consideration of the loan points -- loan origination
fees -- as well as any other fees associated with the loan. The additional
costs include the appraisal charges, credit report fees, processing fees, and
document fees.
One of the confusing aspects of the APR is that on 15-year loans it will carry
a higher relative rate, due to the fact that the points are amortized over 15
years rather than the usual 30 years. When preparing Regulation Z
disclosure (Reg Z, the disclosure of the cost of loan) for a borrower, the
prepaid interest is also included in the APR calculation.
As a way of customer protection from companies that do not declare their

fees associated with a particularly low starter rate on an ARM or below
market rate on a fixed-rate loan, the APR role in such cases is to provide an
estimate of the true cost of the loan.
One of the common situations that occurs when a consumer receives a Reg
Z is that it appears the financed amount is less than the amount that the
borrower is actually financing. Many borrowers will jump on their phones
to contact the company about why they are receiving a loan of $146, 925
while they had actually applied for a loan of $150,000. This is where the
APR becomes handy.
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Let us take a look regarding how the APR is calculated. In this example,
assume a fixed rate of 8.5%, a 30-loan of $150,000 with monthly payments
of $1,153.37.
In order to calculate the APR for this loan, start by deducting $2,250 (1.5
points); $275.00 appraisal fees; $50.00 credit report fees; $500.00 for
processing and documents; and, other fees ($150,000 - $3,075 =
$146,925). At this point, use the $ 146,925 instead of $ 150,000 as the true
loan value in order to calculate the actual cost of this loan. By calculating
the APR loan while putting the value of the loan at $146,925 and monthly
payment of $1,153.37, then the APR will be 8.73%.
LOAN PROCESSING
After the potential borrower submits the loan application to the mortgage
lender, then the application is conveyed to a professional processor who
will order an appraisal of the property and a credit report on the borrower.
The processor is also responsible for sending out the required verification
mailing to confirm the employment status of the borrower, her income,
bank accounts and other liquid assets, and any other claims made by the
borrower that need to be verified.
The role of the Loan Processor:
Requests the appraisal

Request the credit report of the borrower
Requests the verification of employment status, income, bank
accounts and liquid assets.
After this, the processor compares the result of the verification mails to the
information submitted by the borrower in the loan application to confirm
that they match. If there is a difference, the borrower is asked for an
explanation to cover the discrepancy.
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Normally, the lender is highly interested in knowing how the borrower is
going to repay the loan. Through looking at the credit report of the
borrower, the lender will understand how the borrower usually behaves
regarding his commitments and obligations. The credit report usually
shows the credit history of the borrower in the past seven years while the
credit report should be less than 90 days old. The credit information must
be collected from two national credit agencies, as well as a search of the
public record for any involvement by the borrower in judgments, divorces,
tax liens, foreclosures, bankruptcies, or any other possibly damaging
information that might indicate a credit risk. The credit report should
include the personal information on the borrower's employment and
should reflect any credit inquiries made by a creditor within the last 90
days.
Because of advancements in technology, lenders tend to automate some of

the steps of loan processing. This technological advancement helped in
speeding the process and allowed the lender to make effective decisions,
while also contributing in decreasing the origination costs of the loan.
UNDERWRITING
One of the technological upgrades in the loan industry is Automated

Underwriting (AU). Through using the AU system, the lender can easily
and quickly evaluate different types of information including the borrower's
credit history, property information, and loan type to determine the
probability of the borrower repaying the loan. Credit bureau scores are used
in the AU to indicate the borrower's credit history, which is a primary factor
in estimating the mortgage application.
Processor's Final Checklist:
Residential Loan Application: FNMA/FHLMC form or any approved

equivalent
Typed copy of the form
Form completed along with the borrower's signature
Occupancy status included
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Application submitted with the verification documents
Residential Mortgage Credit Report
All supplementary documents, including the public record search
All the open credit accounts listed on the loan application.
Additional credit documentation
Direct verification included for any unlisted accounts on credit report
Letter verifying any adverse items on the list
Verification of employment/income
Verification of employment regarding the past two years
Verification of overtime and bonuses if needed for qualification
Completing of the last year and year-to-date earning section
If the borrower receives sizeable commission, then he need to include
2-year signed tax returns with schedules
Explanation for any employment gaps, and selfemployed
documentation
Two years' signed tax returns with schedules
Year-to-date and past two years financial and income statements
Income analysis form
Verification of deposit
Verified funds sufficient for closing
Average account balance for past two months listed; if not, then the
last two monthly statements
The source of funds: clarifying any substantial changes that took
effect on the account balance or any recently opened accounts or gifts
Gift explanation letter with verification of funds if available
The gift donor, if any, should be an immediate family member of the
borrower
Completed in full and signed by the borrower
Residential appraisal form FNMA/FHLMC official form or
equivalent approved form
Photos of the subject real estate property, street scene of the property
as well as photos of comparable properties
Review appraisal included (if available)
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All addendums and explanations
Purchase contract and escrow instructions
Sales contract with full addendums and signed by all parties
If the good faith deposit is 50% or more of the total down payment,
proof of payment should be included (canceled check or deposit
receipt)
Any additional documents that may be required
Divorce decree/separation agreement (if any)
Verification of child support/alimony if such amounts are used to
qualify, or if these amounts are obligatory to be paid by the borrower.
Construction cost breakdown, signed and in full details (if applicable)
Most recent one-year payment history on the previous mortgage
Rental agreements or lease contracts (if applicable)
Any necessary clarifying documents
Bankruptcy filing statement, schedule of debts, discharge and
explanation (if applicable)
Documents must not be older than 120 days, unless the property is a new
development where the documents may be up to 180 days old.
Eligible alternative documentations
Verification of employment alternative:
Pay stub or salary voucher for the most recent month with a year-to-
date balance indicating earnings
IRS W-2 forms for the previous 2 years
Documented telephone verification
Verification of deposit alternative:
The most recent three months' depository statements. Borrowers

should at least report the ending balance and all transactions
(deposits and withdrawals)
Credit report reference for the previous 12 months, or
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Mortgage payment history for the previous 12 months, or
A copy of all canceled checks in the last 12 months
FICO
The FICO score was created by Fair, Isaac and Company. This credit
scoring system is issued by most mortgage lenders to evaluate the
creditworthiness of the applicants for mortgage loans. The credit score,
known commonly as the FICO score, is a number that estimates the risk of
default or delinquency for the lender by a borrower applying for a loan for a
real estate property. The higher the FICO score, the lower the risk of the
loan and the higher the worthiness of the borrower's credit history. Lenders
use these scores to rank applicants and to determine whether they qualify
for a loan, how much they can have and at what interest rate, as well. The
use of FICO scores in anticipating the ability of the borrower to repay his
loan has increased significantly during the past few years. The
sophistication and the accuracy of the score system has also improved over
years of usage.
FICO scores range from 300 to 8500 points. The outcome is a result of a
complex statistical formula created by Fair and Isaac and based mainly on
the analysis of millions of borrowers' credit history patterns.
The FICO score is considered one of the most important factors in the
decision by the lender over which loans to fund. The credit score is used as
a primary method of screening applicants while employed as a compelling
and determinative factor in the final approval of the loan.
There are several methods for calculating credit scores. The primary
sources for the information used in a FICO score are from the three
national credit reporting companies, which accumulate more than 450
million files of individual customers. These three companies collectively
process over one billion credit statements every month.
The credit scores are based mainly on the credit report of past obtained
credit lines by the applicant and how he managed to repay these credits.
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These credit scores, through complex formulations and calculations,
estimate the likelihood of the borrower to repay the loan in a timely manner
and without any default. Each single characteristic of the report is assigned
a specific weight according to its contribution in anticipating the likelihood
of loan repayment. Any given credit report includes four categories of data
which have been collected and reported to the credit bureau:
Personal information
Credit information
Public record information
Inquiries
The three bureaus collect data independently from different sources, while
information about race, religion, marital status and national origin cannot
be used in the credit score, according to the Equal Credit Opportunity Act
(ECOA).
The three major credit reporting agencies are:
Experian
P.O Box 2104
Allen, TX 75013
8006827654
Trans Union
P.O Box 309
Springfield, PA 19064
8009168800
Equifax
P.O Box 105873
Atlanta, GA 30348
8006851111
When it comes to mortgage lending, the FICO score is the threshold of

approval or denial of any new mortgage loan. As noted, the better the
history, the higher the FICO score will be; the worse the history of credit,
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the lower the score. In some cases, the absence of a credit history may
result in no score on the FICO report. Then, the borrower will have to
submit alternative documents to show his payment pattern, such as utility
bills or rental documents.
There are five major types of information that FICO scores tend to evaluate
and weight as contribution, according to following percentages of
importance.
35%: Payment history on credit accounts, such as credit cards,

department store accounts and car loans.
30%: The amounts owed to creditors, including the total owed in all
accounts whether or not the borrower carried unpaid balances on a
credit card.
15%: The duration of time that the borrower has spent as a credit
user; the longer the better, assuming that the payments were made in
a timely manner.
10%: Has the borrower applied for a new credit line in the last six
months? The more credit acquired, the lower the score.
10%: The types and mix of credit use -- the borrower's score will
decline if the credit is from a credit company which has higher rates
of default.
The FICO score will take in consideration all these categories, not just one
or two of them. The final score is an aggregate of the analysis of all this
information and not a portion of it.
The importance of any factor of this information is determined by its weight

and also in regard with the other overall information of the credit report of
the consumer. Because of the variation in each applicants credit history, a
given piece of information will be have more of an impact on different
individuals. In addition to this, when the credit score changes, the
significance of each piece of information also changes. Therefore, it is
impossible to determine the importance of any piece of information
disregarding its proportion to the other pieces of information in the credit
report. The effect is based on the mix between all bits of information, the
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mix changes from one person to another, and also changes from time to
time for the same person.
The FICO score only concentrates on the numbers reflected in the credit
history of the person. However, the decision of the lender depends on some
factors other than the FICO score, including the income, duration of
employment, and the kind of credit requested.
The FICO score contains both positive and negative information in a credit
report. Late payments lower the score, while an established credit track
record raises it. Probably, the credit score of the borrower is the most
important factor in deciding about the mortgage loan. The following chart
is the general guide for the meaning of the symbols and grades in a FICO
score. While as stated, the higher the score, the better chance to obtain the
loan there is no definitive low grade that automatically disqualifies the
applicant from securing a loan.
FICO Credit Scoring:
A + and A
This is the best grade of the FICO score, where the score ranges from 620
and up with no late payments on a mortgage and one 30-day late payment
on the revolving credit (the credit card balance); also, there will have been
bankruptcies within the past two to 10 years. The maximum debt ratio is
36%-40% while the maximum loan ratio is 95%-100%. When the loan is
approved, this type of credit will win the best and lowest interest rates.
B + and B
This is generally a good credit score, ranging from 581 to 619. The credit
history can show two to three 30-day late payments of mortgage payments
and two to four 30-day late payments on the revolving outstanding balance
of credit card. It will not show any 60-day late payments. There must have
been no discharges of bankruptcy over the last two to four years. The
maximum debt ratio ranges between 45%-50%. And the maximum loan to
value in this case will be 90%-95%. In case the borrower has this grade, his
loan should have an interest rate 1%2% higher than the optimum rate.
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C + and C
This is a fair credit score, from 551-580. The credit history can show three
to four 30-day late mortgage payments. The repayment of installment
revolving credit can show four to six 30-day late payments or two to four
60-day late payments. It must be 1-2 years after a discharge of bankruptcy.
The maximum debt ratio in this case should be around 55%, and the
maximum loan value will be 80%-90%. In case the borrower has obtained
this grade, his loan will have an interest rate 3%-4% higher than the
optimum interest rate in the market.
D + to D
This is a poor credit grade, where the score ranges from 550 and lower. The
credit history can show two to six 30- day late mortgage payments or one to
two 60-day late payment, with isolated 90-days late. The revolving credit
card balance shows a pattern of late payments. A possible current
bankruptcy or foreclosure is allowed where all the unpaid judgments are to
be paid with the loan proceeds. In such a scenario, the applicant should
have stable employment. The maximum debt ratio averages around 60%
with maximum loan to value of 70%-80%. The interest rate in such case
will be around 12% to 14%, but the borrower can always refinance the loan
with better rates after paying for one year on time with no late payments,
and this will bring the interest rate down significantly. The aforementioned
grades are general guidelines. Some lenders may have slightly different
grades for different scores according to their method of evaluation.
After collecting all the needed information, the loan processor will make
sure that the loan file is complete and includes all needed documents to
support his assessment of the applicant. The processor sends the file to the
underwriter who will evaluate the risks brought to the lender and
recommends whether to fund this loan.
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CHAPTER SUMMARY
An overview of the loan processing summarizes the process in these

steps:
The application for a mortgage loan should contain:

- the needed personal information of the applicant
- the detailed data of the property
- the needed disclosures
- the employment verification data
- the assets and the liabilities of the borrower
- the type and the value of the mortgage
- the declarations needed for the loan
- the information for government monitoring purposes
The special information booklet contains two parts:

Part 1 discusses:
Shopping for different services
The job of the broker
Information about negotiating the sales contract
Selecting the attorney
Selecting the lender
Selecting the closing agent
Selecting the title company
The rights of home buyers
Good faith estimate
Lenders referral of closing services providers
Disclosure of closing costs
Escrow closing
Truth in lending
Protection against unfair practices
Kickbacks
Title companies
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Fair credit reporting
Equal credit opportunity
The right to file complaints
Home buyers' obligations
Part 2 includes:
Specific closing services

HUD1 closing statement
Closing costs worksheet
Comparing costs of different lenders
Calculating the transaction
Reserve accounts
Good faith estimate: A predictor of the closing costs, offered by the

lender to the borrower on or within three days of submitting the loan
application
Upon loan application and under the RESPA regulations, the

borrowers should be offered the following:
Special information booklet

Good faith estimate
Mortgage servicing disclosure statement
Truth in lending disclosure requirements:
Name and address of creditor

Amount of the loan
Itemized amount of funds (optional, if good faith estimate is
provided)
Finance charges
APR (Annual Percentage Rate)
Variable Rate Information
Payment pattern
Total number of payments
Demand feature
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Total sale price
Prepayment policy
Late payment policy
Security interest
Insurance requirements
Certain security interest charges
Contract reference
Assumption policy
Required deposit information
The role of loan processor
Issues the appraisal request

Issues the credit report request
Checks authenticity of employment history, bank account and income
verifications
The three major credit reporting bureaus --
Experian
Equifax
Trans Union
FICO credit scores
A grade (620 and above)

B grade (581 to 619)
C grade (551 to 580)
D grade (less than 550 )
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CHAPTER QUIZ
1. The following institutions all fund mortgage loans, except:
a) Fannie Mae (FNMA Federal National Mortgage Association)

b) Freddie Mac (FHLMC Federal Home Loan Mortgage Corp)
c) Ginnie Mae (GNMA Government National Mortgage Assoc.)
d) The Federal Reserve System the Fed
2. The company that the loan payments are made to is referred to as the:
a) Servicer
b) Processor
c) Originator
d) Payee
3. In order to determine the maximum mortgage loan amount for a

given applicant, the lender will use guidelines called:
a) Income to value ratios
b) Upsidedown ratios
c) Debt to income ratios
d) Borrower lender ratios
4. Which of the following serves as the primary security for the

mortgage loan, in case the borrower defaults on the loan:
a) The borrower's personal assets
b) The subject property
c) The borrower's promise to pay
d) The promissory note
5. The standard loan application form used by lenders is called the:

a) Uniform Residential Loan Application
b) Federal Residential Loan Application
c) HUD Residential Loan Application
d) Borrower's Residential Loan Application
6. The loan processor will perform all of the following steps, except:
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a) Order the appraisal
b) Order the credit report
c) Send out employment, income, bank account verification
d) Fund the loan
7. A key technological advance in the mortgage lending industry is:

a) Redlining
b) Automated underwriting
c) Automated funding
d) Distance funding
8. FICO scores are used for:

a) Evaluating appraisals
b) Using the date of application to determine who qualifies for a loan
c) Updating the loan servicing contracts
d) Evaluating the applicants willingness and ability to repay the loan
9. Experian, Trans Union, and Equifax are all:

a) Mortgage lenders
b) Title companies
c) Credit bureaus
d) Software programs
10. The most important factor for obtaining a good loan interest rate is:
a) Borrower's credit history

b) Mortgage market history
c) Current rates
d) Secondary mortgage market guidelines
11. The highest grade in the FICO score averages from:
a) 620 to 850
b) 580 to 780
c) 600 to 800
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d) 500 to 900
12. Under RESPA, the lender should offer the following to the borrower:
a) Credit report
b) Information booklet
c) Special gift
d) The lowest interest rate
13. Which is not one of the steps in obtaining a real estate loan:
a) Application
b) Processing
c) Estimation
d) Underwriting
14. A lenders estimated closing fee for a borrower is called a(n):
a) Appraisal
b) Good faith estimate
c) Good faith deposit
d) Debt deduction
15. Which part of the FICO score is most important?
a) The payment history of mortgage payments

b) The payment history of revolving credit
c) The duration of credit user
d) All of the above
Answer Key:
1. D 6. D 11. A
2. A 7. B 12. B
3. C 8. D 13. C
4. B 9. C 14. B
5. A 10. A 15. D
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CHAPTER THIRTEEN
LOAN UNDERWRITING AND CLOSING
INTRODUCTION
At this point, all the loan documents have been collected by the loan
processor and the loan package is completed. The file now goes to the
underwriter to perform his role, using the information introduced in the
loan package in order to determine whether this loan conforms to
guidelines and should be funded. This is the only remaining step in the
procedure of the loan and if the loan can pass this step successfully, then it
goes directly to the closing and funding.
RISK ANALYSIS
The process of analyzing the amount of risk involved in funding a certain
mortgage loan is known as underwriting. The underwriter will determine
whether the aspiring borrower has the capability to repay the requested
loan, as well as estimating whether the real estate property is able to serve
as sufficient collateral for the loan. The underwriters role also involves the
evaluation of both the borrower and the real estate property as a whole in
order to make sure that the conforming loan can be sold on the secondary
market, or directly to another permanent investor.
Whether the lender plans to keep the loan or sell it on the secondary
market, the loan should be attractive to the investor from on two levels:
have low risk, and be profitable. If any part of the processing or
underwriting is not performed accurately then the lender might find it
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difficult, or e impossible, to sell that loan on the secondary market.
Additionally, if the borrower defaults on an inaccurately-underwritten loan,
the losses may be significant to the lender. For example, in case the
appraisal is set too high and the borrower defaults, the lender could face a
profound loss if the property cannot be sold in case of foreclosure, or the
sale price is not enough to cover the loan value and the default fees and
charges.
UNDERWRITING GUIDELINES
If the lender is preparing to sell the loan on the secondary market, then the
lender must follow the guidelines set by Fannie Mae and Freddie Mac.
These guidelines are used primarily to protect the current lender or any
future lender as well as qualifying the potential of the borrower to repay the
loan on timely basis.
When the underwriter receives the loan package, he will begin the process
of evaluating the risk factors associated with certain elements inside the
application.
The different categories of risk analysis are:
Loan-to-value ratios
Loan amount
Down payment
Income ratios
Employment
Credit history
Appraisal
LOAN-TO-VALUE RATIO
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The LTV (loan-to-value ratio) is the ratio between the amount funded and
the total value of the property. For example, if the property value is
$100,000 and the funded amount (loan value) is $80,000, then the loan-
to-value ratio is 80% in this case. The difference between the amount of the
loan and the total value of the property equals the value of the down
payment paid by the borrower. The down payment is the equity (share) of
the borrower in the value of the property.
LOAN AMOUNT
Estimating the LTV is usually the most important step of the underwriting
process. With the increase of the down payment paid by the borrower, the
LTV ratio goes down, and consequently decreases the lenders risk. The
main uncertainty that faces the lender is that in case of default by the
borrower, the property will sold for less value. This means that the lender
will keep the property after foreclosure or it will be sold for less value;
either scenario is not a favorable situation for the lender. So, the task of the
underwriter is to make sure that the LTV ratio falls within the standard
guidelines of the particular loan type.
DOWN PAYMENT
Usually, the lender will request a down payment to be paid by the borrower
to demonstrate interest in the property as well as the financial acumen to
repay the loan. The rationale in such cases is that the borrower will do his
best to protect the investment if his personal money is tied up in the
investment, not just the loan funds. The capability of the borrower to pay
the down payment has been previously verified during the loan processing,
through checking his bank account to make sure the money is there. The
Verification of Deposit (VOD) establishes the existence and history of funds
to be used for the down payment as well as determining how long the funds
have been in the account. The reason for this check is to make sure that the
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loan applicant had not borrowed that amount recently from a friend or
relative, so there is actually no personal money involved in the purchase.
INCOME RATIOS
The ability of the borrower to repay the loan is a primary concern for the
lender. The underwriter will do the analysis for the risk associated with the
default of the borrower due to his inability to repay the installments in a
timely manner. The front-end-ratio was created according to the long
history of mortgage loans and default cases that had occurred through that
time. The front-end-ratio is the percentage that the housing expenses
represent from the borrower's monthly income. The percentage of income
that can be used for the housing differs according to the loan time. The VA,
FHA, and conventional loans differ in their requirements for the housing
percentage. Assuming that the loan is a conventional one, the following
expenses are added together as the housing expenses:
Principal
Interest
Hazard insurance premium
Property taxes
Mortgage insurance premiums
Homeowner's association dues
Land rent (if any)
Second mortgage payment (if applicable)
The total of all the previous expenses is considered the housing expenses
and should not exceed 28% of the gross monthly income of the borrower. In
some instances, the lender may accept a higher ratio if the borrower has a
strong credit history with no long-term obligations.
The majority of borrowers have other monthly payments, other than

housing expenses, including child support, alimony, credit card
payments, car payments, student loan repayment, or other regular
monthly payments. When adding these debts to the housing
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obligations, the total forms the back-end ratio or the total-debt
service. The back-end ratios are usually calculated separately from
the front-end ratios.
In most cases, traditional lenders will use the normal guidelines of
the total debt service, not to exceed the 36% mark of the gross
monthly income. In some cases, the lender can accept a higher ratio
of debt if the applicant is able to show
-the ability to pay a larger down payment from savings;
-a statement showing a large amount of money in savings;
-an extra strong credit history;
-a high net worth; or,
-a strong outlook for future earnings
EMPLOYMENT
The underwriter of the loan will check the Verification of Employment
(VOE) in the processed application in order to further determine how the
loan will be repaid by the applicant. The following factors are taken into
consideration by the underwriter:
The consistency of the salary/wage of the applicant

The potentiality of continued employment with the current employer
The consistency of bonus/overtime and its likelihood for continuing
The conformity of the dates of employment in the application with
the dates in the VOE
If the employer had signed the VOE
The applicant has spent at least 2 years with the same employer (if
the applicant has spent less than this period with the employer then,
a VOE is requested from the previous employer).
CREDIT HISTORY
Although it may seem that the mortgage lender is only concerned with the
ability of the borrower to repay the loan applied for, actually the lender is
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equally concerned with the willingness of the borrower to repay the loan.
The underwriter will review the previous residential mortgage credit report
to determine whether the borrower has a history of making mortgage
payments in a timely manner, according to the contract terms. If the credit
report in fact shows a positive history of meeting payments on time, the
underwriter will view it as a good sign of the of the borrowers
creditworthiness.
APPRAISAL
After checking the LTV ratios, loan amounts, down payments, income
ratios, employment, and the credit history report available in the loan
application package, the underwriter is required to reach a decision about
the safety of funding this particular loan to this particular borrower.
Because the mortgage loan is primarily secured by the property itself, the
value of the property should be taken into consideration to verify the LTV
ratio. The value of the property is determined by a professional appraisal.
The main role of the underwriter is to make sure that the funds of the
mortgage lender are protected in case the borrower defaults on the loan
payments and the lender resorts to foreclosure. This is done through
making sure of the value of the property which will be used to calculate the
LTV ratio. For example, if the lender is offering the borrower a LTV of 80%,
then the amount of the loan cannot exceed 80% of the value of the
property.
In case the property goes into foreclosure, the lender should feel reasonably
safe that the loan money will be regained eventually, because of the 20%
buffer zone between the value of the loan and the value of the property.
If the lender approves a loan with a higher LTV (90% for example), then the
20% buffer zone will be smaller and the risk of not collecting the loan
complete value will decline. Because of the greater risk contained by this
practice, the lender will impose higher loan cost on these loans with 90% or
even 100% of the LTV ratio. In cases of applying for a loan with a loan to
value which is higher than the usual 80%, the borrower should be prepared
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to pay higher interest rates and loan points than the usual 80% loans. On
top of this, the borrower is also obliged to purchase a mortgage loan
insurance policy.
FEDERAL AND STATE DISCLOSURES AND NOTICE

OF RIGHTS
The lenders who make mortgage loans and the mortgage brokers who are
involved in arranging them should work in full compliance with various
state and federal laws regarding disclosure. The underwriters should be
fully aware of these laws, as well, and work and act accordingly.
The settlement -- or the closing process as it is called in some states -- is the

formal process where the complete ownership of the property is transferred
from seller to buyer. It is considered the final step in the real property
buying process. It is also the time when title is transferred from the seller to
the buyer, as well.
There are certain disclosures that protect the rights of the buyer from the
unfair practices of the mortgage lenders. These disclosures are required at
different times during the loan transaction process.
In the previous chapter, we discussed the disclosures and the declarations

required when the borrower is applying for the loan, including: the special
information booklet (not necessary for refinancing), the good faith
estimate, the mortgage servicing disclosure statement, and truth-in-lending
disclosure statement.
DISCLOSURES AT SETTLEMENT/CLOSING
The HUD-1 settlement statement is a standard form that shows clearly all
the charges and the payments imposed on the borrower and the seller
regarding the settlement of the transaction. RESPA allows the borrower to
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request a check of the HUD-1 settlement statement one day before the
actual settlement date. The settlement or the closing agent must provide
the borrower with the completed HUD-1 settlement statement based on
information known to the agent at that time.
The HUD-1 settlement statement shows the actual settlement costs of the
loan transaction. In some cases split forms are prepared, one for the buyer
and one for the seller. In case the buyer or the seller does not attend the
closing process, then the HUD-1 settlement statement should be mailed or
delivered as soon as possible before the settlement or closing date.
The initial escrow statement should contain itemized costs of the estimated
taxes, insurance premiums and other anticipated charges to be paid from
the escrow account during the first year if the loan. It also lists all the
escrow payment amounts and any required buffer amounts. Although the
settlement statement is usually given at the settlement, the lender has 45
days from settlement to deliver the escrow statement.
DISCLOSURES AFTER SETTLEMENT

The loan servicers are required to deliver an annual escrow statement to the
borrower once a year. The annual escrow statement is meant to summarize
all the escrow account deposits and payments during the following 12-
month period. It is also meant to notify the borrower of any shortage or
surplus amounts in the account and advises the borrower about the best
course of action being taken during this year.
A servicing transfer statement is required in case the loan servicer decides

to sell or reassign the loan servicing to another establishment. Generally,
the loan servicer should notify the borrower about this transfer 15 days in
advance before the actual date of transfer. As long as the borrower is
making timely payments to the previous loan services, then he cannot be
penalized for 60 days. The notice of transfer should include the name and
the address of the new loan servicer, a toll-free number and the date that
the new loan servicer will start accepting payments from the borrower.
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LOAN CLOSING
After receiving and collecting all the information needed to make an
informed choice, after this information undergoes analysis and processing,
and the security of the loan has been verified, it is time to make the decision
on whether to make the loan. The choice will be made by the assigned loan
officer whose job is to decide which loans should be funded, or a loan
committee may undertake this job instead.
After the loan approval, the process continues to the last step -- the loan
closing -- where necessary documents are prepared, processed and signed.
The borrower receives the package of closing documents. Some of these

documents must be signed in front of a notary. The note and trust deed
should also be signed as the previous disclosures as well. When all the
documents are signed by the borrower, the trust deed will be recorded, the
loan will be funded, and the property is transferred to his possession.
CHAPTER SUMMARY
Risk analysis: This process is called underwriting in which a loan

officer is required to gauge all the risks associated with funding this
particular loan and this particular borrower. The process estimates
the potential for the borrowers capability and willingness to repay
the loan applied for.
The categories of risk analysis:
Loan-to-value ratios (LTV)

Loan amount
Down payment
Income ratios
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Employment
Credit history
Appraisal
The housing expenses involved in calculating the debt-to-income

ratio:
Principal
Interest
Hazard insurance premium
Property taxes
Mortgage insurance premiums
Homeowner's association dues
Land rent (if any)
Second mortgage payment (if applicable)
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CHAPTER QUIZ
1. The practice of analyzing the degree of risk involved in the

mortgage loan is known as:
a) Loan processing
b) Loan approval
c) Loan steering
d) Loan underwriting
2. The process of ________ involves the evaluation of both the

property and the borrower.
a) Loan application
b) Warehousing
c) Redlining
d) Loan underwriting
3. Upon receiving the loan package, the underwriter begins the

process of:
a) Evaluating the risk factors of certain elements on the application

b) Closing the loan
c) Gathering information about applicable interest rate
4. The loan-to-value ratio (LTV) is the relationship between:
a) The income of the borrower and the value of the property

b) The amount of the loan and the value of the property
c) The lender's liability and the borrower's risk
d) The loan amount and the future value of property
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5. The greater the borrower's ________, which would lower the LTV
ratio, the less the risk of the loan to the lender
a) Income
b) Down payment
c) Mortgage insurance
d) Collateral
6. The underwriter will use ___________ to determine the risk of

default because of the lack of the buyer's ability to make the payment
in a timely manner.
a) Risk ratios
b) Liability ratios
c) Income ratios
d) Loan-to-value ratios
7. Mortgage debt ratios (front-end ratio) for a loan is determined by:
a) Calculating the percentage of monthly income necessary to meet

the housing expenses
b) Calculating the percentage of monthly income necessary to meet
the educational expenses
c) Calculating the percentage of monthly income necessary to meet
future projected household expenses
d) Calculating the percentage of monthly income necessary to meet
the monthly housing expenses minus any long-term debts
8. Monthly payments by a borrower, other than housing, are known

as:
a) Long-term debts
b) Back-end debts
c) Front-end debts
d) Forbearance debts
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9. What is considered the main factor in deciding if the borrower will
repay the loan:
a) Bank account
b) Employment
c) Credit history
d) Personal verifications
10. The value of the property is determined by the:
a) Opinion of the borrower

b) Opinion of the lender
c) Appraisal
d) Underwriter
11. What is the last step of the loan process?
a) Underwriting
b) Approval
c) Closing
d) Analysis
12. The borrower should receive the HUD-1:
a) One day before the closing date

b) One day after the closing date
c) At the time of loan application
d) At the time of approval
13. Loans with higher LTV (higher than 80%) will involve:
a) Higher risk for the lender

b) Higher interest rates for the borrower
c) Lower buffer zone than 20%
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d) All of the above
14. The borrowers __________ allows the lender to approve a loan

higher than 80% LTV.
a) Good credit history

b) Marital state
c) Unusual circumstances
15. The_______ is considered one of the important documents to be

checked by the underwriter during the loan underwriting process.
a) Verification of employment
b) Birth certificate
c) Marriage certificate
Answer Key:
1. D 6. D 11. C
2. A 7. A 12. A
3. A 8. B 13. D
4. B 9. C 14. A
5. B 10. C 15. A
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CHAPTER FOURTEEN
LOAN SERVICING
INTRODUCTION
The simple definition of loan servicing is: performing all the tasks and
obligations needed for the good health of the loan during its life, both from
the perspective of the borrower and the lender, while making sure that the
process is profitable for the loan servicing company. The job of the servicer
is to conduct day-to-day management of the individual loans, as well as
managing the entire servicing portfolio and making sure that the mortgagor
and the investor enjoy protected investments.
The servicing is an independent task. It can be performed by the lender who

originated the loan or sold to another lender, investor, or a servicing
company. When a borrower applies for a loan he probably thinks that the
originating lender will retain the loan and carry out its servicing until it is
paid off or the property is sold. In most cases, though, this is not practical.
Today, the market changed; mortgage servicing rights are usually bought
and sold between different lenders and investors.
Commonly, the originating parties of any mortgage loan, like mortgage

brokers, will transfer the servicing rights of the loan to another mortgage
lender or investor to carry on with the task. Because loan servicing is still a
profitable process, the servicing contract will be sold for a fee, i.e. the
mortgage broker collects a fee from the investor in exchange for
transferring the servicing right to him. This fee is called the servicing
release fee or premium.
MORTGAGE SERVICER
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ROLES AND RESPONSIBILITIES
The primary job of the loan servicer is to collect the monthly payments for
the loan and manage the escrow account that had been previously
established. The escrow account would be set by the lender in order to
manage the payment of the property taxes and the hazard insurance
premiums, once they become due on the property during the year. In this
way, the lender uses the escrow account to protect its investment in the
property.
When the escrow account is set up, the servicing company should provide
the borrower with an estimate for the annual estimated taxes, insurance
premiums, and any other anticipated charges during the upcoming year,
with the anticipated total for these payments.
The mortgage servicing company is also required to give the borrower an

annual report about activity in the escrow account. The statement should
reflect the payments made for property taxes and home owners insurance.
In order to protect consumers, the National Affordable Housing Act

requires the lender or the mortgage servicer to do the following:
Provide the customer with a disclosure statement:
The disclosure statement indicates whether the lender intends to sell the
loan immediately after closing, or whether the mortgage servicing can be
sold at any time during the life of the loan, as well as the percentage of the
loans previously sold by the lender. In 1992, lenders had to disclose the
percentage of the loans for which servicing was sold in the previous two
years, i.e. 1991 and 1992. Starting in 1993, lenders had to disclose the
percentage for the past three years.
The percentage is usually marked like this: 0-25%, 26-50%, 51-75%, 76-
100%. The lender also must provide information about the servicing
procedures, transfer protocols and dispute resolution.
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If the borrower had a face-to-face interview with the lender, then the
borrower should receive the disclosure statement at the time the
application is submitted. If the borrower is applying for the loan through
mail, then the lender has three days to send the disclosure statement to the
applicant or the borrower. On the other hand, if the borrower does not
return the disclosure statement form to the lender after signing it, then the
lender cannot fund the loan.
Sending the proper notification to the borrower if the loan

servicing rights are to be sold to another party:
If the current loan servicing company is planning to sell the loan servicing
rights to another party, the borrower must be notified at least 15 days
before the actual effective date of transfer of the rights, unless he has
received a previously written transfer note at the time of loan closing. The
effective date is the date when the rights to the loan servicing are
transferred to the new servicer and the collection address is changed to the
new servicer's address.
In some cases, the servicing company has up to 30 days after the effective
date to send the notification: These circumstances are:
1. The lender is ending the contract because the borrower already

defaulted on the loan.
2. The servicing company is filing for bankruptcy.
3. The Federal Deposit Insurance Corporation or the Resolution Trust
Corporation have begun proceedings to take over the servicer's
operations.
When the loan servicing rights are being sold, the borrower should receive
notices from the selling servicing company and another notice from the
company that will take over the loan servicing. The new servicer should
send notification to the borrower in a period not to exceed 15 days after the
transfer of rights.
The notice coming from the new servicer should include:
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1. The name and the address of the new servicer.
2. The effective date when the old servicer will stop accepting payments
and the new servicer will start accepting monthly payments from the
borrower.
3. Toll-free or collect-call telephone numbers for both the current and
new servicer that the borrower can call for more information.
4. Information informing the borrower whether she can continue
optional insurance like mortgage insurance or disability insurance
and what procedure the borrower should follow in order to maintain
the coverage. The borrower should also know if there will be any
change in the insurance policy terms.
5. The borrower should receive a statement declaring that there will be
no change in the condition of the mortgage documents, except the
terms that are directly related to the servicing of the loan. For
example, if under the old conditions the borrower had to pay the
property taxes on his own, the new servicer cannot demand the
opening of an escrow account instead. In case the previous servicer
was neutral regarding this point, then the new servicer may require
the change in these terms.
Borrower should be granted a grace period during the transfer

of servicing rights:
After the transfer, the borrower is allowed a grace period of 60 days. During
this period, the borrower cannot be charged a late fee in case of mistakenly
making the payment to the old servicer instead of the new one. In addition,
if the new servicer received a late payment from the borrower due to
mistake, the servicer cannot report it to the credit bureau.
The servicer should respond instantly to written inquiries:
If the borrower believes that there are some fees collected by accident, or if
there is any problem regarding the servicing of the loan, then the borrower
can send a written inquiry to the servicer. The account number of the loan
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should be included in this inquiry, along with the reason why the borrower
believes there has been a mistake in the payment collection.
Within 20 business days of receiving the written inquiry, the servicer

should respond to the borrower confirming receipt of the inquiry. Within
60 business days, the servicer should respond by correcting the account or
justifying the payment in question. In either case, the servicer should
respond in writing regarding the resolution of the inquiry.
The borrower should not deduct any disputed amounts from the monthly
payments. Most servicers will consider this a partial payment, refuse the
check and charge late payment fees, or more drastically -- the servicer may
declare that the borrower defaulted and start a foreclosure procedure.
What should a borrower do in case of an unresolved complaint?
If the borrower believes that the servicer did not respond properly to a
written inquiry sent by the borrower and/or not within the time limits, then
he can contact the local or state consumer protection office.
The borrower can also send a complaint to the Federal Trade Commission
(FTC). Its address: Correspondence Branch, Federal Trade Commission,
Washington DC 20580. Although the FTC does not usually intervene in
individual cases the information submitted by the borrower may help in
realizing there is a pattern of violation of the law.
The borrower may also benefit from some legal advice from an attorney.
According to the National Affordable Housing Act, borrowers can initiate
class action suits and obtain actual damages, plus additional damages, for a
pattern or noncompliant practice. In case of successful suits, the borrower
may be also reimbursed for legal fees.
What if the borrower has a problem with the servicer?
There is a wide array of licenses and authorities under which a mortgage

company services a home loan, including the real estate broker license
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issued by the Bureau of Real Estate (BRE). Regardless of the authority or
the license under which the servicer is chartered, there are several steps
that a borrower can make to try to solve problems regarding loan servicing.
The majority of the loan servicers have a toll-free number for customer
service. The borrower should first start by calling the servicer and explain
the problem. When a borrower calls the servicer, he should have the loan
number and the pertinent documents ready. The borrower should
document the call through writing down the name of the customer service
agent, the date and the time of call and what was promised in that call.
If the customer service agent is not able to solve the issue on the same call,
the borrower should ask the customer service agent to follow-up, and
schedule a time-frame when the borrower will be re-contacted. Also, after
speaking with a customer service agent, or in case the borrower was unable
to reach the servicer through phone, he should send a hard-copy mail
explaining the problem. The mail should be sent to the correspondence
address of the servicer, which appears on the monthly loan statement or
documents.
According to section 6 of the Real Estate Settlement Procedures Act

(RESPA), which is enforced by the Department of Housing and Urban
Development (HUD), a servicer is required to acknowledge such a written
request to resolve a problem within 20 business days and to attempt to
resolve the problem within 60 business days. If the correspondence is not
acknowledged or the problem not resolved within this time frame, then the
borrower may file a complaint with the HUD through its website
http://www.hud.gov or contact the HUD enforcement center at 202708
2350. The address to mail a complaint to HUD is: Department of Housing
and Urban Development, Room 9282 Washington DC 20410.
In some cases, the borrower can open a civil law suit against the servicer.
What does the transfer of servicing rights mean?
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When the borrower applies for a loan from a mortgage company or a bank,
there is always a possibility that the loan will be re-sold in the future to
another lender or investor, or transfer the servicing rights to another
institution. Servicing means the collection of the monthly payments of the
mortgage and the management of the operational procedures related to
mortgage loans. When the servicing rights are sold, it means that the new
lender or the new servicer will start collecting the payments, handle the
escrow account, pay the insurance premiums, pay property taxes, and
answer the questions of the borrowers. This may happen just after closing
the loan or it may happen years later.
The practice of selling and transferring the servicing rights to another

lender is a very common and a completely legal practice done by most
lenders in the mortgage industry market. In most cases, the loan is not sold
alone, but bundled in a package with several other loans. A reasonable
percentage of loan originators and lenders immediately sell the servicing
rights just after closing the loan as their standard procedure. This practice
is more cost- effective for these lenders as servicing the loan is not a regular
part of their business. It is not uncommon for borrowers to obtain a loan
from the bank in their neighborhood, only to find that it is sold after closing
to another institution out of state. It is also common that the servicing
rights may be sold more than once during the loan life.
No matter how many times the servicing rights are sold or when, nothing
should change for the borrower regarding the monthly payments or loan
conditions. In fact, the transfer of rights has nothing to do with the
borrower himself.
What are the effects of transferring the servicing rights?
The company currently holding the servicing rights holds the sole decision
of transferring servicing to another institution. The company doesn't need
to get the borrower's permission for such a practice, but is obliged to inform
the borrower about the servicing transfer before it actually occurs.
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The transfer of servicing rights should not affect the borrower or the loan
quality by any means. The original terms and conditions of the loan should
remain the same till the end of the loan life no matter how many times the
servicing rights are transferred. As for fixed-rate loans, the interest rate and
loan duration will never change till the end of the loan life. The monthly
payment amount and schedule should remain the same except for changes
in taxes or insurance requirements raising or lowering the escrow amount.
If the borrower is holding an Adjustable Rate Mortgage (ARM), then the

original conditions of the loan will remain the same while the rate will
change according to the agreed-upon adjustment periods (six months, one
year, three years, etc.). All this information should be included in the loan
contract, but the borrower may want to verify it with the new servicing
company. If the original lender agreed that the borrower can change his
mortgage into a fixed-rate loan after a certain period of time, then the
borrower should confirm whether this agreement will be approved by the
new servicer.
When should the borrower be notified about the transfer?
When the lender decides to transfer the servicing rights to another

institution, it should send a goodbye letter to the borrower five to 15 days
before the next payment is due. The letter should include the name of the
new servicing company that will take care of payment collection, its
designated address, contact phone numbers of the representative
responsible for the loan and the date the borrower should send the next
payment to the new servicer. The borrower should receive a welcome letter
from the new servicer that affirms the same information. Both letters
should contain identical information about the name of the new servicing
company, its address, phone number, toll free number if available, and the
date of the next payment.
An important consumer safeguard
It is highly important to receive both letters from the original servicer and
the new servicer. It is crucial for the borrower to inform the original
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servicer in case he only receives a letter from the new servicer in order to
verify the transfer of the servicing rights or not. It is also important for the
borrower to keep the servicer updated about the address and the contact
details of the borrower to ensure receiving all mailed correspondences.
Where the borrower should make the next payment
If the borrower has received both letters, from the old and the new
servicers, and verified the contents with the old servicer, then he should
proceed with payment to the new servicing company. If the payment is sent
to the old servicing company, then the borrower risks that the monthly
payment won't reach the new servicer on time, incurring late payment fees,
or having the payment get lost in between. It the borrower's responsibility
to send the monthly payment to the new servicing company once he is
informed about the transfer of the servicing rights.
The welcome letter usually includes the information with the next payment
coupons. But if the payment is due before the coupons arrive, the borrower
should write the loan number on the check and send it to the address
provided in the welcome letter. If the borrower has coupons from the old
servicing company, then he can include one with this payment.
The borrower should make sure that he reads all the information included
in the welcome letter carefully, and that he understands the instructions of
payment very well. The payment date will not change by any means because
it is determined in the original conditions of the loan. In case the payment
is made through electronic funds transfer or direct deposit from the bank,
the borrower should cancel those existing arrangements and file a new form
directing the bank to deposit the monthly payments to the new servicer.
Since such procedures may take time, the borrower may need to send a
check for the first payment with the new servicer in order to avoid late
payment fees and until the electronic orders take effect. This is also the
borrowers responsibility. The new servicer is not allowed to collect the
payment from the borrower's savings or checking account without his
permission and signature.
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If the borrower mistakenly sends the monthly payment to the previous
servicer, then that servicer should forward it to the new servicing company,
but this will likely not recur with the payments to follow; by continuing to
send payments to the old servicer, the borrower is risking that they will get
lost. Often, the old servicer entity doesnt even exist anymore, due to
merger or takeover.
What will happen to the borrower's escrow account?
It is the responsibility of the old servicing company to inform the insurance

company and the tax authority of the change of servicer. If the escrow
account is interest-bearing, then all interests due should be credited to the
account by the old servicer before the transfer of rights takes place. The old
servicer is responsible of taking care of this issue before the transfer.
In some cases, after the servicing rights are transferred, the new servicing
company may analyze the escrow account. During the analysis, the lender
reviews the escrow amounts and determines if it is adequate to cover the
fees for insurance, taxes and any other premiums paid through escrow. If
the amounts in the escrow account are found insufficient then the lender
may ask the borrower to increase the monthly payments to cover the
shortage. If it is the regular policy of the new servicer to analyze and review
the escrow accounts then the monthly payment may change in amount, and
the borrower should receive a formal letter from the servicing company
explaining this change and why it took place.
What happens to the insurance policy and the taxes?
If the borrower receives a notice that either their tax or the insurance
premium is due, then she should make sure that the new servicer has this
updated information and confirm that the funds have already been
escrowed for the premium. If the new company has not received a copy of
the bill, it will usually direct the borrower to send the bill in for payment. If
the borrower has a question about any issue after the transfer of the
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servicing rights, then she should contact the new servicing company, even
though it was the previous servicer that collected the funds for the
insurance or tax payments.
Some mortgage companies may offer to place in escrow life or disability

insurance (the type of insurance that will pay off the mortgage in cases of
death or disability). In such cases, the lender who originated the policies is
named as the beneficiary. If the borrower takes out any of these policies
then the old servicing company should inform the borrower about the
effects the transfer of rights will have on the insurance, and what are the
actions needed to maintain the coverage against these accidents.
For flood and hazard insurance, the previous servicer's responsibility is to

notify the insurance agent about the transfer. Usually, it is doable to change
the name of the beneficiary company into the name of the new servicing
company, but it is a wise move for the borrower to make sure that
everything went smoothly; so in case something happens, the name on the
check matches the name of the servicing company.
Who will send the end-of-year tax statement to the borrower?
The borrower should find out which servicing company will be reporting
the interest paid for income tax purposes. Sometimes, both lenders will
report for the periods they had the loan under their responsibility. It is
common that the new servicer will compile the information from the old
servicer and send one complete statement to the borrower at the end of the
year. The borrower should make sure of this issue at the time of transfer in
order to determine if there will be one or two statements at the end of the
year.
CONSUMER CHECKLIST
The borrower should always keep the loan servicer updated about any
changes in his address, phone number, e-mail or other contact
details. This information should be provided in writing and forwarded
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to the address indicated in the welcome letter. This address in most
cases is different from the address where the payment checks are
sent.
When loan servicing rights are transferred, the borrower should
receive both goodbye and welcome letters. If not, the borrower should
call the former servicer to verify the transfer.
When the borrower receives the letters, he should confirm they
include the name, address and contact information of the new
servicing company, along with the payment instructions.
When making the monthly payments after the transfer, the borrower
should follow the instructions carefully to avoid losing the funds.
The borrower should make sure that the insurance companies
(homeowners, flood/hazard, life, disability) and the tax authority
have been notified about the transfer.
The borrower should find out which company will submit the end-of-
year tax report for income tax purposes.
Should any questions arise after the transfer took place, the borrower
should contact the new servicer as soon as possible; attending to the
problem promptly makes it easier to be handled.
CHAPTER SUMMARY
Loan servicing is the day-to-day management of individual loans,
collection of monthly payments and management of escrow accounts.
Servicing rights are a profitable business, with most companies

specializing in this process not being the originators of the loan.
Servicing rights are usually bought and sold on the mortgage market.
The company selling the servicing rights of a loan to another company

should notify the borrower about this transfer 15 days prior to the
actual transfer date.
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The actual transfer date is called the effective date, when the new
servicing company starts receiving the monthly loan payment and
becomes responsible for the management of the loan and escrow
account.
The previous servicing company should provide a letter containing

the new servicing companys name, address, and contact information.
The new servicing company sends a letter with the same information
along with the payment instructions for the monthly payments to
come.
There is a grace period of 60 days during the time of transfer, so in

case there is a late payment during this period, there will be no late
fees.
If the borrower does not receive the goodbye letter from the old
servicer, he should verify the letter received from the new servicer
with the old servicer.
It is the borrower's responsibility to change the name of beneficiary

on the life and disability insurance policies to the name of the new
servicing companies
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CHAPTER QUIZ
1. Who is required to conduct day-to-day management of individual

loans, as well as the entire servicing portfolio?
a) Loan processor
b) Loan servicer
c) Loan originator
d) Loan officer
2. An escrow account is a(n):

a) Account established to provide borrowers with the funds needed to
make loan payments
b) Account established to provide interest payments to lenders
c) Fund established to pay any foreclosure costs
d) Fund established by lenders to pay tax and insurance premiums
3. This law enacted in 1990 protects borrowers from abuse by loan

servicers:
a) Real Estate Settlement Procedures Act (RESPA)
b) TruthinLending (Regulation Z)
c) National Affordable Housing Act
d) FIRREA
4. If the borrower has had a face-to-face interview with the lender then
he must receive the disclosure statement:
a) At the time the application is submitted
b) Within three days
c) Within one week
d) When the loan is funded
5. The current loan servicing company transferring servicing rights to

another servicer must notify the borrower of the transfer at least
_____________ before the effective date:
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a) 15 days
b) 30 days
c) Within 45 days
d) No notification is required
6. Which of the following is included in the disclosure of transfer?

a) The name and address of the new servicer
b) The effective date that the prior servicer will stop accepting loan
payments
c) The effective date when the new servicer will begin accepting loan
payments
d) All of the above
7. After the transfer of rights, there is a grace period of:

a) 21 days
b) 45 days
c) 49 days
d) 60 days
8. During the grace period, the borrower:

a) Can cancel the loan
b) Can have the total amount of the loan called due and payable
c) Is not responsible for late fee charges
d) Should contact the new servicer and renew the servicing contract
9. If the borrower believes an improper charge or penalty was collected

by mistake, or if there are any problems with the servicer, he should:
a) Contact the servicer in writing
b) Subtract the amount of the mistake from the next payment
c) Make the regular payment and ignore the mistake
d) Stop making payments until the mistake is rectified
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10. RESPA requires a servicer to acknowledge a written request to resolve
a problem within:
a) 10 business days
b) 20 business days
c) 30 business days
d) 40 business days
11. RESPA states the servicer should respond by rectifying mistakes or

submitting a written explanation within:
a) 40 days
b) 60 days
c) 90 days
d) 120 days
12. On flood and hazard insurance, whose responsibility is it to notify the

insurance agent regarding the change in servicing rights?
a) The previous servicer
b) The new servicer
c) The borrower
d) The original lender
13. If a borrower has a question after loan servicing is transferred, he

should ask:
a) The old servicer
b) The new servicer
c) HUD
d) The information center
14. On life and disability insurance, whose responsibility is it to notify the

insurance agent on changes in servicing rights?
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a) The old servicer
b) The new servicer
c) The borrower
d) The original lender
15. When a new servicer takes over the loan, the end-of-year tax
statement should be submitted by the:
a) Borrower
b) Loan originator
c) New servicer after compiling info from old servicer
d) Tax authority
Answer Key:
1. B 6. D 11. B
2. D 7. D 12. A
3. C 8. C 13. B
4. A 9. A 14. C
5. A 10. B 15. C
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CHAPTER FIFTEEN
CONSUMER PROTECTION MEASURES
INTRODUCTION
The Consumer Credit Protection Act was established in 1968 and was
considered landmark legalization at that time. This Act launched the Truth
in Lending disclosures. It stated for the first time that the creditor has to
declare and explain the cost of borrowing in common language, so that
terms were clear to the borrower. The goal was for the borrower to know
exactly how much he was going to pay in advance for the borrowing
charges, to have the opportunity to compare the costs of different lenders,
and to shop for the best lending opportunity.
The protections imposed on credit have greatly increased since the passage
of that important bill in 1968. The concepts of "fairness" and "equality"
have been embodied in different laws to prohibit unfair discrimination in
credit transactions. Laws have made it mandatory for the lender to tell the
borrower why his credit request was declined. It also allowed the borrowers
to learn more about their credit records, and set up a way for the consumers
to settle disputes over billing issues.
Each of these laws was meant to apply more protection for the borrowers of
credit, an essential progression because of the great involvement of credit
in the daily life of every person in this country. With the growth in
complexity of credit borrowing itself, these laws were crucial to lessen
problems and confusion regarding the process.
WHAT CREDITORS LOOK FOR
Creditors are mainly interested in finding borrowers who are able and
willing to repay their debts. Another plus for a borrower is to possess extra
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security as collateral to protect their funds. So, creditors are looking for the
Three Cs.
Capacity
Character
Collateral
CAPACITY
Is the borrower able to repay his debt? That is why creditors ask questions
about the borrower's employment; when did start working for his current
employer, what are his current wages? Creditors are also interested to know
the expenses of the borrower; how many dependents are there in the family
of the borrower? Is the borrower responsible for paying alimony or child
support, and for how long? Also the creditor wants to know if there are any
other regular expenses or obligations.
CHARACTER
Is the borrower willing to repay the loan? Creditors will look into the
borrower's credit history and analyze his past repayment history toward
past and current obligation to determine whether he will commit to
payments on time or not. Creditors are also interested in signs of stability in
the borrower's life; the creditor asks questions like how long has the
borrower been in his current residence? Does the borrower rent or own his
home?
COLLATERAL
Creditors also want to make sure that their funds are fully protected in case
the borrower defaults on the loan. The creditor will want to know what are
some other resources of the borrower other than monthly income, such as
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savings or any other investment, and can they be used as collateral for the
loan in case of no payment.
Creditors usually use different combinations of these three factors to reach

their final decision about the loan. Some creditors set unusually high
standards, while others will refrain from funding certain type of loans to
avoid uncertainty. Also, different creditors have different rating systems.
Some creditors rely mainly on their experience with past borrowers and
their instinct about the particular applicant being looked at, while other
creditors base their choice just on meeting common standards of credit-
scoring, statistical analysis to gauge the ability of borrowers to repay debts.
The creditor will assign a certain number of points to each of the different
characteristics with direct relation to the ability and the willingness of the
borrower to repay the loan applied for. The borrower then will be rated
according to the sum of the points he has earned.
Although the facts may be the same, the way that each creditor will utilize
and process these characteristics can lead to different conclusions. One
creditor may find a given borrower to be an acceptable risk, while another
creditor will decline the loan for the same borrower with the same facts.
INFORMATION NOT FOR USE BY CREDITORS

The Equal Credit Opportunity Act (ECOA) does not mean that every
applicant will get approved for the loan she is asking for; the borrower still
needs to fulfill the requirements of the creditor. What the Act does mean is
that creditors cannot use any information that may lead to discrimination
against the borrowers. The ECOA bans creditors from discrimination
according to age, marital state, color, gender, or national origin. The Act
also declares that there shall be no discrimination if the borrower receives
public income including veterans benefits, welfare, and social security, or
because the borrower benefits from his rights under federal credit laws,
such as filing a billing error notice with a given creditor. This protection
means that the creditor cannot use any of this information as grounds to:
Discourage the consumer from applying for a loan with the creditor.
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Decline a loan for the borrower if he is qualified for the requested
amount.
Apply terms for the borrower's loan, different from those allowed for
another borrower with similar income, expenses, and credit history.
Close an existing loan because of age, marital status, national origin,
religion, race, color, or gender, because of receiving public income, or
because of exercising the rights granted by the federal credit law.
Although creditors are banned from discriminating against borrowers

according to their national origin, they can take immigration status into
consideration when gauging the risks involved with the loan.
SPECIAL RULES
Over the past 35 years, the rules of creditworthiness have drastically
changed. Due to these large-scale changes, applicants cannot be blamed for
not knowing their rights when borrowing money from credit
establishments. Consumer protection has become complicated because of
the wide array of acts and measures defending everyone's right to equal
protection under those laws.
Age: Previously, many older applicants had complained about declined

loan applications because they had passed a certain age. Others had
complained about reductions or cut offs of their credit just after their
retirement. The law is very specific about how a person's age may be used in
making creditworthiness decisions.
Creditors are allowed to ask a borrower about his age, but if he is old
enough to legally sign loan documents (18- or 21-years old according to
each state's law) then the creditor is not allowed to:
Reject a borrower because of his age, or offer the borrower less credit,
or less favorable terms solely because of his age.
Ignore the borrower's income after retirement when evaluating the
application.
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Close the borrower's credit account or ask him to re-apply for credit
because he reached a certain age or had retired.
Decline a borrowers credit application or close a borrower's account
because credit life insurance or any other credit-related insurance is
not available for those of a certain age.
Creditors can include age as one of the categories in the credit score sheet,
but if the applicant is more than 62-years old, then he must be awarded
points equal to those given to a person who is 62-years old.
Given the fact that the financial situation of each person changes at certain
points of his life, creditors are allowed to ask some questions that are age-
related. For example, the creditor can ask the borrower how long he has
spent in his current work position, and how long he plans to work until
retirement, and how long the current income of the borrower will last. An
older person may not be qualified for a large loan with a small down
payment and long repayment period, but may qualify for a small loan with
a shorter repayment duration and relatively larger down payment. Even
though that in many cases income declines with age, the applicant can still
support his application with a solid credit report and his repayment history
with past creditors. So, even with consumer protection, age is still one of
the factors which a creditor can consider when estimating the risk of that
loan.
Public assistance: Creditors are not allowed to decline credit requests

from borrowers receiving public support or assistance, such as temporary
assistance for needy families (TANF). As in the case of old age, public
assistance is also considered as one factor among others used to estimate
the qualifications of the applicant, and should be analyzed in regard to the
other factors of that specific applicant. So, the creditor is allowed to ask
some questions regarding the public assistance received, such as: How long
will this assistance remain effective, or how long will the borrower remain
qualified for this assistance. If the borrower is receiving public aid because
of his dependents, then the borrower may ask for the age of these
dependents and when the assistance will stop for them. This information
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will help the creditor determine whether it is possible to consider this
public assistance as a part of the applicant borrowers income.
Housing loans: When applying for a housing loan, the Equal Credit
Opportunity Act protects the borrower requesting a loan for home
improvements or home acquisition from discrimination by the creditor
according to the race, origin, color, or gender of the borrower, or because of
the national origin or race of the occupants in the neighborhood. The ECOA
also bans creditors from including the information about the race and
national origin of the neighbors or the borrower himself in the appraisal
report. It is also mandatory that the borrower receive a copy of this report,
provided that he submits a written request to receive one.
Gender discrimination: In general, both men and women are protected

against discrimination based on gender when applying for credit. Although
the Act outlaws discrimination based on gender, its main aim is to protect
women from being refused when applying for credit based on the
misconception that single women neglect their debts and/or lose their
income when they marry and stop working to take care of their children.
The law states clearly that being a woman or a man should make no
difference when estimating the qualifications of a loan applicant.
Additionally, the marital status of the woman should make no difference
either, no matter if she is single, divorced, married, widowed, or separated.
Below are some important protections mentioned by the law:
Gender and marital status: Commonly, the creditor will not ask for the
gender or include it in the application form. Also, borrowers are not
expected to put Mr., Mrs., or Miss before their names.
Childbearing plans: Creditors are banned from asking female applicants

about birth control practices or future childbearing plans; in addition, they
are not allowed to make any decisions based on assumptions about the
applicant's plans.
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Income and alimony: Creditors must count any type of income from the
woman, including income from part-time employment. Alimony and child
support payments are considered part of the woman's income and the
creditor should include them in the total income of the applicant. Women
are not compelled to declare such types of payment, but if they are cited in
their application, then the creditor should include them in the total income.
It is the applicants responsibility to demonstrate to the creditor that she
can keep a steady income out of payments such as alimony or part-time
wages.
Telephones: Creditors should not ask women whether they have a

telephone under her name or not, as this will be considered major
discrimination against married women whose phones might in their
husbands name. A creditor may ask if an applicant has a telephone in their
residence.
Gender-neutral accounts: Many women have been declined at least

once for a loan. Some women have had to bring their husbands to cosign for
their loans meaning that the husband is required to pay if the wife
defaulted on the loan even if the woman had her own resources to pay for
the loan herself. Single women had bigger problems getting a loan because
they were regarded by creditors as less reliable borrowers than single men.
Now, women have the right to their own credit based on their own history
and monthly earnings. This means that a woman can obtain her own credit
and her own account, not a duplicate card on her husband's account or a
joint account where the husband has to cosign. See the rules, below:
Creditors cannot refuse to open an account or fund a loan based on

gender or marital state.
A woman can choose to use her first name and maiden name (Jessy
Gold), her first name and husband's last name (Jessy Smith), or her
first name and a combined last name (Jessy Gold-Smith).
If a woman is creditworthy, the creditor is not allowed to ask her to
bring her husband to co-sign with her unless community property
rights are involved.
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Creditors are not allowed to ask questions about the current or ex-
husband when a woman is applying for a loan based on her own
income, unless that income includes alimony, child support, or
separate maintenance payments from a spouse or former spouse.
The last rule is not applicable if a woman's husband is going to use the
account or will be responsible for paying the debts on the account or if the
woman is living in a community property state.
The community property states are: Arizona, California, Idaho, Louisiana,

Nevada, New Mexico, Texas, Washington, and Wisconsin.
Change in Marital Status: It is not unusual when married women face

some credit cut-off after the death of their husbands. Single women have
had accounts involuntarily closed when they got married. On the other
hand, many married women reported that they had their accounts closed
when they got divorced. The law declares that creditors may not force a
woman to re-apply for credit because of any change that occurred to her
marital status (divorced, married or widowed). The creditor is also not
allowed to close a woman's account or change the terms of her loan based
on these reasons. There must be other signs indicating an alteration in the
creditworthiness of the woman accompanying any marital changes, in order
to allow the creditor to take any action. For example, the creditor may ask a
woman to re-apply for credit if she relied on her husband's income to get
the credit the first time.
When a woman sets up her own account, she can protect herself by
establishing her own history of handling debt. She can rely on this record in
case of any changes that occur to her marital status and the financial
consequences of this. When a woman is planning to get married and
decides to take her husband's name, she should notify her creditors that she
wishes to maintain her separate account.
DENIAL OF CREDIT APPLICATIONS
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As noted above, the borrowers race or gender can never affect his chances
in obtaining the credit, and should not be used to discourage the individual
from applying for a loan. Creditors should never delay or decline any credit
application based on these reasons. According to the Equal Credit
Opportunity Act, a borrower should be notified regarding the approval or
denial of his credit application within 30 days of its submission. If the
application is denied then the notification should be in writing, declaring
the reason for denial with specific reasons, as well as disclosing the right of
the applicant to ask for an explanation. The borrower has the same rights if
an account is closed by the creditor.
In other words, if borrowers are declined for a credit application, then they
should be able find out why. The reason for the denial may be that the
creditor has the perception that the borrower had requested more money
that what he apparently could repay through his current income. Another
possible reason is that the borrower had not worked or lived in the
community long enough to be considered a stable enough risk. Whatever
the reason for the denial, the applicant has the right to know what they are
to provide him with options to improve his creditworthiness.
BUILDING A GOOD CREDIT HISTORY

On the first attempt to obtain credit, the borrower may face the frustration
of being declined because of a lack of credit history. Apparently, it seems
that would-be borrowers need credit in order to get more credit. Some
creditors will disregard this point and focus instead on the applicant's job,
salary, and other financial information submitted in the application.
However, most creditors will be interested in knowing how the applicant
has handled his past financial obligations; how reliably has the applicant
repaid his debts. Creditors will search records kept by credit bureaus, or
credit reporting agencies, whose role is to collect, store and report
information about borrowers. This information is routinely supplied by the
lenders and includes the amount of credit a borrower has received and how
or if it has been repaid.
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Below are some ways a borrower can begin building good credit:
Start by opening a checking account or a saving account or, even

better, both. The accounts themselves will not establish a good credit
report but may be used as a sign that the borrower has money and
can manage it. Cancelled checks are another sign of reliability,
showing the borrower is committed to paying his utility bills and rent
bills on time.
Apply for a department store credit card. Repaying the outstanding
credit balance on time is a plus in a credit history.
Ask if it is acceptable for a creditor to issue a credit card against
deposited funds. Even though the credit limit will be no greater than
the deposited amount, a credit card is another sign of financial
stability for the would-be borrower.
If the borrower has just moved to the town, she can ask for a
summary of any credit record kept by the credit bureau in her former
residence town or city.
If the borrower, according to his current credit standing, does not
qualify for a loan, he can ask a friend or a relative to cosign the
application for more creditworthiness.
If the borrower is turned down for a credit application, he has the
right to find out why and try to address the reasons.
MAINTAINING COMPLETE RECORDS

Mistakes that occur on a borrower's credit can affect the future credit he
applies for. A consumer's credit record is so important that the borrower
should confirm that the report prepared by the credit bureau is complete
and accurate. The Fair Credit Reporting Law declares that a borrower must
be told about what's in credit file and have any errors or mistakes corrected.
NEGATIVE INFORMATION
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In case the creditor declines a borrowers credit application because of
unfavorable information on the credit report supplied by a credit agency,
the borrower has the right to obtain the name, address and contact
information of this agency. Then, the borrower can contact them by mail or
in person. Although the borrower may not receive the same exact copy of
the report, he should be able to learn exactly what is in the report. The law
also indicates that the agency should help the borrower interpret the
information in the report, as the raw data report may require professional
expertise to access it. If the borrower is asking about a credit refusal that
was made within 60 days, then the credit bureau should not charge him any
fees for explaining the report.
If the borrower notifies the bureau about an error, the bureau must
investigate and solve this error within 30 days after receiving the notice.
The bureau will contact the creditor and ask it to remove any incomplete or
inaccurate information from the credit file. If the borrower does not agree
with the findings of the report, he submit a short statement -- not more
than 100 words -- with the file, in order to present his side of the dispute.
The future reports to other creditors should also include this statement or
its summary.
OUTDATED INFORMATION
In some cases, credit information is too old to convey an accurate picture of
the borrower's current financial situation. There is a limit for such
information to be kept in a credit file.
Bankruptcies should not be included in the report after 10 years.

However, information about any bankruptcy that occurred in any
time should be reported if the borrower is applying for life insurance
with a face value exceeding $150,000, for a job paying $75,000 or
more, or for credit with a principal amount of $150,000 or more.
Lawsuits and judgments paid, tax liens, and most other unfavorable
type of information should not be added to the report if they
happened more than seven years previously.
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A borrower's credit report should not be provided to anyone who does not
have a legitimate business reason to see it. Department stores to which a
borrower is applying for credit may examine the record, but curious
neighbors, of course, may not do the same. Prospective employers may
examine a borrower's record with his permission only.
FILING A COMPLAINT WITH FEDERAL AGENCIES

If the borrower has a complaint about a bank or any other financial
institution, the Federal Reserve System may be able to help in such a
situation. The Fed investigates consumer complaints received against
statechartered banks that are part of its system. Complaints about these
types of banks or financial institutions will be investigated by one of the 12
Federal Reserve banks around the country. The Fed will forward any
complaints about banks or financial institutions to the appropriate federal
regulatory agency; it should notify the borrower about where the complaint
has been forwarded. On the other hand, a consumer may contact the
appropriate agency through the list that will be provided later in this
chapter. In most cases, these agencies will not handle individual
complaints, but will use the information about a consumer's credit
experience to help enforce the credit laws.
When the consumer is submitting a complaint to the Fed, it should be in

writing and should be addressed to the appropriate department. The
written complaint should be directed to the Division of Consumer and
Community Affairs, Board of Governors of the Federal Reserve System,
Washington, DC 20551. Make sure to provide the full name and the address
of the bank, a brief description of the complaint, and any documentation
that could help in investigating this complaint. (It is advisable to send
copies, instead of the originals.) The letter should also be signed and dated.
The Fed will acknowledge the complaint within 15 business days, letting the
consumer know whether the Fed will investigate this complaint or will
instead forward it to the appropriate federal bank to investigate.
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For the complaints handled by the Fed itself (those related to state-
chartered members banks), the Fed will analyze the bank's response to the
complaint to ensure that the consumers' concerns have been settled, and
will send the consumer a letter about its findings. If the investigation
resulted in discovering a violation of the Feds laws and regulations, it will
notify the customer about the nature of the violation and the corrective
action the bank has been directed to take.
Although the Fed will investigate complaints about the banks it regulates, it
does not have the authority to resolve all types of issues, such as contractual
and factual disputes about bank policies or procedures. However, if a
customer files a complaint, a bank may voluntarily offer to work with the
customer in order to resolve the situation. If the matter is not resolved, the
Federal Reserve should advise the customer about whether he should
pursue a legal procedure to resolve the issue.
FEDERAL CONSUMER PROTECTION LAWS

The substantial influence of the federal government in housing issues has
provided a healthy environment for the continual growth of private
ownership of properties in the United States. Because of the fact that the
laws guarantee fair and equal treatment of all consumers have been passed,
more people are able to buy their own residences.
EQUAL CREDIT OPPORTUNITY ACT (ECOA)

Credit a loan -- is used by millions of individuals to finance their needs
like education, buying a house, remodeling their current residence, or
boosting their business.
The Equal Credit Opportunity Act (ECOA), discussed previously, is

designed to make sure that all consumers enjoy an equal chance in
obtaining a loan. However, this does not mean that all consumers are
qualified to any loan they apply for. As noted, there are several factors of
qualification like income, expenses, number of dependents, debts, and
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credit history taken into consideration when qualifying a customer for a
loan and determining his creditworthiness.
This law protects a borrower when dealing with any type of creditor who
regularly extends credit, such as banks, small loan companies, finance
companies, retail stores, department stores, credit card companies, and
credit unions. All the parties involved in granting credit - including
mortgage brokers who arrange the financing of sold houses -- are covered
by this law. Businesses applying for loans are also protected by it.
According to ECOA, when a consumer is applying for a loan, the creditor

may not:
Discourage the applicant from applying for credit because of his

sexual orientation, race, national origin, religion, marital state, or age,
or because the applicant is receiving public assistance income.
Ask the applicant to reveal his or her sex, race, national origin or
religion. The creditor may request the borrower to reveal this
information voluntarily (except for religion) if applying for real estate
loan. This information helps the authorities and federal agencies to
enforce the anti-discrimination laws. The borrower may be asked
about his or her residence status or immigration status.
Ask the applicant whether he or she is widowed or divorced. When
permitted to ask about the marital status, the only terms that can be
used in this case are: married, unmarried, or separated.
Refrain from considering regular alimony, child support, or separate
maintenance payments as part of the income. The creditor may ask
for proof that the applicant is receiving these payments consistently.
Under ECOA, the applicant has the right to:
Get credit without a co-signer, if the borrower meet's the creditor's

standers.
Have a cosigner other than a borrower's husband or wife, if one is
necessary.
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Keep his or her own accounts after a name change because of marital
status change, reaching a certain age, or retiring, unless the creditor
has evidence that the borrower is not able or willing to pay his debts.
Know whether the application submitted to the creditor is approved
or declined within 30 days of submitting the completed application to
the creditor.
Know the reason for declining the application. The creditor must give
the applicant a notice explaining the specific reason for rejecting the
application or a notice declaring the right of the applicant to request
an explanation for the rejection reasons.
Receive a clear and acceptable reason for the application rejection.
Acceptable reasons may include: "Your income is too low, or You
were not employed long enough. Unacceptable reasons may include
You did not meet our minimum requirements to qualify," or "You
did not receive the minimum required points on our scoring system.
Indefinite and unclear reasons are considered illegal.
Know why the borrower was offered less favorable terms than applied
for, if the creditor had accepted similar terms for other applicants.
Examples of less favorable terms may include higher finance charges,
or a lower amount of money than the requested amount in the
application.
Know why the borrower's account was closed or why the terms of the
account had been changed into less favorable ones, unless the account
was inactive or delinquent.
REMEDIES FOR DISCRIMINATION

If a consumer suspects discrimination, then she should:
File a complaint with the creditor itself to confirm that the applicant
is aware of the law. In such cases, the creditor may find the error and
rectify it accordingly.
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Check with the Attorney General of the state to see if the creditor had
breached the law of equal credit opportunity or not in order to
prosecute the creditor.
File a lawsuit in federal district court. If the applicant wins the
lawsuit, she can obtain damages, including punitive damages (which
are damages up to $10,000 for the fact that the law was breached)
and compensation for attorney's fees and court costs.
The borrower can also join other denied applicants and file a class
action suit. The group can receive punitive damages of up to
$500,000 or 1% of the creditor's net worth, whichever is less.
The applicants can also report the breaches to the appropriate
government agencies. If a borrower was declined by a creditor, the
creditor must supply the name and the address of the appropriate
governmental agency that the applicant can contact. Although some
of these agencies do not deal with individual cases, they can use the
information aggregated from different individual complaints in order
to decide which establishments should be investigated.
Agencies that May be Involved in a Complaint:
If the case involves a retail store, department store, small loan company,
mortgage company, oil company, public utility, state credit union,
government lending program, or credit card company the consumer should
contact:
Consumer Response Center, Federal Trade Commission (FTC)

Washington, D.C. 20580
The FTC cannot intervene in individual complaints, but the information

provided may indicate a pattern of possible breaches that require further
actions taken by the Commission.
If the complaint concerns a nationally-chartered Bank (National or N.A.

will be part of the name of the establishment), then the consumer should
submit the complaint to:
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Comptroller of the Currency Compliance Management, Mail Stop
7-5 Washington, D.C. 20219
If the complaint involves a state-chartered bank that is insured by the

Federal Deposit Insurance Corporation (FDIC), but is not a member of the
Federal Reserve System, then the consumer should write to:
FDIC Consumer Affairs Division
Washington, DC 20429
If the complaint involves a federally-chartered bank or federally-insured

savings and loans association, then the consumer should file the complaint
with:
Office of Thrift Supervision, Consumer Affairs Program

If the complaint concerns a federally-chartered credit union, then the

consumer send it to:
National Credit Union Administration, Consumer Affairs

Division
If the complaint concerns all kinds of creditors, then the consumer should
file his or her complaint with:
Department of Justice, Civil Rights Division
EQUAL CREDIT EMPLOPYMENT ACT REGULATION B
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Regulation B was issued by the Board of Governors of the Federal Reserve
System to implement the provisions of the Equal Credit Opportunity Act
(ECOA). The law was enacted in 1974 to make it unlawful for creditors to
discriminate in any aspect of a credit transaction on the grounds of gender
or marital status. In 1976, through the amendments to the Act, it became
unlawful for the creditor to discriminate on the basis of race, gender, color,
religion, national origin, age, receipt of public assistance and the good faith
exercise of rights under the Consumer Credit Protection Law.
The main goal of the ECOA is to stop discrimination in the approval of

credit by requiring banks and all types of creditors to make extensions of
credit equally available to all creditworthy applicants with fairness,
impartially, non-biased, and without discrimination on any unlawful
grounds. The regulation is applied to consumer and other types of credit
transactions.
REAL ESTATE SETTLEMENT PROCEDURES ACT

(RESPA)
This Act, previously discussed, protects the consumer from any unlawful
practices and abuses during the purchase process of residential real estate
property and the associated loan process and enables them to be better
informed users (consumers) by requiring disclosure and declarations of the
exact costs of the settlement services.
RESPA applies to all federally related mortgage loans used to purchase or

refinance real estate property improved with one to four units, provided
that the property includes the primary residence of the applicant. These
may also include most purchase loans, assumptions, refinances, property
improvement loans, and equity lines of credit. In such the case that you
have a complaint regarding such issues then you should contact the HUD's
Office of Consumer and Regulatory Affairs, Interstate Land Sales/RESPA
Division which is responsible for enforcing RESPA Act.
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The Department of Housing and Urban Development (HUD), the Federal
Housing Administration (FHA) monitors several regulatory programs to
make sure of the equity and the efficiency of the housing sales. The Real
Estate Settlement Procedures Act (RESPA) is applicable to most of
mortgage loans and lenders, not just the FHA-backed mortgages.
The Goals of RESPA
To aid applicants to get fair settlement services by requesting the

creditors and those involved in the loan processing to disclose clearly
the key service costs in advance.
To protect borrowers by eliminating kickbacks and referral fees that
would unnecessarily increase the costs of settlement services.
To protect borrowers through prohibiting certain practices dome by
the creditors that may increase the cost of settlement services.
RESPA requires the borrower to receive the disclosure of the costs at

various times. Some of these disclosures are meant to declare the main
costs associated with the settlement procedure, some will outline the lender
servicing and escrow account practices. In addition to this, some
disclosures will also describe business relationships between settlement
service providers.
RESPA is also meant to protect the borrowers by requesting a series of

disclosures that should prevent unethical practices by different mortgage
lenders, and also the disclosures that can help the borrowers to choose the
most suitable real estate settlement servicers for their own case. These
disclosures should be done at various times throughout the settlement
procedures.
Disclosures submitted at the time of filing the loan application:
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When a potential mortgage borrower applies for a mortgage loan, the
lender must provide him or her with the following:
The Special Information Booklet, which contains the needed

information about the various real estate settlement services.
The Good Faith Estimate of settlement costs, which shows the
charges that the potential buyer is likely to pay for settlement and
states whether the lender requires the buyer to use a particular
service provider or not.
The Mortgage Servicing Disclosure Statement, which explains to the
buyer whether the lender intends to keep the mortgage loan in its
portfolio or will transfer it to another lender for servicing, and also
provides the needed information about how the buyer can file the
disputes and resolve any complaints he has. RESPA does not impose
specific penalties for lenders that fail to provide these disclosures on
time, but bank regulators have the authority to impose such fines on
the lenders.
If the borrower is applying through mail or over the internet (not in person)
and did not receive such disclosures at the time of application then the
lender should send these disclosures within three business days of the
application date.
If the lender declined the loan application within these three days then the
bank is not required to send this information to the borrower.
As we said before, the RESPA Act is not responsible for imposing fines and
penalties in case of failure of delivering these declarations within the
appropriate time, but the bank regulators have the authorities needed to
impose fines to these banks that do not comply with the federal law.
Disclosures before the time of settlement (closing time):
An Affiliated Business Arrangement Disclosure is required in case

that the settlement service provider is referring the customer to
another firm where there is a connection between bother service
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providers, such as common ownership. The service provider should
not force the borrower to use a specific service provider.
A preliminary copy of the HUD1 Settlement Statement is required,
in case the borrower request it 24 hour before the closing date. This
form gives estimates of all the settlement charges that should be paid,
both by the buyer and the seller.
Disclosures at settlement
The HUD1 Settlement Statement is required to show the actual

charges of settlement.
An Initial Escrow Statement is required at closing or within 45 days of
closing. This itemizes the estimated taxes, insurance premiums, and
other charges that will need to be paid from the escrow account
during the first year of the loan.
Disclosures after settlement
An Annual Escrow Loan Statement must be delivered by the servicer

to the borrower. This statement states in brief all escrow account
payments and deposits during the past year of the loan. It also
notifies the borrower of any shortages or surpluses in the account and
tells the borrower how these can be paid or refunded.
There should be a Servicing Transfer Statement if the current servicer
of the loan is willing to transfer the servicing rights to another
servicer.
In addition to these disclosures, RESPA also protects the borrowers by

prohibiting some other practices:
Kickbacks, fee-splitting, and unearned fees: Any person is

prohibited from depositing or receiving a fee, kickback, or anything of
value against referrals of settlement service business involving
federally related mortgage loan, which includes almost all the loans
made for residential properties. RESPA also prohibits fee splitting
and receiving unearned fees for services not actually performed.
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Breaches for these RESPA provisions can be punished with criminal
and civil penalties.
Seller-required title insurance: The seller is prohibited from
requesting the buyer of the real estate property to use a specific title
insurance company. The buyer can sue the seller who breaches such
provision.
Limits on Escrow Accounts: There is a limit implied by RESPA on
the amount that the lender can request the buyer to deposit in the
Escrow Account for paying the taxes, hazard insurance, and other
property related charges. RESPA does not require the lender to ask
the borrowers to open an escrow account, but some government loan
programs and some lenders may require an escrow account. During
the life of the loan, RESPA also prohibits the lender from charging
additional amounts for the escrow account. In addition to this, each
year the lender must notify the borrower of any escrow account
shortage and return any surplus amounts more than $50.
Borrowers who believe that a settlement service provider has breached the RESPA
law in an area where the Department has enforced authority may wish to file a
complaint. The complaint should outline the violation and identify the violators by
name, address and phone number. Complainants should also provide their own
contact information including the name, and a phone number for follow
up questions and explanations from the HUD. Requests from the
complainant for confidentiality can be entertained. These complaints
should be sent to:
Director, Interstate Land Sales/RESPA Division, Office of

Consumer and Regulatory Affairs, U.S. Department of Housing
and Urban Development, Room 9146, 451 7th St SW
TRUTH IN LENDING ACT (TILA)
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The Truth in Lending Act (TILA), Title I of the Consumer Credit Protection
Act also known as Regulation Z -- is aimed at promoting the informed use
of consumer credit by requiring disclosures about its costs and terms. The
Truth in Lending Act requires the declaration of the "Financial Charge" and
the "Annual Percentage Rate" and some other costs and terms of credit
in order to give the consumer the chance to compare and choose between
different available credit options. This Act also limits the liability on the lost
and stolen Credit Cards. Generally, this Act is applicable for every person or
business that offers or extends credit. When the credit is offered or
extended to a borrower, it is subject to finance charges or is payable by a
written agreement in more than four installments, the credit is intended
primarily for personal, family, or household uses, the loan balance is equal
to or exceeding $25,000, or is secured by an interest in real property or a
dwelling.
TILA aims to help the consumer to compare the costs of cash versus credit
transaction, as well as the cost of credit among different lenders. The
regulation also requires that the lender sets a maximum interest rate in
variable rate contracts secured by the borrower's residence. The Act also
implies a certain limit on home equity plans that are subject to the
requirements of specific sections of the Act and requests a maximum
interest that may apply during the term of mortgage loan. On top of this,
TILA also establishes the standards of disclosure forms for advertisements
that refer to certain credit terms.
Originally, the federal Truth in Lending Act was enacted by the congress on
1968 as a solid part of the Consumer Protection Act. The law was originally
designed to protect the consumers in credit transactions by demanding
clear declaration of the key costs and the major terms of the lending
agreement. On 1980, the Act was reformed and simplified as a part of the
Depository Institution Deregulation and Monetary Control Act. The Truth
in Lending Act is essential for small businesses involved in consumer credit
transactions or consumer leasing.
Regulations:
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The Act had been implemented by the Federal Reserve Board through two
major regulations:
Reg Z explains how to comply with the consumer credit parts of the law.
The law is applied to each person or business that offers or extends credit, if
four conditions are fulfilled:
1. The credit is offered to the consumer

2. The credit is offered on regular basis
3. The credit is subject to "finance charges" interest or must be paid
in more than four installments according to a written agreement.
4. The primary use of the credit is personal, family or household.
If the credit was extended to business, for commercial or agriculture

purposes, then regulation Z do not apply for such loan types.
Regulation M includes all the rules for consumer leasing transactions. This
law applies to contracts in the form of a bailment or lease where the use of
personal property is primarily for private, family or household uses. The
lease period must exceed $ 25,000; regardless of whether the lease has the
option to purchase the property at the end of the lease term.
HOME MORTGAGES
In most cases, the home loan or home mortgage is considered the biggest
lending transaction an individual will take. Usually this is the highest
amount a person borrows to purchase a residence. This particular type of
loans became more complicated in the recent years. In the old years, any
person looking to buy a residence or a new home would have few options to
choose from. In most cases, he will only have the option of a traditional 30
year fixed rate loan to fund his new property. Nowadays, there are several
types of mortgage loans with varying durations and interest rates. These
loans are available to every home buyer looking for a loan to fund his or her
new property. The Federal Reserve Board and the Federal Home Loan Bank
Board have published a book called "Consumer Handbook on Adjustable
Rate Mortgages" in order to help the borrowers to understand the purposes
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and uses of Adjustable Rate Mortgage loans. Regulation Z requires the
creditors offering ARMs to offer this book or any similar book to the
consumer looking for a loan.
DISCLOSURES
In general, the disclosures are required before the credit is offered. In
certain cases, the disclosures should be done in periodic billing statements.
Reg M includes similar rules for disclosing terms when leasing personal
real estate, family or household use, if the obligation total is less than
$25,000.
Generally, the disclosure is required before a closed-end credit transaction

is completed (settlement). (There is one exception for this when the credit
is extended over the phone or by e-mail; in those cases, a disclosure may be
made after the fact.) Disclosure is also required before the first transaction
under an open-end account, and once more at the time the periodic billing
statement is sent.
A "closed-end credit transaction" is any transaction that includes any credit

arrangement (either a consumer loan or credit sale) that does not fall
within the definition of an open-end credit transaction.
An "open-end credit transaction" refers to all credit transactions that

include credit arrangements like revolving credit cards, where the
consumer (credit card holder) is not required to pay off the principal
amount by any specific date. Instead, the credit card holder is simply
charged the interest rate on the principal amount periodically and is usually
required to make a minimum payment on periodic basis (usually monthly).
The term credit sale means a sale in which the seller is the lender; that is,
the amount of the purchase price is financed by the seller. This includes any
consumer lease, unless the lease is terminable without a penalty at any time
by the consumer, or in the event:
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The consumer agrees to pay an amount equal to, or more than, the
total value of the property or services involved.
The consumer has the opportunity to purchase the property for at
least nominal consideration.
According to Reg Z, the disclosure should include the following essential

credit terms:
Finance charges: Commonly, the most important disclosure to be

submitted, this is the amount of money charged to the borrower for
the credit.
Annual percentage rate: This is the estimation of the annual costs and
charges of the credit and should be disclosed every year of the loan
life.
Annual financed: The amount that is being borrowed through a
consumer loan transaction, or the amount of the sale price in cases of
a credit sale.
Total payments: Includes the total amount of periodic payments
being paid by the consumer or the borrower.
Total sales price: The total cost of the purchase on credit, including
the down payment, as well as periodic payments.
Evidence of compliance with TILA should be kept for at least two years
after the date of disclosure. Disclosures should be clear and specific and
delivered in a form that the borrower can easily keep.
HOME OWNERSHIP AND EQUITY PROTECTION ACT

(HOEPA)
HOEPA deals specifically with highrate and/or highfee mortgage loans
that are refinanced or a home equity installment loan.
HOEPA addresses certain deceptive and vague practices in home equity

lending. It is considered as an amendment to TILA, establishing the
standards and requirements for certain loans with high rates and high fees.
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The rules for these kinds of loans are contained in section 32 of Reg Z
which implements TILA so the loans are also called section 32 mortgage
loans. Below, which loans are covered by HOEPA, its disclosure
requirements, prohibited features, and the actions that the borrower can
take against lenders who breach the law.
Which loans are covered:
A loan is covered by the law if it meets the following criteria:
For the first lien mortgage (the first and original loan on a specific
property), the annual percentage rate (APR) is eight percentage
points more than rates on Treasury securities of comparable maturity
For the second lien mortgage (the second loan on a specific property),
the APR is ten percentage points more than the rates on Treasury
securities of comparable maturity.
The total fees and points payable by the consumer on or before
closing exceed $625 or 8% of the total loan amount, whichever is
greater (the amount of $625 is as of 2003; this benchmark figure is
set every year by the Fed, based on the prevailing Consumer Price
Index). The credit insurance premiums written in connection with the
credit transaction are counted as fees.
These standards do not cover the loans to buy or to build a home, reverse
mortgages, or home equity lines of credit (similar to revolving credit
accounts).
Required Disclosures
If a loan meets the above standards, the consumer taking this loan should
receive some disclosures at least three days before the date of loan closing.
Lenders must provide the consumer with a written notice stating that the
applicant does not need to complete the loan, even if the lender has
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delivered the final approval and all disclosures. The borrower-to-be still has
three more days to decide whether to accept the loan or pass.
The disclosures must clearly warn the applicant that, upon accepting the
loan the lender will hold a mortgage on the property, meaning that the
borrower could lose the property or the money invested in it if he is unable
to make the periodic loan payments (default on the loan).
The creditor must disclose the APR of the intended loan, the regular
payment amount (including balloon payments if any), and the loan total
amount. The creditor should also state whether the insurance premium is
included in the total amount of the loan. In case of variable interest rate
loans, the creditor must declare in the disclosure that the rate and monthly
payment can increase and state the maximum amount for the monthly
payment.
In addition to TILA disclosures, the borrower should receive these

disclosures no later than the closing date of the loan.
Prohibited Practices
The following options are banned from use with highrate and/or high fee
loans.
Balloon payments: These refer to when regular monthly payments do

not fully pay off the principal balance and a major payment of more
than twice the amount of the regular monthly payment is required,
for loans with less than five-year terms. There is only one exception,
for bridge or swing loans of less than one year used by consumers to
buy or build a home. In such cases, balloon payments are not
prohibited.
Negative amortization, which involves paying small monthly
payments that do not fully pay off the loan which cause an increase in
the total principal debt.
Default interest rates are higher than predefault rates.
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Interest rebates upon default calculated by any method less favorable
than the actual method.
Repayment plans that consolidate more than two periodic payments
that should be paid in advance from the proceeds of the loan.
Most types of prepayment penalties, including refunds of unearned
interest calculated by any method less favorable than the actual
method.
Creditors also may not:
Issue loans based on the collateral value of a secured property

disregarding the borrower's ability to repay the loan. Additionally, the
proceeds for home improvement loans must be delivered either
directly to the borrower, jointly to the borrower and the home
improvement contractor, or, in some instances, to the escrow agent.
Refinancing a HOEPA loan into another HOEPA loan within the first
12 months of originating the loan, unless the new loan is in the
borrower's best interest. The prohibition also applies to assignees
holding or servicing the loan
Mistakenly considering a closed-end, high-cost loan as an open-end
loan. For example, a high-cost loan may not be structured as a home
equity line of credit if there is no reasonable expectation that a repeat
transaction will occur.
Compliance Breaches
The borrower still has the right to sue the creditor for breaches of these new
requirements. In a successful case, the borrower may be able to recover
statutory and actual damages, court costs, and attorney fees. A breach of
the highrate, high-fee requirements of TILA may enable the borrower to
cancel the loan for up to three years.
Other Features of TILA
The Truth in Lending Act has other important features. If the credit terms
are advertised then the key terms of the loan should be disclosed. Also, the
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law enables the borrower to cancel some types of credit lines within a
period of time, such as equity loans.
In order to assist creditors, sellers and lessors, the Fed has provided a series
of standard disclosure forms and clauses for Reg Z and Reg M. Copies of
these regulations as well as the standard forms can be found in public
libraries and law school libraries. Reg Z can be found in the Code of Federal
Regulations at 12 C.F.R. Part 226. Reg M can also be found in the Code of
Federal Regulations at 12 C.F.R. 213.
The penalties for failure to comply with the TILA can be substantial. The
creditor who violates the disclosure requirements may be sued for twice the
amount of the finance charge. In the case of a consumer lease, the amount
is 25% of the total of the monthly payments under the lease, with a
minimum of $100 and a maximum of $1000. Costs and attorney fees may
also be compensated to the borrower. A lawsuit must be filed by the
consumer within a year of the breach occurrence. However, if the creditor
sues more than a year after the violation date, violations of TILA can be
asserted as a defense.
Real Estate Brokers, Not Credit Arrangers
Reg Z, enacted by the Fed under TILA, classifies mortgage creditors as

arrangers of credit. Thus, creditors must fill out settlement disclosure
statements in each real estate property loan closing. As for real estate
brokers, they could be viewed as credit arrangers when closing a contract
sale, or assumption sale or other seller-financed sale. The Fed wanted to
make brokers responsible for preparing TILA disclosure forms, as well; this
was resisted by brokers.
Congress finally settled the issue in favor of the brokers. The Depository
Institution Deregulation Act of 1982 prevents federal authorities from
assigning arranger of credit status to real estate brokers in seller-financed
transactions. This means that the real estate broker remain exempted from
the credit arranger rules of Regulation Z.
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This does not mean that brokers are totally insulated from complying with
Reg Z. If a broker has customarily financed sales and is lending mortgage
funds, then he is considered as a credit arranger as any other lender or
creditor in the market, and therefore must fulfill the requirements of Reg Z.
Other laws include:
Rights to Financial Privacy Act
This Act provide a borrower from financial institutions with the right to
expect that their financial activities will have a reasonable amount of
privacy from federal government scrutiny. The law establishes specific
procedures and exemptions concerning the release of borrowers financial
records and imposes requirements financial institutions must meet prior to
releasing such information to the federal government.
Expedited Funds Availability Act
The Act requires all banks, savings and loan associations, saving banks and
credit unions to make funds deposited into checking, and certain other
accounts available according to specified time schedules and to disclose
their funds availability policies to their borrowers. The law does permit an
institution to delay the consumer's use of deposited funds but instead limits
how long any delay may last. The regulation also establishes rules designed
to speed the return of unpaid checks.
Fair Debt Collection Practices Act
This Act is designed to eliminate abusive, vague and unfair debt collection
practices. It applies to third-party debt collectors or those who use an alias
in collecting consumer debts. However, very few commercial banks, saving
banks, saving and loan associations and credit unions are covered by this
Act since these institutions usually collect their own debts. Complaints
concerning debt collection practices are generally filed with the Federal
Trade Commission.
The Federal Trade Commission Act
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This law requires federal financial regulatory agencies to maintain a
consumer affairs division to assist in resolving consumer complaints
against institutions they supervise. This assistance is given to help provide
necessary information to consumers about problems they have in order to
address complaints concerning acts or practices which may be unfair or
vague.
Home Equity Loan Consumer Protection Act
The Act requires creditors to disclose terms, rates, and conditions -- APRs,
lending charges, payment terms, and information about variable rate
features -- for home equity lines of credit with the applications and before
the first transaction under the home equity loan. If the disclosed terms are
changed, the consumer can refuse to open the plan and entitled to a refund
of any fees paid in connection with the application. The Act also limits the
circumstances under which a creditor may terminate or change the terms of
a home equity loan after it is opened.
Home Mortgage Disclosure Act (HMDA)
The Home Mortgage Disclosure Act requires certain lending institutions to

annually report their origination and acquisition of home purchase and
home improvement loans as well as the applications submitted for these
loans. The type of loan, location of the property, consumer's race and
origin, sex and income are also reported. The institutions are required to
report all the needed information regarding their lending available to the
public and must post a notice of availability in their public lobby. The
disclosure statements are also available in the central depositories in
metropolitan areas. This information can help the public determine how
well these institutions are serving the housing credit needs of their
neighborhoods and communities.
Home Mortgage Disclosure Act Aggregation Project
Through data collected from each loan closed in one of the covered
institutions, the Federal Financial Institution Examination Council (FFIEC)
prepares disclosure statements and several reports for each institution in
each metropolitan Statistical Area (MSA), showing its lending patterns by
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location, age of housing stock, income level, sex and racial characteristics.
The disclosure statements and reports are made available to the public at
the central depositories in each MSA.
The council is a formal interagency body empowered to prescribe uniform

principles, standards and reports for the federal examination of financial
institutions by the Board of Governors of the Federal Reserve System
(FRB), the Federal Deposit Insurance Corporation (FDIC), the National
Credit Union Administration (NUCA), the office of the Controller of the
Currency (OCC), and the office of Thrift Supervision (OTS). The council
also makes recommendations to promote uniformity in the supervision of
financial institutions.
National Flood Insurance Act
This insurance is available for any real estate property holder whose local
community participates in the National Program by adopting and enforcing
flood plain management. Federally regulated creditors are required to
compel borrowers to purchase flood insurance in certain locations. The
creditors also must disclose to borrowers that their structure fall within the
limits of a flood hazard area.
Credit Practices Rule
The rule prohibits creditors from using certain remedies, such as

confession of judgment, wage assignments, non-possessory, non-purchase
money, and security interest in household goods. The rule also prohibits
lenders from misrepresenting a co-signer's liability and requires that
lenders provide co-signers with a notice explaining their credit obligations;
it also prohibits the pyramiding of late charges.
Electronic Fund Transfer Act
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This act provides consumer protection for all transactions using a debit
card or electronic means to debit or credit an account. It also limits a
consumer's liability for unauthorized electronic fund transfer.
The Interstate Land Sale Full Disclosure Act
The act protects consumers from fraud and abuse in the sale or lease of
land. It requires land developers to provide each purchaser with a
disclosure document called a property report. The report includes
information about the subdivision and must be delivered to each purchaser
before the signing of the contract. The act and regulations also require that
certain provisions and regulations be included in the contract for sale to
protect consumers from fraud and abuse in the sale or lease of land.
Fair Credit Reporting Act (FCRA)
This is one of the most important acts protecting borrowers' identity and
credit information. It is designed to promote the accuracy, fairness and
privacy of information collected and maintained by credit reporting
agencies.
The FCRA gives borrowers specific rights, establishing procedures for

correcting mistakes on a person's credit record and requiring that the
record only be provided for legitimate business needs. It is also mandatory
that the record be kept confidential. A credit record may retain judgments,
liens, suits and other adverse information for seven years, except for
bankruptcy which may be kept for 10 years. If the borrower has been
denied a loan, a costfree credit report may be requested within 30 days of
declination.
Consumers may sue any credit reporting agencies for breaching the
confidentiality laws, or for not correcting an individuals credit record.
Consumers are entitled to regain actual damages, plus punitive penalties
that the court may award if the breach was proved to be intentional. In any
successful case, a consumer will also be awarded court costs and attorney
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fees. A person who obtains a credit report without proper authorization, or
an employee of a creditreporting agency who provides a credit report to
unauthorized persons may be fined up to $ 5000 or imprisoned for one
year or both.
The access to the consumer's file is limited. Only people and institutions
with needs recognized by the FCRA may legally gain access to a file. This
normally includes creditors, government agencies, insurers, employers,
land lords and some businesses
Each consumer has access to his or her own file. Upon request, the credit
reporting agency must provide a consumer with information in the file and
the list of everyone who had requested a copy within a certain period of
time. There is no charge if the consumer has been denied for credit within
the last 60 days. In addition, a consumer is entitled to one free report every
12 months period if unemployed or receiving welfare, or if there is proof
that a report is inaccurate.
A consumer can remove his or her name from credit reporting agencies
lists used for unsolicited credit card and insurance offers. Unsolicited offers
must include a tollfree number where the consumer can call and optout
of receiving such offers.
The Community Investment Act (CRA)
The CRA is designed to encourage depository institutions to help meet the

credit needs of communities in which they operate, including low- and
moderate-income neighborhoods. It was enacted by Congress in 1977 and is
implemented by Regulation BB.
The Fair Housing Laws
Through the past 140 years, property ownership has become a reality for
many American citizens, although the process has not been fair for
everybody. There is no area where the country has experienced more
growing pains than in the area of discrimination and prejudice.
Over the years, however, laws have been created to make the housing
market equitable, standardizing the process for all citizens. Many of these
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laws have been aimed at discriminatory practices in the sale, financing and
rental of homes. Since discrimination on such a basis is prohibited, federal
authorities have taken an active role to stop such practices.
1866 Civil Rights Act
This federal law prohibits discrimination based on race in property

transactions. It was upheld by the Supreme Court in Jones v Mayer.
However, the law was basically ignored until 1968.
Civil Rights Act of 1968 and 1988 Amendments
In leasing or selling residential properties, the Civil rights Act of 1968

expands the definition of discrimination to include not only race, but
national origin, color and religion. The Fair Housing amendment Act of
1988 widened this to include age, sex, and handicapped status. Under these
laws, real estate offices are required to display fair housing posters. Any
complaints must be filed with HUD.
Fair Housing Act
The Fair Housing Amendment Act of 1988 and the Title VIII of the Civil
Rights Act of 1968 together constitute the Fair Housing act. The Act
provides protection against the following discriminatory housing practices
if they are based on race, sex, religion, color, handicap, marital status or
national origin.
Denial of house renting

Denial of house sale
Treating applicants differently for housing
Treating residents differently in connection with terms and
conditions
Advertising discriminatory housing preferences or limitations
Providing false information about the availability of housing
Harassing, coercing or intimidating people from enjoying or
exercising their rights under the Act.
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Blockbusting for profit, i.e., persuading an owner to sell or rent
housing by stating that people of a particular race, religion, etc. are
moving into the neighborhood.
Imposing different loan terms on the basis of a protected class for
purchasing, constructing, improving, repairing or maintaining a
residence.
Denying use of, or participation in, real estate services, such as
brokers' organizations or multiple listing services.
Significant recent changes in the Fair Housing Act of 1988
In addition to the expansion of protected classes and creating new

enforcement procedures, the 1988 act amendments to the Fair Housing Act
also created an exemption to the provision barring discrimination on the
basis of marital status for housing developments used by persons aged 55
years or older.
The Housing of Older Persons Act of 1995 (HOPA)
This law makes several changes to the 55-years-and-older exemption. First,

it eliminates the requirements that such housing have significant facilities
and services designed for the elderly. Second, HOPA establishes a good
faith reliance immunity from damages for persons who in good faith believe
that the 55-and-older exemption applies to a particular property, if they do
not actually know that the property is ineligible for exemption and if the
property has formally stated in writing that it qualifies for the exemption.
HOPA retains the requirement that the housing must have a person who is
55 years of age or older living in at least 80% of its occupied units. It also
still requires that the property publish and follow policies and procedures
which demonstrate intent to provide housing for persons 55 and older.
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Changes were made to enhance law enforcement, including amendments to
criminal penalties in section 901 of the civil rights act of 1968 for breaches
of the Fair Housing Act title VIII.
Fair Housing Assistance Program (FHAB)
The purpose of this program is to strengthen nationwide fair housing

efforts by helping individual state and local governments administer laws
that are consistent with the Federal Fair Housing Act.
Eligible grantees are state and local enforcement agencies administering

statutes that HUD has found to be similar to the federal statue. The Fair
Housing Act does not prescribe in any detail the methods to be employed
by HUD in reimbursing local enforcement agencies.
Funding is provided to assist state and local authorities in carrying out

activities related to the administration and enforcement of their fair
housing laws and regulations. Such activities include complaint processing,
training, implementation of data and information systems, and other
special projects designed to enhance the agency's administration and
enforcement of its fair housing law or ordinance.
Fair Housing Investigate Programs (FHIP)
This program was established by the Housing and Community

Development Act of 1987 and amended in 1992. FHIP provides funding to
public and private entities formulating or carrying out programs to prevent
or eliminate discrimination practices.
Through four distinct categories of funding, FHIP supports projects and

activities designed to enhance compliance with the act and substantially
equivalent state and local laws prohibiting housing discrimination. These
activities include programs of enforcement, voluntary compliance and
education and outreach. The program provides a coordinated approach to:
1) Further the purposes of the Fair Housing Act.

2) Guarantee the rights of all Americans to seek housing in an open
market free of discrimination.
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3) Inform the American citizens of its rights and obligations under the
Fair Housing Act.
Enforcement of the Fair Housing Act
HUD had a lead role in the administering of the Fair Housing Act since
1968. The 1988 amendments, however, have greatly increased the
Department's enforcement role. First, the newly-protected classes have
provided significant sources of new complaints. Second, HUD's expanded
enforcement role took the department beyond investigation and
conciliation into the mandatory enforcement area.
The Fair Housing Act gives HUD the authority to hold administrative
hearings and to issue subpoenas. The administrative law judge in these
proceedings can issue an order of relief, including actual damages,
injunctive or other equitable relief and penalties.
Complaints filed with HUD are investigated by the Office of Fair Housing
and Equal Opportunity (FHEO). If the complaint is not successfully
conciliated then FHEO determines whether reasonable cause exists to
believe that a discriminatory housing practice has occurred. Where
reasonable cause is found, the parties to the complaint are notified by
HUD's issuance of a determination as well as a charge of discrimination
and a hearing is scheduled before the administrative law judge. Either party
complainant or respondent may cause the HUD-scheduled
administrative proceeding to be terminated by choosing instead to have the
matter litigated in federal court.
Whenever a party has so elected, the Department of Justice takes over

HUD's role as counsel seeking resolution of the charge on behalf of the
aggrieved person, and the matter proceeds as a civil action. Either form of
action is subject to review in the U.S. Court of Appeals.
The penalties range up to $10,000 for a first breach and up to $50,000 for
the third violation and those thereafter. The penalties are paid to the
federal government; damage payments go to the victims.
458
The act adds criminal penalties of a $100,000 maximum fine and
imprisonment as sanctions against people who willfully fail to give
information and evidence or who willfully give false information in a fair
housing investigation or proceeding.
Age Discrimination Act of 1975
This Act prohibits discrimination on the basis of age in programs and

activities receiving federal financial assistance. It applies to all ages, and
permits the use of certain age distinction and factors other than age that
meet the act's requirements. The age discrimination act is enforced by the
civil rights center.
Title II of the Americans with Disabilities Act (ADA)
Title II prohibits discrimination against persons with disabilities in all

services, programs and activities made available by state and local
governments. The Department of Justice oversees enforcement of the ADA.
The regulation covers all state and local government and extends the
prohibition of discrimination in federallyassisted programs established by
section 504 of the rehabilitation act of 1973 to all activities of state and local
governments including those that do not receive federal financial
assistance. HUD is the designated agency for all programs, services, and
regulatory activities relating to state and local public housing, and housing
assistance and referrals.
STATE LAWS
Many state laws also provide rights and remedies in consumer financial
transactions. Unless a state law conflicts with a particular federal law, the
state law will apply. Some states have usury laws, which establish
maximum rates of interest that creditors can charge for loans or credit
sales. The maximum interest rates vary from state to state and depend
upon the types of credit transaction involved.
Complaint filing process
459
If the consumer has a complaint against a financial institution, the first step
is to contact an officer in the institution and attempt to resolve the
complaint directly. Financial institutions value their customers and most
will be helpful. If the consumer is unable to resolve the complaint directly,
the institution's regulatory agency can be contacted for assistance.
The agency will usually acknowledge receipt of a complaint letter within a

few days. If the letter is referred to another agency to investigate the
complaint, the financial institution may be given a copy of the complaint
letter.
The complaint should be submitted in writing and should include the

following.
Complainant's name, address, and telephone number

The institution's name and address
Type of account involved in the complaint, i.e., checking, savings, or
loan, and account numbers if applicable
Description of the complaint, including specific dates and the
institution's actions (copies of pertinent information or
correspondence are helpful)
Date of contact and names of individuals contacted at the institution
with their responses
Complainant's signature and the date the complaint is submitted.
The regulatory agency will be able to help resolve the complaint if the
financial institution has breached a banking law or regulation.
However, the agency may not offer much assistance when the
consumer is simply unsatisfied with the institution's policy or
practices, and no law or regulation has been violated. In addition,
regulatory agencies do not resolve factual or most contractual
disputes.
460
CHAPTER SUMMARY
This chapter describes the laws enacted by the government to protect
consumers and borrowers trying to obtain a loan to buy a residential
property from any unfair and vague practices of financial institutions.
Creditors wants to work with borrowers who possess the Three Cs.
Capacity, Character and Collateral
A consumer should know the information that she is free not to

disclose to the creditor (although a consumer may voluntarily submit
this information to the financial institution).
Discriminatory practices against loan applicants based on their sex,

age, national origin or race are prohibited by law.
A creditor who declines a borrowers credit application based on

unfavorable information on their credit report must supply contact
information for the credit agency to the applicant if asked. If the
borrower notifies the bureau about an error, the bureau must
investigate and solve this error within 30 days.
The Equal Credit Opportunity Act (ECOA) was enacted to confirm

that all consumers enjoy an equal chance to obtain a loan.
If the consumer has any disputes with a financial institution he

should contact the institution first try to solve the dispute directly. If
the institution was not able to solve the dispute then the consumer
should contact the appropriate agency or authority for help in solving
the problem.
461
CHAPTER QUIZ
1. Which 1968 landmark legislation launched truth in lending disclosure:
a) The Consumer Credit Protection Act

b) Real Estate Settlement Procedures Act (RESPA)
c) Equal Credit Opportunity Act (ECOA)
d) Community Reinvestment Act
2. Which of the following is not one of the Three C's of credit?

a) Capacity
b) Character
c) Collateral
d) Cash
3. Title II, which outlaws discrimination by all state and local

government services against persons with disabilities, is part of:
a) The Anti-Discrimination Law of 2003
b) The Americans with Disabilities Act (ADA)
c) Both A & C
d) Neither A or C
4. Under the Equal Credit Opportunity Act, borrowers must be notified

within _____after submitting their application if it is approved.
a) 20 days
b) 30 days
c) 40 days
d) 50 days
5. _____ ensures consumers are given an equal chance to obtain credit.

a) RESPA
b) ECOA
c) TILA
d) RFPA
462
6. ________ establishes procedures for correcting mistakes on a
person's credit record and requires that consumer records only be
provided for legitimate business needs.
a) Rights to Financial Privacy Act
b) The Fair Trade Commission Act
c) The Fair Credit Reporting Act
d) Home Equity Loan Consumer Protection Act
7. ________ requires federal agencies to encourage depository financial

institutions to help meet the credit needs of their communities,
including low and moderate income neighborhoods.
a) Electronic Funds Transfer Act
b) Home Mortgage Disclosure Act
c) The Community Reinvestment Act
d) National Flood Insurance Act
8. When was the first civil right legislation enacted?

a) 1866
b) 1966
c) 1964
d) 1988
9. ________ prohibits discrimination based on race by upholding the

1866 Civil Rights Act.
a) Ragin vs New York
b) Jones vs Mayer
c) Easton vs Strassburger
d) Span vs the Avenel corporation
10. ______has enforced the Fair Housing Act since its 1968 adoption.
a) HUD
463
b) VA
c) FED
d) FDIC
11. The Fair Housing Acts penalties range up to ______ for a first
violation.
a) $2,000
b) $5,000
c) $10,000
d) $20,000
12. Data is kept in personal credit records for ______ years, except for
bankruptcy information.
a) 7 years
b) 5 years
c) 10 years
d) 20 years
13. Bankruptcy information is retained in a persons credit record for

_____.
a) 15 years
b) Forever
c) 10 years
14. When was the Equal Credit Opportunity Act enacted?
a) 1974
b) 1976
c) 1978
d) 1988
464
15. Regulation B was issued by the Fed to implement ECOAs provision
outlawing creditors from discriminating on the grounds of gender or
marital status.
a) True
b) False
Answer Key:
1. A 6. C 11. C
2. D 7. C 12. A
3. B 8. A 13. C
4. B 9. B 14. A
5. B 10. A 15. A
465
also called historical or
GLOSSARY chronological age.
ADA: Americans with Disabilities

Acceleration clause: Provision Act.
in a real estate financing Adjusted Cost Basis: A
instrument allowing the lender to propertys income tax cost basis,
declare the full debt due plus additional costs such as
immediately if the borrower improvements, and subtractions,
breaches any of the provisions of such as depreciation in value.
the loan agreement. Also referred
Adjusted Gross Income: Gross
to as a call provision.
income subtracted by income and
Accession: The process of Social Security taxes.
manufactured or natural
improvement or addition to Adjacent: Next to, nearby,
property. bordering, or neighboring (not
Accrued depreciation The necessarily in real contact).
difference in cost between the Adjustable-rate mortgage
replacement value of a new
(ARM): Loan in which the
building and its current appraised
value. Depreciation which interest rate increases or decreases
accumulates over time. periodically to reflect changes in
the cost of money.
Acquisition cost: Amount of Adjusted basis: Purchase price

money required to acquire title to of property plus cost of specified
a property, it includes the improvements, minus any
purchase price as well as the depreciation deductions taken.
closing costs, legal fees, escrow,
Adjusted Gross Income Gross
service charges, title insurance,
income with federal and state
recording fees and other such income taxes and Social Security
expenses. subtracted.
Actual age: Number of years
since a building was completed; Adjustment period: Time
period between when the interest
466
rate or monthly payment for an Agreement: Contract between
adjustable-rate mortgage is two or more persons to do or not
changed. do a certain thing, for
consideration.
Administrative agency:
Government agency administering Air rights: The right to
a complicated area of law and unobstructed use and possession
policy, implementing and of the air space over a parcel of
enforcing detailed regulations that land. This right may be transferred
have the force of law. For example, separately from the land.
the Bureau of Real Estate is the
Alienation: The transfer of
administrative agency charged
ownership or an interest in
with regulating the real estate
property from one person to
business.
another, in any way.
Ad valorem: Latin phrase
Alienation, Involuntary:
meaning according to value,
Transfer of an interest in property
referring to taxes assessed on the
against the will of the owner, or
value of property.
without any action by the owner
Advances: Funds provided by the (ensuing through operation of law,
beneficiary to pay taxes to natural processes, or adverse
safeguard the lenders interest possession).
according to the trust deed.
Alienation, Voluntary: When
Affirm: (a) To confirm or an interest in property is
approve. voluntarily transferred by the
owner to someone else (generally
b) To make a sincere declaration
by deed or will).
that is not under oath.
Alienation clause: A security
After-acquired title: If a title is
instrument provision giving the
acquired by a grantor only after a
lender the right to declare the full
conveyance to a grantee, the deed
loan balance due immediately if
to the grantee becomes effective at
the borrower sells or else transfers
the time the grantor actually
the security property; also termed
receives title.
as due-on-sale clause.
467
All-inclusive Deed of Trust: suing the borrower for a deficiency
Refer: Wrap-around Loan judgment in certain
circumstances.
Amenities: The features of a
property that adds to the pleasure Apportionment: A division of
and /or convenience of owning it, property or liability into
such as a swimming pool, a proportionate parts (may not be
beautiful view, a gym and so on. equal parts).
Americans with Disabilities Appraisal: An estimate of the

Act: Federal law mandating that value of a piece of property as of a
public facilities must be accessible specific date.
to disabled people.
Appraiser: Person who evaluates
Amortization, Negative: The the value of the property,
adding of interest-not-paid to the especially a trained and
principal balance of a loan. experienced person who has
expertise in this field.
Amortize: To pay off a debt
gradually, with installments that Appraiser, Fee: A self-employed
include both principal as well as appraiser who is hired to appraise
interest. real estate for a fee, as opposed to
an appraiser who works for a
Annual percentage rate
lender, a government agency, or
(APR): All the charges paid by the
some other entity as a salaried
borrower for the loan (including
employee.
the interest, origination fee,
discount points, and mortgage Appreciation: An increase in
insurance costs), expressed as an value; the opposite of
annual percentage of the amount depreciation.
borrowed.
Appropriation: Keeping
Annuity: Sum of money received property or reducing it to a
in a series of payments at regular personal possession, excluding
intervals (usually annually). others from it.
Anti-deficiency rules: Laws Appurtenances: Rights that go

prohibiting a secured lender from along with ownership of a
468
particular piece of property, such Assessment: Property valuation
as air rights or mineral rights. for taxation purposes.
These are generally transferred
Assessor: Officer responsible for
with the property, but in some
determining the value of the
cases they may be sold separately.
property for taxation.
Appurtenances, Intangible:
Asset: A thing of value owned by
Rights concerning ownership of a
a person.
piece of property that does not
comprise physical objects or Assets, Capital: Assets that a tax
substances. An access easement is payer holds, other than (a)
a good example of this. Property held for sale to
customers, and (b) Depreciable
APR: Annual Percentage Rate.
property or real property used in
Area: (a) Locale or region. the taxpayers trade or business.
Real property is a capital asset if it
(b) The size of a surface, normally
is used for personal use or for
in square units of measure, as in
profit.
square feet or square miles.
Assets, Liquid: Any assets or
ARM: See Mortgage, Adjustable-
cash that can be turned into cash
Rate.
(liquidated), such as stock in a
Arranger of credit: A real estate company.
licensee or attorney who arranges
Assign: Transfer of rights
a transaction where credit is
(particularly contract rights) or
extended by a seller of residential
interests to another.
property.
Assignee: One to whom rights or
Artificial person: A legal unit,
interests are assigned.
such as a corporation, treated as
an individual having legal rights Assignment: (a) Transferring
and responsibilities by the law; as contract rights from one person to
distinguished from a normal another.
being, a human. An artificial
(b) In case of a
person is also called a legal person.
lease, the transfer of
the entire leasehold
469
estate by the original Back-End Ratio: The
tenant to another. borrowers mortgage payments
added to any other regular
Assignment of contract and
monthly financial obligations,
deed: The instrument through divided by total gross income
which a new vendor is substituted
for the original vendor in a land
contract. Bad debt/Vacancy factor: A
percentage deducted from a
Assignor: Someone who assigns propertys potential gross income
his rights or interest to another. to find the effective gross income,
Assumption: Action by a buyer estimating the income that will
to take on personal liability for probably be lost due to vacancies
paying off the sellers existing and non-payment of rents by the
mortgage or deed of trust. tenants.
Assumption fee: A fee paid to Balance, Principle of: An

the lender, generally by the buyer, appraisal principle which holds
when a mortgage or deed of trust that the maximum value of real
is assumed. estate is achieved when the agents
in production (labor, capital, land,
Attachment: Court-ordered and co-ordination) are in proper
seizure of property belonging to a balance.
defendant in a lawsuit, so it will be
available to satisfy a judgment if Balloon payment: A payment
the plaintiff wins. An attachment on a loan (usually the final
creates a lien in case it is real payment) that is substantially
property. larger than the regular installment
payments.
Auditing: Verifying and
examining records, particularly Bankruptcy: a) A condition
the financial accounts of a resulting when the liabilities of an
business or other organization. individual, corporation, or firm
exceeds assets.
b) A court declaration that an

individual, corporation, or firm is
insolvent, resulting in the assets
470
and debts being administered Beneficiary: (a) One for whom a
under bankruptcy laws. trust is created and on whose
behalf the trustee administers the
Base Line: Main east-west line in
trust.
the government survey system
from which township lines are b) The lender in a deed of trust
established. Each principal transaction.
meridian has one base line
c) Someone who is entitled to
associated with it.
receive real or personal property
Basis: Figure used in calculating under a will (a legatee or devisee).
the gain on the sale of real estate
Beneficiarys Statement:
for federal income tax purposes;
Document in which a lender
also called the cost basis.
confirms the status of a loan (the
Basis, Adjusted: The initial interest rate, principal balance,
basis of the owner in the property, etc.) and describes any claims that
plus capital expenditures for could affect an interested party.
improvements and minus any
Bill of sale: A document used to
allowable depreciation deductions.
transfer title to personal property
Basis, Initial: The amount of the from a seller to a buyer.
owners original investment in the
Blanket mortgage: Mortgage
property: the cost of acquiring the
that include more than one
property including closing costs
property parcel as security.
and other expenses along with the
purchase price. Block: A group of lots surrounded
by streets or unimproved land in a
Bearer: A person in possession of
subdivision.
a negotiable instrument.
Bond: a) A written obligation,
Benchmark: A surveyors mark
normally interest bearing, to pay a
at a known point of elevation on a
certain sum at a specified time.
stationery object, used as a
reference point in calculating b) Money put up as a surety,
other elevations in a surveyed protecting against failure to
area, most often a metal disk set perform, negligent performance,
into cement or rock. or fraud.
471
Bonus: An additional payment, example, South 20 west 100
over and above the due payment. feet is a call.
Cap: A limit on how much a

lender may raise an Adjustable
Broker, Associate: Someone
Rate Mortgage interest rate or
who is qualified as a broker and is
monthly payment per year, or over
affiliated with another broker.
the life of the loan.
Bundle of rights: The rights
Capital: Money or other forms of
inherent in ownership of property,
wealth available for use in
including the right to use, lease,
producing more money.
enjoy, encumber, will, sell, or do
nothing with the property. Capital assets: Assets held by a
taxpayer other than property held
Buy down: Discount points paid
for sale to customers in the normal
to a lender to reduce (buy down)
course of the taxpayers business.
the interest rates charged to a
It also comprises depreciable
borrower, especially when a seller
property or real property used in
pays discount
the taxpayers trade or business.
Therefore, real property is a
capital asset if owned for personal
California Fair Housing Law: use or for profit.
Law that guarantees equal
Capital expenditures: Money
treatment for everyone in all
spent on improvements and
business establishments, often
alterations that add to the value of
referred to as the Rumford Act.
the property and/or prolong its
Cal-Vet loans: State- sponsored life.
residential finance program
Capital gain: Profit achieved
utilized to provide cheap home
from the sale of a capital asset. It
and farm loans to veterans,
is a long-term capital gain, if the
Call: A specification that describes asset was held for more than one
a segment of the boundary in a year and it is a short-term capital
metes and bounds description; for gain, if the asset was held for one
year or less.
472
Capital improvement: Any Carry-back loan: Refer:
improvement so designed that it Mortgage, Purchase Money.
becomes a permanent part of the
Carryover clause: Refer: Safety
real property or that will have the
clause.
effect of prolonging the propertys
life significantly. Cash flow: The residual income
after deducting all operating
Capitalization: A method of
expenses and debt service from
appraising real property by
the gross income.
converting the anticipated net
income from the property into the CC&Rs: A declaration of
present value; also called the covenants, conditions, and
income approach to value. restrictions that is generally
recorded by a developer to place
Capitalization rate: A
restrictions on all lots within a
percentage used in capitalization
new subdivision.
(Net Income = Capitalization Rate
x Value). It is the rate believed to Certificate of Discharge:
represent the proper relationship Document given by the mortgagor
between the value of the property to the mortgagee when the
and the income it produces; the mortgage debt has been paid in
rate that would be a reasonable full, acknowledging that the debt
return on an investment of the has been paid and the mortgage is
type in question; or the yield no longer a lien against the
necessary to attract investment of property; also called a satisfaction
capital in property like the subject of mortgage or mortgage release.
property. It is also called the cap
rate. Certificate of Eligibility:
Document issued by the
Capital loss: A loss that is a Department of Veterans Affairs
result of a sale of a capital asset. It regarding the veterans eligibility
may either be long-term (held for for a VA-guaranteed loan.
more than one year) or short-term
(held for one year or less). Certificate of Reasonable
Value (CRV): Based on an
CAR: California Association of appraisers estimate of the value of
Realtors. a property, it is mandatory for a
473
VA-guaranteed home loan to be the title transferred to him. It may
authorized; the amount of the loan also be called a settlement.
cannot be more than the CRV.
Closing costs: Expenses incurred
Certificate of Sale: Document while transferring real estate in
given to the purchaser at a addition to the purchase price.
mortgage foreclosure sale, instead
Closing date: Date on which all
of a deed which is replaced with a
the terms of a purchase agreement
sheriffs deed only after the
have to be met, or else the contract
redemption period expires.
is terminated.
Chain of Title: Record of
Closing statement: Accounting
encumbrances and conveyances
of funds from a real estate
pertaining to a property.
purchase, furnished to both seller
Chattel: An article of personal and buyer.
property.
Cloud on title: A claim,
Chattel mortgage: Using encumbrance, or apparent defect
personal property as security for a that makes the title to a property
debt. unmarketable.
Chattel real: Personal property Collateral: Anything of value

closely associated with real used as security for a debt or
property. A lease is a good obligation.
example.
Collusion: Agreement between
Client: Someone who employs a two or more persons to defraud
broker, lawyer, appraiser, or any another.
other professionals. A real estate
Color of title: Appears to be of
broker may have clients who is
good title, but in fact, is not.
either is a seller, a buyer, a
landlord, or a tenant. Commercial bank: Type of
financial institution that has
Closing: The last stage of a real
traditionally emphasized
estate transaction when the seller
commercial lending (loans to
receives the purchase money and
businesses), and also makes
the buyer receives the deed with
residential mortgage loans.
474
Commercial property: Property of comparables provide data for
that is zoned and used for business estimating the value of the subject
purposes, such as restaurants, property using the sales
office buildings. Set apart from comparison approach.
residential, industrial, and
Comparative Market Analysis:
agricultural property.
Estimate of property value for
Commission: a) Compensation appraisals based on indicators
received by a broker for services from the sale of comparable
provided in connection with a real properties.
estate transaction (normally a
Condition: (a) A provision in a
percentage of the sales price).
contract that makes the parties
b) Group of people gathered for a rights and obligations depend on
purpose or a function (generally a the occurrence (or nonoccurrence)
governmental body, as in a of a particular event; also called a
planning commission). contingency clause.
Commitment: A lenders (b) A provision in a deed that

promise to make a loan, in real makes title-conveying subject to
estate finance; loan may be firm or compliance with a particular
conditional. (A conditional loan is restriction.
based on fulfillment of certain
Condominium: A subdivision
conditions, such as a satisfactory
that provides an exclusive
credit report on the borrower.
ownership (fee) interest in the
Co-mortgagor: Family member airspace of a particular portion of
(generally) who accepts real property, and an interest in
responsibilities for the repayment common in a section of that
of a mortgage loan, along with the property.
primary borrower, to help the
Confirmation of sale: Court
borrower qualify for the loan.
approval of a sale of property by an
Comparable: In appraisal, a executor, administrator, or
property that is similar to the guardian.
subject property and which has
been sold recently. The sales prices
475
Conforming loan: Home Contract, Land: A contract for
mortgage loan in which the the sale of real property in which
borrower and real estate conform the buyer (the vendee) pays in
to Fannie Mae and Freddie Mac installments. The buyer obtains
guidelines, with a lower interest possession of the property
rate than a non-conforming loan. immediately while the seller (the
vendor) retains legal title until the
Conformity, principle of: This
full price of the property has been
principle holds that property
paid. It is also called the
values are boosted when buildings
conditional sales contract,
are similar in design, construction,
installment sales contract, real
and age.
estate contract, or contract for
Consideration: Something of deed.
value provided to induce entering
Contract of deed: Refer:
into a contract; money, personal
Contract, land.
services, love. Without
consideration, a contract is not Contract of adhesion: A one-
legally binding. sided contract that is unfair to one
of the parties.
Construction lien: Refer: Lien,
Mechanics. Contract of sale: See: Purchase
agreement.
Consumer Price Index: An
index that tracks changes in the Contractual capacity: The legal
cost of goods and services for a capacity to enter into a binding
typical consumer. contract. A mentally competent
person who has attained the age of
Contiguous: Adjacent, abutting,
majority is a person with
or in close proximity.
contractual capacity.
Contingency clause: See:
Contribution, Principle of: An
Condition.
appraisal principle which holds
Contract: A written or oral that the value of real property is at
agreement to do or not do its best when the improvements
specified things, in return for produce the highest return
consideration.
476
proportionate with their cost the Cooperative sale: A transaction
investment. in which the listing agent and the
selling agent work together but for
Conventional loan: Mortgage
different brokers.
loan not guaranteed by
governmental agency, such as the Corporation: Legal entity that
Veterans Administration. acts via its board of directors and
officers, usually without liability
Conversion: a) Misappropriating
on the part of the person or
property or funds belonging to
persons owning it.
another (for example, converting
trust funds to ones own use). Correction lines: Guide
meridians running every 24 miles
b) The process
east and west of a meridian, and
where an apartment
standard parallels running every
complex is changed to
24 miles north and south of a base
a condominium or
line, used to correct inaccuracies
cooperative.
in the rectangular survey system of
Conveyance: Transfer of title of land description caused by the
real property from one person to earths curvature.
another through a written
Cost approach to value: One of
document (usually a deed).
the three key methods of
Cooperating agent: A member appraisal. An estimate of the
of a multiple listing service who subject propertys value is
finds a buyer for property listed determined by estimating the cost
for sale by another broker. of replacing the improvements,
and deducting the estimated
Cooperative: Building owned by accrued depreciation from it while
a corporation, in which the adding the estimated market value
residents are the shareholders. of the land.
Each shareholder receives a
proprietary lease for an individual Cost basis: See Basis.
unit along with the right to use the
Cost recovery deductions: See:
common areas.
Depreciation deductions.
477
Covenant: An agreement or a Credit union: Financial
promise to perform or not perform institution that may serve only
certain acts (generally imposed by members of a certain group (as in
deeds). See: CC&Rs. a labor union or a professional
association) and has traditionally
Credit arranger: A mediator
emphasized consumer loans.
between prospective borrowers
and lenders negotiating loans,
such as a mortgage broker.
Damage deposit: See Security
Credit bidding: When the lender
deposit.
obtains a property by bidding the
amount the borrower owes in a Damages: a) Losses suffered by a
foreclosure sale. person due to a breach of contract
or a tort.
Credit union: Financial
institution that may serve only b) An amount of money the
members of a certain group (as in defendant is ordered to pay to the
a labor union or a professional claimant in a lawsuit.
association) and has traditionally
Debit: A charge or debt owed to
emphasized consumer loans.
another.
Credit history: Credit accounts
which demonstrate a loan Debtor: Someone who owes
applicants past record of meeting money to another.
financial obligations
Debt service The amount of
Credit report: Credit history of funds required over a period of
loan applicants, compiled time to cover the repayment of
companies in the credit reporting interest and principal on a debt.
industry, which are used to
determine creditworthiness. Debt Service Ratio A measure
for debt service showing the
Credit scoring: Evaluation proportion of gross income a
method for assessing the debtor is currently using for
creditworthiness of loan housing payments
applicants
Declaration of Abandonment:
An owner-recorded document that
478
voluntarily releases a property Deed, Tax: A deed that a buyer of
from homestead protection. a property obtains at a tax
foreclosure sale.
Declaration of Homestead: A
recorded document that creates Deed, Trustees: A deed that a
homestead protection for a buyer of a property receives at a
property that would otherwise not trustees sale.
receive it.
Deed in lieu of foreclosure: A
Deduction: Amount of which deed given to the lender by the
portion income tax is not required borrower (who has defaulted) to
to be paid. avoid foreclosure proceedings by
the lender.
Deed: Correctly executed and
delivered written instrument that Deed of reconveyance: Once
conveys title to real property (from the debt has been repaid the
the grantor to the grantee). security property is released from
the lien that is created by a deed of
Deed, Gift: Deed in which there
trust. The instrument used is
is no support of valuable
called the deed of reconveyance.
consideration, most frequently
listing love and affection as the Deed of trust: To secure the
consideration. repayment of a debt, an
instrument is used that creates a
Deed, Grant: The most
voluntary lien on real property.
commonly-used type of deed in
This lien includes a power of sale
California, it uses the word grant
clause that allows non-judicial
in its words of conveyance and
foreclosure. The parties to this
holds certain implied warranties
deed are the grantor (borrower),
that the property is not
the beneficiary (lender) and the
encumbered and has not been
trustee (neutral third party).
deeded to someone else.
Deed restrictions: Provisions in
Deed, Quitclaim: Deed
a deed that set restrictions on the
conveying any interest in the
use of property. It may either be
property that a grantor may have
covenants or conditions.
at the time of executing the deed,
without warranties.
479
Default: When one of the parties a long time period, for life, or at
to a contract fails to fulfill one or will.
more of the obligations or duties
Department of Housing and
as enforced by the contract.
Urban Development: (HUD)
Deferred maintenance: Federal agency responsible for
Curable depreciations that ensue public housing programs, FHA-
due to maintenance or repairs that insured home mortgage loans, and
were postponed and thus caused enforcing the Federal Fair
physical deterioration. Housing Act. The FHA and Ginnie
Mae both are a part of HUD.
Deficiency judgment:
Determination by the court that Department of Housing and
the borrower owes more money Urban Development: Federal
when the security for a loan does agency which guarantees lenders
not completely satisfy a debt against foreclosure loss on certain
default. loans provided to veterans
Delinquency: Failing to make Depreciable property: In

timely mortgage payments. regards to the federal income tax
codes, a property that is qualified
Delivery: When a deed is legally
for depreciation deductions as it
transferred from the grantor to the
might wear out and may have to
grantee, thus transferring title.
be replaced.
Demand: One of the four
Depreciation: a) A loss in value
elements of value (other three
as a result of physical
being scarcity, utility, and
deterioration, functional
transferability). It is a desire to
obsolescence, or external
own along with the ability to
obsolescence.
afford.
b) Allocating the cost of an asset
Demise: a) Conveying an interest
over a period of time for the
in real property via the terms of a
purpose of income tax deductions.
lease.
Developer: Someone who
b) Transferring an estate or
subdivides land or improves land
interest in property to someone for
to obtain a beneficial use.
480
Development Loans: Loans Disintermediation: The rapid
which finance the purchasing of outflow of money from banks into
real property and the financial institutions perceived to
accompanying
provide a higher rate of return
Disbursements: Money spent or Down payment: Portion of the
paid out, usually on a construction purchase price of a property that is
schedule paid in cash by the buyer,
Disclaimer: Denying legal generally the difference between
responsibility. the purchase price and the
financed amount.
Discount points: Percentage of
the principal amount of a loan that Due-on-Sale Clause: A
is collected by the lender or provision in a trust deed allowing
withheld from the loan amount the lender to call the entire loan
when the loan is originated. This balance due if the borrower
is done to increase the lenders transfers title. See: Acceleration
revenue on the loan. Clause.
Discount rate: Interest rate Dwelling: A place of living, a

which is charged when a member house or a home.
bank borrows money from the
Federal Reserve Bank.
Discrimination: Unequal
treatment given to people on the Earnest money: Deposit made
basis of their race, religion, sex, by a real estate buyer
national origin, age, or some other demonstrating her good faith.
attribute; prohibited by state and
federal law. Easement: Right given to
another person or entity to
Disintegration: Period of trespass upon property that is not
decline in a propertys life cycle, owned by that person or entity.
when the propertys current
economic usefulness is ending and Easement, Access: An easement
constant maintenance becomes that allows the holder of the
inevitable. easement to reach (and leave) his
481
property (which is the dominant piece of land. There is a dominant
tenement) by passing through the tenant, without a dominant
servient tenement; also called an tenement.
easement for ingress and egress.
Economic life: Time period
Easement, Appurtenant: An when an improved property yields
appurtenant easement is a right to a return on investment apart from
use an adjoining property. The one the rent due to the land itself; also
benefitting from the easement is called the useful life.
the dominant tenement.
Economic obsolescence: Loss
Easement by express grant: of value due to factors stemming
Easement that is voluntarily from beyond the property.
created in a deed, will, or other
Effective age: Age of a structure
written instrument.
as its condition indicates and the
Easement by express remainder of its usefulness (as
reservation: When an easement opposed to its actual age).
is created in a deed by which the Effective age of a building may be
property is divided by the increased if maintained well.
landowner, the servient tenement
Ejectment: Legal action through
is transferred while the dominant
which possession of real property
tenement is retained.
is recovered from someone who
Easement by implication: has illegally taken possession of it;
Easement that is created by law so also called an eviction.
as to provide access to a
Emblements, Doctrine of: Law
landlocked parcel of land.
allowing an agricultural tenant to
Easement by necessity: Such enter the land for harvesting the
an easement is most commonly crops even after the lease period
implied in favor of grantees that ends.
do not have any access to their
Eminent domain: Right of the
land except over the land owned
government to take title to real
by the grantor.
property for public use by
Easement in gross: Easement condemnation. The property
benefitting a person rather than a
482
owner receives just compensation of money/damages which could be
for property. an injunction, rescission, or a
specific performance.
Encroachment: Unlawful
intrusion onto neighborhood Equitable right of
property, often due to a mistake redemption: Real estate owners
regarding boundary location. right to take back property after
default but before foreclosure, by
Encumber: Placing a lien or
paying all debt, costs and interest.
encumbrance against the title to a
property. Equity: Difference between the
current market value of the
Encumbrance: Non-possessory
property and the liens against the
interest in real property, such as a
property.
mortgage (loan), a lien (voluntary
or involuntary), an easement, or a Escalation clause: Provision in
restrictive covenant that limits the a lease agreement that allows an
title. increase in payments on the basis
of an increase in an index, such as
Entitlement: In terms of a VA
the consumer price index.
loan, it is the amount of the
borrowers guaranty. Escheat: Reverting of a property
to the state in case there are no
EPA: Environmental Protection
capable heirs found.
Agency.
Escrow: Agreement that a neutral
Equal Credit Opportunity Act:
third party will hold something of
Federal law prohibiting lenders
value (money or a deed) until the
from discriminating against loan
provisions of a transaction or a
applicants on the basis of race,
contract may be carried out.
color, religion, national origin, sex,
marital status, or age, or that the Escrow agent: Neutral third
applicants income is generated party entrusted by a seller and
from public assistance. purchaser to hold a something of
value pending the fulfillment of
Equitable remedy: Judgment
conditions needed to close a
granted by a civil lawsuit to a
transaction.
complainant that is not an award
483
Escrow instructions: Expenses, maintenance: Cost
Directions that a party to a of cleaning, supplies, utilities,
transaction gives to an escrow tenant services, and other
agent specifying the terms under administrative costs for properties
which the escrow is to be that produce income.
conducted.
.
Estate: Interest held by the
property owners, it may be a Fair Credit Reporting Act:
freehold or a leasehold property. Consumer protection law
regulating the disclosure of
Estate at sufferance: Unlawful consumer credit reports
occupation of a property by a
tenant after their lease has Fair Employment and
terminated. Housing Act: Civil rights law in
California prohibiting all housing
Estate at will: Occupancy of real discrimination on the basis of
estate by a tenant for an indefinite race, color, religion, sex, marital
period, which either party can status, national origin, sexual
terminated at will orientation, familial status, source
Estate of inheritance: Estate of income, or disability; also called
that may be passed on to the heirs the Rumford Act.
of the holder, as in a fee simple. Fair Housing Act: Also called
Estate for years: Interest in real Title VIII of the Civil Rights Act of
property that permits possession 1968, federal law that makes
for certain, set time period. discrimination illegal on the basis
of race, color, religion, sex, marital
Estoppel letter: Document used status, national origin, sexual
in mortgage negotiations to orientation, and familial status,
establish facts and financial source of income, or disability for
obligations; also called an estoppel the purpose of sale or rental of
letter. residential property (or just land
that may be used for constructing
Expenses, fixed: Recurring
a residential building).
property expenses such as real
estate taxes or hazard insurance.
484
Fair Market Value: The price Federal Reserve (the Fed):
that a buyer and seller, willing but Government body that regulates
not compelled to sell or buy, would commercial banks and
implements monetary policy in
Federal Deposit Insurance
order to stabilize the national
Corporation (FDIC): Federal
economy.
agency that insures accounts in
savings and loans and commercial Federal Reserve System:
banks, bolstering confidence in the Consisting of the twelve Federal
banking system. Reserve Banks, which make loans
to member banks.
Federal Home Loan Bank
System (FHLB): Twelve Federal Trade Commission
regional wholesale banks that loan (FTC): Federal agency with the
funds to FHLB members to bolster responsibility for investigating and
local community lenders. terminating unfair and misleading
business practices; in charge of
Federal Home Loan Mortgage
enforcing the Truth in Lending
Corporation (FHLMC)
Act.
(Freddie Mac): Federally-
sponsored agency that buys Fee: See: Fee Simple.
mortgages on the secondary
Fee simple: Recognized this as
market, bundles and sells them to
investors. the highest form of estate
ownership in real estate. Duration
Federal Housing of this ownership is unlimited and
Administration (FHA): Federal can be conveyed in a will to the
agency that insures lenders for the owner's heirs.
repayment of real estate loans.
Fee simple absolute: A form of
Federal National Mortgage freehold ownership, not subject to
Association (FNMA) (Fannie termination.
Mae): Federally-sponsored
Fee simple defeasible: A form
agency that buys and sells
of fee simple estate subject to
residential mortgages, thereby
termination in case of a condition
enhancing liquidity in the
not being fulfilled or there is an
mortgage market.
485
occurrence of a specified event; First lien position: Mortgage or
also called a qualified fee. a deed of trust that has a higher
lien priority than any other
Fee simple subject to a
mortgage or deed of trust against
condition subsequent: Form of
the property.
estate ownership that can only be
terminated by legal action in case Fiscal year: Twelve-month
a condition is not fulfilled; also period that is used as a business
called a conditional fee. year for accounting, tax, and other
financial activities, in contrast to a
FICO Score: The credit scoring
calendar year.
system used by most mortgage
lenders to evaluate the credit Fixed disbursement plan:
worthiness of the applicants for Financing arrangement in a
mortgage loans. construction project where loan
proceeds are to be disbursed in a
Finance Charge: A fee charged
series of preset installments at
for the use of credit, charges that
are paid separately from the loan different phases of the
proceeds construction.
Financial Institutions Fixture: Personal property that is

Reform, Recovery, and permanently attached to land or
Enforcement Act (FIRREA) of improvements so that it becomes a
1989: Federal law that part of the real property.
refurbished the regulatory system
for savings institutions Forbearance: A temporary
delay in foreclosure actions
Financial statement: granted by a lender or creditor
Summation of facts that show the that postpones monthly payments
financial condition of an
Foreclosure: Sale of real
individual (or a business),
property by mortgagee, trustee, or
including a detailed list of assets
other lien-holder when a borrower
and liabilities.
defaults.
Finders fee: A referral fee paid
Foreclosure, Judicial: (a) Sale
to someone who directs a buyer or
of property as ordered by the
a seller to a real estate agent.
court.
486
b) Lawsuit that is filed by a property of a debtor previously
mortgagee or deed of trust under the control of a third party.
beneficiary to foreclose on the
General plan: Long-term,
security property of a defaulting
comprehensive plan for
borrower.
development of a community
Foreclosure, Non-judicial: implemented through zoning and
Trustees foreclosure under the other laws; also called a
power of sale clause in a deed of comprehensive plan or master
trust. plan.
Forfeiture: Failure to perform a Gift funds: Money given by a

duty or condition leading to a loss relative (or a third party) of a
of rights or something else of buyer who himself does not have
value. enough cash to close a transaction.
Freehold: Estate in land where Good faith deposit: Deposit

ownership is for an indefinite provided by a prospective buyer to
length of time, such as a fee simple the seller as evidence of his good
or a life estate. intention of closing the
transaction; also called an earnest
Front money: Money needed to
money deposit.
initiate a project, including
expenses such as attorneys fee, Goodwill: Intangible asset of a
loan charges, feasibility studies, business it acquires from having a
and a down payment. good reputation with the public.
Goodwill is generally as indication
Functional obsolescence: Loss
of the future return business.
of value from causes within the
property, excluding any due to Government National
physical deterioration. Mortgage Association
(GNMA) (Ginnie Mae): One of
the three main secondary market
Garnishment: Legal procedure agencies, this federal agency is
through which a creditor acquires part of the Department of Housing
access to the funds or personal and Urban Development.
487
Government-sponsored calculate an estimate of the
Enterprise: GSEs are private propertys value; also called the
corporations chartered and gross rent multiplier.
managed by the federal
Gross Income Multiplier
government. Secondary market
Method: Way of appraising
agencies Fannie Mae and Freddie
residential property by reference
Mac are the most important GSEs
to its rental value; also called gross
in the real estate industry.
rent multiplier method.
Government Survey System:
Guardian: Person appointed by a
System of grids made up of range
court to manage the affairs of a
and township lines dividing the
minor or an incompetent person.
land into townships, which are
further subdivided into sections. Guide Meridians: Lines running
Identification of a particular north-south (parallel to the
property is done through its principal meridian) at 24-mile
location within a particular intervals, in the Government
section, township, and range; Survey System.
called the Rectangular Survey
System. Habitability, implied
warranty of: Warranty implied
Grant: To transfer or convey an by law in every residential lease
interest in real property through a that states that the property is fit
written instrument. for habitation.
Grantee: Person receiving a grant Hard Money Loan Usually
of real property. made by a private lender, with a
high rate of interest, the loan is
Granting clause: Words in a
backed by the value of the
deed that points out the grantors
property, not the borrowers
granting clause.
creditworthiness.
Grantor: Person conveying an
Highest and Best Use: Legal
interest in real property.
and physically possible use of a
Gross Income Multiplier: property that, at the time it is
Figure multiplied by the gross appraised, is most likely to
income of a rental property to
488
generate the greatest return over a Homestead: Dwelling occupied
particular time period. by the owner along with any
appurtenant outbuildings and
Holden Act: See Housing
land.
Financial Discrimination Act.
Homestead Law: State law
Holder in Due Course: One
providing limited protection to
who has taken a note, check or
homestead properties against
similar asset prior to it being
judgment creditors claims.
overdue, in good faith and for
value, and with no knowledge that HUD: See Department of Housing
it had previously been dishonored. and Urban Development.
Holdover tenant: Tenant who Hypothecate: Using real

keeps possession of leased property as collateral for a debt
property after the lease term has without having to give up
expired. possession of it.
Home Equity Line of Credit Impounds: Borrowers funds

(HELOC): Credit account collected and kept in a reserve
secured by equity in the account by the lender.
borrowers home, enabling him to
Improvements: Additions to
borrow up to a specified credit
land property that are man-made.
limit.
Imputed knowledge: Legal
Home Equity Loan: Loan
doctrine stating that a principal is
secured by a second mortgage on a
considered to have notice of
principal residence, usually used
information that the agent has,
for a non-housing purpose.
even if the agent never told the
Homeowners Association: principal.
Non-profit organization
Income, Disposable: Income
comprising homeowners from a
that remains after the payment of
particular subdivision, responsible
taxes.
for enforcing their CC&Rs and
managing other community Income, Effective gross:
affairs. Measure of a rental propertys
capacity to generate income
489
calculated by subtracting a bad as property held for the
debt/vacancy factor from the production of income in the
economic rent-potential gross income tax code.
income.
Income ratio: Criteria used for
Income, Gross: total income of a qualifying a buyer for a loan, to
property before making any find if their income is sufficient.
deductions such as bad debts, The buyers debt and proposed
vacancies, operating expenses, etc. housing expenses should not be
over a specified percentage of his
Income, Net: It is the income
income.
that is capitalized to estimate the
value of a property. It is calculated Increment: An increase in value,
by subtracting the operating the opposite of which is
expenses (i.e. fixed expenses, decrement.
maintenance expenses, and
Independent contractor:
reserves for replacement) of the
Contractor who is self-employed
property from the effective gross
and whose method of work is not
income.
controlled by another.
Income, Potential gross:
Index: Changes in the cost of
Economic rent of the property, the
money indicated in a published
income the property would earn if
statistical report, which can be
it were available for lease in the
used to make adjustments in such
current market.
areas as wages, rental figures, and
Income approach to value: loan interest rates.
One of the three main methods of
Inflation: Decrease in moneys
appraisal in which an estimate of
purchasing power, measured by
the property value is based on the
the Consumer Price Index; real
net income it produces; also called
estate is considered a hedge
the capitalization method or the
against inflation because it
investors method of appraisal.
generally holds its value.
Income property: Property
Installments: Portion of a debt
which generates rent or other
paid in successive period, usually
income for the owner, referred to
to reduce a mortgage.
490
Installment Sales Contract: owners agreement, such as
Real estate purchase structured to unpaid taxes.
be paid in installments with title
retained by seller until all
payments are made; also called Joint tenancy: Ownership of a
contract of sale and land contract. property interest by two or more
parties, each of whom has an
Instrument: Written document undivided interest with the right of
formulated to set the rights and survivorship (sharing equally in
liabilities of the parties; examples the interest of a deceased joint
are a will, lease, or promissory tenant with the surviving tenants).
note.
Joint venture: Agreement to
Institutional Lender: A invest in a single property or
commercial bank, savings bank, business by two or more parties.
thrift or insurance company that
makes real estate loans Judgment: A court ruling
directing that one party is
Interest: Money charged by bank indebted to another one and
or other lending institution for the setting the amount of
use of money. Also, a partial indebtedness.
degree of ownership.
Judgment creditor: Party who
Interest rate: Percentage of an has received a judgment from the
amount of money that is the cost court for money owed to her.
of using it, usually expressed as a
monthly or yearly percentage. Judgment debtor: Party whom
a judgment has been directed
Interim loan: Short term loans against for money owed.
made generally to finance
construction. Judgment lien: Claim upon the
property of a debtor as the result
Investment property: Property of a judgment, enabling the
acquired for its capacity to judgment creditor to have the
produce income or anticipated property sold for payment to
resale value, such as office satisfy the judgment.
buildings or undeveloped land.
Junior mortgage: Mortgagee
Involuntary lien: Lien applied whose claims on a property will be
against a property without the
491
addressed only after previous
mortgages have been settled. Leasehold improvements:
Fixtures attached to real estate
that are installed by the tenant and
which can be moved by him after
Land: Earths surface area that is the leases expiration if their
solid, and not composed of water. removal does not damage the
property.
Land contract: Installment
agreement for the purchase of real Legal description: Legally
estate in which the buyer may use proper identification of realty by
and occupy the land, without the one of three agreed-upon
passage of deed or title until all or methods: the government
a portion of the selling price is rectangular survey, metes and
conveyed. bounds, lot and block number.
Landlord: Person, the lessor, Lessee: Person to whom property

who rents property to another is rented under a lease; a tenant.
person, the lessee.
Lessor: Person who rents
Landmark: A stationary object property to another person; a
that serves a boundary or landlord.
reference point for a land parcel.
Leverage: Using borrowed funds
Late charge: Amount assessed to raise purchasing power and
by a lender against a borrower enhance profitability of an
who misses making an installment investment.
payment when due.
License: Having the right granted
Lease: Contract agreement in by the state of California to work
which an owner of real property, as a real estate broker or
in exchange for the consideration salesperson.
of rent, passes the rights of
possession to the property to Licensee: Person who hold a real
another party for a specified time estate license, which conveys the
period. privilege to accept compensation
for helping with a real estate
Leasehold estate: Tenants transaction.
ownership interest in the property
that is leased to her.
492
Lien: Encumbrance against Loan Origination, Wholesale:
property rendering it security for Loans originated by mortgage
the payment of a debt, mortgage brokers and mortgage
or other money judgment.
correspondents who subsequently
Life estate: Freehold land sell the loan to large, wholesale
interest that terminate upon the lending institutions
death of the owner or another
Loan Origination Fee: The cost
designated person.
a lender charges for originating a
Life tenant: Individual who is loan, usually in the form of
permitted to possess property for points
her lifetime or during the lifetime
of another specified person. Loan package: Documents
considered by the lender
comprising important information
Liquidated damages: Amount regarding the loan, such as
designated in a contract that one property description, the agreed-
party will owe the other party in
upon purchase price and sale
case of a breach of contract.
terms
Lis pendens: Recorded notice
that the rights to the possession of Loan-to-value ratio (LTV):
real property is the subject of Ratio calculated by dividing the
litigation, thus impacting mortgage principal by the property
disposition of its title. value.
Listing: Employment contract in Lock-in: Agreement to maintain
writing between an agent and a certain rate or price for a
principal authorizing the agent to specified time period.
conduct services for the principal
regarding the principals property. Lot and block number: Method
Also, a record of the property for of land description that relies on
sale by the broker authorized by the placement of recorded plats.
the owner to sell it.
Loan Origination, Retail: Loan

processing done wholly by a local MAI: Professional membership
bank and small-scale lenders in the Appraisal Institute.
493
Margin: Figure added to an index land boundary lines, utilizing
in order to adjust an interest rate those lines with their terminal
on an adjustable-rate mortgage. points and angles.
Marginal property: Realty that Mineral rights: Authorization to

generates barely enough income to amass income from the sale of gas,
cover the cost of using it oil and other resources
underground.
Marketable title: Title that a
court will assess as being free
enough from defect so it will Monument: Fixed object and
enforce its acceptance by buyer. point specified by surveyors to
establish land locations, such as
Market Data Approach: See boulders or unusual trees.
Sales Comparison Approach. One
of the three methods of appraisal, Mortgage: Written instrument
it compares recently-sold that establishes a lien on real
properties to the property being estate as security for payment of a
appraised. designated debt.
Market price: Actual price paid Mortgage banker: Person who

for a property in a transaction. originates, finances, sells, closes,
and services mortgage loans,
Market value: Highest price a which are generally insured or
willing buyer will pay for a guaranteed by a private mortgage
property and the lowest a willing insurer or government agency.
seller will accept, assuming no
undue, outside pressures. Mortgage broker: Places loans
with investors for a fee, but does
Mechanics lien: Lien created by not service them.
law against real property as
security for payment for the labor Mortgage commitment:
and materials used for the Agreement between a borrower
improvement of the property. and a lender to set up a loan at a
later date, dependent on the
Meridian: North-south line used conditions specified in the
in government rectangular survey. agreement.
Metes and bounds: Land Mortgagee: Someone who

description method that relies on receives a mortgage from a
494
mortgagor to secure a loan or Negative cash flow: The
performance of a duty; also called situation where the income
a lender or a creditor. generated by a property is less
than the outflow of cash necessary
Mortgage loan disclosure to sustain it
statement: Statement on a form
approved by the Real Estate Net income: Actual earnings
Commissioner that discloses to a remaining after deducting all
potential borrower the terms and expenses from gross income.
conditions of a mortgage loan,
required by law to be proffered by Negotiable instrument: A
mortgage brokers before the written unconditional promise or
borrower is bound by the loan order to pay a certain amount of
terms. money at a defined time or on
demand
Mortgagor: Person who provides
a mortgage on property to a Net operating income: The
mortgagee to secure a loan or the income from realty or a business
mortgagees performance of a after deducting operating expenses
duty. but before deducting tax payments
on and interest and principal
Multiple listing: Arrangement payments.
between real estate brokers to co-
operate by providing information Non-conforming loan:
to each other regarding listings Mortgage loan that does not meet
and to split commissions between the criteria for being funded by
the listing and selling brokers. Fannie Mae or Freddie Mac.
Mortgage-backed securities: Non-institutional lenders:

Investment instrument based on a Other sources of real estate loans
pooling of mortgages besides banks, thrifts and
insurance companies, such as
Negative amortization: mortgage bankers, mortgage
Increase in a loans outstanding brokers, pension funds and private
balance due to periodic debt individuals
service payments not covering the
total amount of interest attached Note: Written instrument
to the loan. acknowledging a debt and
promises to pay.
495
Notice, Actual: Implied or funds from the mortgagee after
express factual knowledge some loan payments have been
made.
Notice, Constructive: Fact
which should have been Open listing: Listing provided to
discovered due to ones actual a number of brokers without a
notice and/or inquiries that a duty to compensate any besides
reasonably prudent person would the particular broker who first
be expected to make secures a buyer ready, willing and
able to accept the listings terms or
Notice, Legal: Notice required obtains the sellers acceptance of a
by law to be given different offer.
Notice to quit: Notice provided Open mortgage: Mortgage that

to a tenant to vacate property has matured or whose payments
are late, so that it is open to being
foreclosed upon.
Obsolescence: Decline in value
to a reduction in desirability and Operating expenses: Funds
usefulness of a structure because used to maintain property, such as
its design and construction insurance and repairs, but
become obsolete or decline due to excluding depreciation or finance
a structure becoming outmoded, costs.
not in keeping with current needs.
Option: Right without the
Offer to purchase: Proposal to a obligation, to lease or purchase a
property owner by a potential property upon specified terms
purchaser to acquire the property during a specified period.
under previously-stated terms.
Optionee: One who receives or
Open-end loan: Type of loan acquires an option.
under which an additional amount Optionor: One who gives or sells
of money may be loaned to a an option.
borrower under the same trust
deed. Oral contract: An agreement not
in writing, usually unenforceable.
Open-end mortgage: Mortgage
including a clause under which the Overall capitalization rate:
mortgagor may obtain additional Rate calculated by dividing net
496
operating income by the propertys Personal property: All property
purchase cost. that is not realty; also known as
personalty.
Package loan: Mortgage Physical depreciation: Decline

created in which the principal loan in value stemming from age, wear
amount is raised to include and tear, and the elements.
improvements and movable items
such as appliances, along with real Planned Unit Development
estate. (PUD): Zoning or land-use plan
for large tracts that includes
intensive development of common
Partially amortized note: A and private areas, designed as one
periodic payments schedule on the integrated unit.
principal amount is set, so that the
interest accruing during the loan Plottage: Increasing the value of
term and other surplus unpaid a plot of land that has been
principal is to be paid off the end assembled from smaller plots
of the term. under a single ownership.
Pass-through securities: Points: Fees provided to lenders

Securities originated by the VA to attract a mortgage loan. One
and FHA to support the secondary point equals one percent of the
mortgage market, guaranteed by principal loan amount, which
Ginnie Mae lowers the funding amount
advanced by the lender, effectively
Percentage lease: Property raising the interest rate.
lease with the rental amount based
on a percentage of sales made on Positive cash flow: The
the premises, with a set minimum situation where the income
amount; usually used by retailers. generated by a property is greater
than the outflow of cash necessary
Periodic estate: Lease based on to sustain it
a specified calendar amount of
days, like month to month or year
to year; also known as a periodic Premises: Land and buildings,
tenancy. an estate.
Prepayment clause: Mortgage

clause conveying the privilege to a
497
borrower to pay her entire debt Processing: The compilation of
prior to its maturity loan application documents for the
consideration of a lender
Prepayment penalty: Charges
levied against a borrower for Procuring cause: Legal term
paying her entire debt prior to its for the cause resulting in the
maturity, if there is no objective of a real estate broker or
prepayment clause agent procuring a ready, willing
and able realty purchaser, used to
Primary mortgage market: determine who is entitled to a
The market for consumers to commission.
directly obtain a mortgage loan
Promissory note: Borrowers
Prime rate: Short-term interest signed promise to repay the loan
rate that a bank charges its most to a specific person under specific
creditworthy business customers terms.
Principal: a) Employer of a Property: Rights that a party has

broker or agent to use and possess land or chattel
b) Amount of money from the to the exclusion of anyone else.
mortgage or other loan, apart from
the interest due on it.
c) One of the main parties in a real Proprietorship: Business
estate deal ownership, including the
management of real estate, by a
Private lender: One who invests person, as opposed to a
their own money into real estate corporation or partnership.
loans, directly or via brokers.
Proration: Allocation between
Private mortgage insurance seller and purchaser of
(PMI): Mortgage guarantee proportional shares of a debt that
insurance that protects has been paid, or due to be paid,
conventional lenders in case of regarding a realty sale, such as
default, with premiums paid by property taxes and insurance.
the borrower.
Purchase capital: Funds used to
Probate: To prove the validity of purchase realty, from whatever
a will of a deceased person. source.
498
Purchase money mortgage:
Mortgage provided by a buyer Real estate investment trust
(grantee) to a seller (grantor) in (REIT): Mutual fund authorized
partial payment of a real estate by law to be immune from
purchase price. corporate taxes if most of its
profits are distributed to
individual investors who are taxed.
Quiet enjoyment: Right of an
owner or tenant to the use of a Real property: All the rights
property without any interference inherent in ownership to use real
to their possession. estate.
Quiet title: Court action to Real Estate Settlement

remove a defect or cloud on an Procedures Act (RESPA):
owners legal right to a piece of Federal law requiring lenders to
realty. offer information to borrowers on
settlement costs.
Quitclaim deed: Conveyance
establishing only the grantors Realtor: Real estate professional
interest in real estate, with no who follows the code of ethics
ownership warranties. pursuant to their membership in
the National Association of
Realtors.
Range lines: Used in the Recapture clause: Contract

government rectangular survey clause allowing party granting an
method of land description as interest or right in real estate to
lines parallel to the principal re-take it under specific
meridian, demarcating the land conditions.
into 6-mile strips called ranges.
Recording: Act of entering
Real estate: Land and all documents regarding title to real
permanent attachments to it. estate in the public record.
Real Estate Advisory Recourse: Authority of a lender

Commission: Ten-member to assert a claim to funds from a
board that makes borrower in default, besides the
recommendations to the Real property pledged as collateral.
Estate Commissioner on pertinent
issues.
499
Redlining: Unlawful policy of a function as a similar, previous
lender denying to make loans in building.
certain areas with high minority
populations due to alleged overall Reproduction cost: In
lending risks there without appraisals, the cost of construction
considering the creditworthiness of a replica of a property as of a
of each applicant. certain date.
Release clause: Mortgage clause Reserve requirement:
that provides property owner with Controlled by the Fed, the amount
the right to pay off part of their of reserve funds that banks and
indebtedness, releasing a specified thrifts must have on hand to
portion of the property from the safeguard depositors.
mortgage.
Reversion: Lessors right to take
Refinance: The replacement or possession of leased property
renewal of a current loan with new upon the end of a lease.
financing.
Right of survivorship: Right of
Regulation Z: See Truth-in a surviving joint tenant to take the
Lending Law. interest of a deceased joint owner.
Reinstatement: The curing of a Right of way: Easement right to

default on a loan secured by a trust use to specific path for access or
deed passage, as well as the subdivision
areas allocated to government use
Release clause: A provision of a for streets and other types of
blanket loan allowing the release public access.
of a particular land parcel on
repayment of a specified part of Riparian rights: Rights
regarding water use on, under or
the loan.
adjacent to a persons land,
providing reasonable use of such
Rent: Compensation paid for the water.
use of realty.
Rollover mortgage: Loan in
Replacement cost: In which the interest rate and the
monthly payment are
appraisals, the cost of construction
renegotiated, generally every five
to replace or serve the same years.
500
which generates funding for
Rumford Act: See Fair Housing primary lenders to provide new
Law. loans to consumers.
Security instrument: Realty

Sale-and-leaseback: Seller interest permitting the property to
retains occupancy to land by be sold if the obligation for which
leasing it back simultaneously with the security interest was created is
its sale, generally for a long term defaulted upon.
lease.
Separate property: As
Sales comparison approach distinguished from community
to value: In appraisals, property, property owned by a
estimating value through analysis spouse prior to marriage; acquired
of comparable properties recent by gift or bequest; or, by proceeds
sales prices. from other separate property.
Salesperson: One licensed to Servicing: The administration of

perform any act authorized by the an existing loan.
states Real Estate Law, if
employed by a broker also Straight-line depreciation:
licensed.\ Method of depreciation which uses
equal yearly reductions to estimate
Satisfaction piece: Written propertys book value.
instrument for the recordation and
acknowledgement of a mortgage Subdivision: Land tract divided
loans last payment. into plots appropriate for the
construction of homes, as per the
Section of land: Square mile in states Subdivided Lands Law.
the government rectangular survey
description of land. Subject to mortgage: Method
to take title to mortgaged realty
Secondary trust deed: Loan is without being personally liable for
secured by a trust deed favoring payment of amount due on the
the seller, and recorded promissory note. If the new buyer
subsequent to the first trust deed fails to make payments going
forward, the most he will lose is
Secondary mortgage market: his equity in the property.
The buying and selling of pools of
mortgages by lending institutions
501
Subordination clause:
Instrument allowing a mortgage Tenancy by the entireties:
recorded at a subsequent date to Estate that exists just between
take precedence over an earlier spouses, with each having equal
mortgage. right of possession and with right
of survivorship.
Surety: One who guarantees
anothers performance; a Tenancy in common:
guarantor. Ownership of real property by two
or more persons, with each having
Survey: Procedure under which a an undivided interest but without
parcel of land is measured and its the right of survivorship.
area calculated.
Tenant: Person given possession
Swing Loan: A temporary, short of real property belonging to
term loan, made on a borrowers someone else for a fixed term or at
equity in his present home. will.
Tax: Charge assessed against Thrifts: Savings banks, savings &

individuals, corporations and loans and other institutions which
organizations to fund government. specialize in investments in real
estate deeds of trust.
Tax-free exchange: Trade of
one property for another that is Tight money market: When the
excluded from tax liability on any demand for money is greater than
profit when the trade occurs. the supply, interest rates rise and
standards for borrowers to meet
Tax sale: Property being sold become tougher
after a period of unpaid taxes.
Time of the essence: A contract
Tenancy at sufferance: condition requiring that all
Tenancy created when a lawful references to specified dates
tenant retains possession of a regarding performance be
property after the lease followed exactly.
terminates.
Title: Establishes that a land
Tenancy at will: License to owner has lawful possession of a
possess realty and tenements for property, having all the elements
an indefinite period, at the owners of ownership.
will.
502
Title insurance: Insurance estate and the lender is the
policy providing protection from beneficiary.
losses caused by possible defects
in the title. Truth-in-Lending Law
(Regulation Z): Federal law
Title search: Public records enacted to inform borrowers
inquiry to ascertain any issues of regarding the complete cost of a
ownership and encumbrance loan.
regarding realty.
Topography: Surface of the land;

may be hilly, flat, rocky. Underwriting: Process of
evaluating an applicants
capability to meet the obligations
Township: Six-mile square tract of a real estate loan
located between two range lines
and two township lines established
by government rectangular survey. Unit in place method:
Projecting the cost of building a
Trade fixtures: Articles annexed structure based on estimating the
to rental structures by a price of its individual components,
commercial tenant in the course of such as the foundation, floors,
operating their business, walls and cost of labor.
removable by the tenant.
Unity: Four unities are needed to
Trust deed: Conveyance of realty establish a joint tenancy: interest,
to a neutral third party (trustee) possession, time and title. Thus,
which that person holds for joint tenants are required to have
another partys benefit. equal interests created by a
conveyance, the identical
Trustees sale: A non-judicial undivided possession, and the
foreclosure sale done by the same use during the same time.
trustee, it takes place only when a
trust deed includes a power of sale Unruh Act: State law requiring
clause. real estate borrowers be provided
with explicit notices of default on a
Trustor: Party who gives mortgage to safeguard
property to a trustee to be held on homeowners from losing their
a beneficiarys behalf, so that the residence due to default on a retail
trustor becomes the owner of real installment purchase.
503
Unsecured loan: In an applicants bank to establish the
unsecured loan, the lender existence and history of funds that
receives a promissory note from can be used for the loans down
the borrower but without a payment and other charges
security (such as a trust deed or
mortgage) for payment of the debt Verification of Employment
(VOE): Confirming the loan
Urban property: City, closely- applicants employment
settled realty.
information by obtaining current
Usury: Interest rate data from the employer, such as
impermissibly set higher than pay stubs and tax forms
allowed by law.
Warranty: Promise or guaranty
Utility: One of the elements of
included in a contract.
value, the capability to provide
gratification, inciting the wish to
Warranty deed: Instrument that
possess a property.
includes a covenant declaring the
grantor will protect the grantee
from claims on title.
Valid: Having legally sufficient
force, enforceable by a court. Without recourse: Phrase
employed in endorsement of a
Value: What something is worth note or bill indicating that the
to a particular party. holder cannot expect payment
from the debtor personally if non-
Variable expenses: Operating payment occurs.
costs for a property that rise upon
occupancy. Wrap-around Loan: See All-
inclusive Deed of Trust. Wraps an
Vendee: Buyer, a purchaser. existing loan with a new one, with
the borrower making one payment
Vendees lien: Lien applied to for both loans. .
property according to a contract of
sale, to secure buyers deposit.
Yield: Interest rate earned by a
lender on the loan amount.
Vendor: Seller
Verification of Deposit
(VOD): Form used by loan
504
INDEX
A Appraisal, 10, 11, 12, 280, 349,
350, 351, 352, 357, 362, 388, 390,
Acceleration clause, 98, 100,
398, 401, 466, 493
101, 137,465
Appraiser, 195, 351, 352, 466
Accession, 465
Appreciation, 6, 120, 175, 233,
Accrued depreciation, 353, 465,
295, 342, 466
476
Appropriation, 466
Acquisition cost, 260, 342, 343,
Appurtenances, 46, 73, 468
465
APR, 12, 110, 372, 373, 374, 384, ,
Actual age, 343, 344
476, 468
Ad valorem, 466
ARM, 92, 93, 94, 115, 117, 173, 410,
Adjustable rate mortgage, 92,
468, 471
115, 173, 410, 443, 471
Arranger of credit, 449, 468
Adjusted Gross Income, 465
Artificial person, 468
Adjustment period, 92, 410, 465
Assessment, 468
Administrative agency, 466
Assessor, 468
After-acquired title, 466
Assets, 366, 367, 471, 485
Air rights, 466,468
Assignee, 471
Alienation Clause, 99, 100, 101,
Assignment, 122, 123, 452, 469,
112, 467
475
All-inclusive Deed of Trust,
Assignor, 465
467, 503
Assumption, 5, 119, 235, 349, 373,
Amenities, 249, 273, 318, 338, 467
385, 449, 469
Americans with Disabilities
Act, 459, 465, 473 Attachment, 48, 69, 71, 475, 469,
Amortization, 473 498
Annual percentage rate, 447, Auditing, 469
467 B
Annuity, 6, 120, 467
Back-End Ratio, 469
Anti-deficiency rules, 466
Balance, 325, 469
Apportionment, 466
505
Balloon payment, 103, 105, 110, Closing, 12, 13, 109, 195, 235, 244,
196, 197, 447, 469 249, 258, 259, 261, 262, 294, 384,
Bankruptcy, 33, 76, 77, 244, 377, 399, 401, 473
405, 430, 469 Comparables, 317, 336, 338, 340,
Base Line, 50, 51, 56, 58, 470 474
Bearer, 470 Comparitive Market Analysis,
Benchmark, 446, 470 474
Beneficiary, 146, 147, 476 Condominium, 296, 474
Blanket mortgage, 470 Conforming loan, 217, 389, 475
Bond, 470 Consumer Price Index, 448,
Bonus, 471 475, 479
Broker, 195, 196, 222, 246, 471 Conveyance, 482, 503, 507
Bundle of rights, 471 Correction lines, 476
Buy down, 471 Cost approach to value, 339,
354, 476
C
Cost recovery deductions, 476
California Fair Housing Law, Covenant, 75, 137, 472, 477
451, 471 Credit history, 362, 401, 477
Cal-Vet loans, 205, 215, 223, 471 Credit union, 170, 477
Cap, 265, 283, 285, 347, 471
Capital, 16, 230, 231, 261, 290, 291, D
292, 293, 296, 297, 468 Damage deposit, 477
Capitalization, 344, 347, 471 Debit, 477
Carry-back loan, 472 Debt service, 260, 295, 296, 477
Carryover clause, 472 Debt Service Ratio, 259, 260,
Cash flow, 281, 295, 472 268, 294, 478
CC&Rs, 76, 85, 478, 483, 493 Debtor, 477
Certificate of Eligibility, 207, Deduction, 478
208, 211, 472 Deed, 5, 6, 7, 72, 86, 102, 120, 121,
Certificate of Reasonable 134, 473, 484, 509
Value, 208, 211, 223, 473 Default, 9, 126, 130, 138, 147, 450,
Chain of Title, 473 485
Chattel, 473 Delinquency, 485
506
Depreciation, 228, 230, 261, 262, Estate, 1, 2, 9, 10, 11, 14, 16, 30, 42,
290, 292, 294, 295, 341, 342, 471, 57, 142, 149, 164, 195, 196, 223,
479, 485 233, 234, 244, 245, 351, 352, 357,
Developer, 480 368, 408, 416, 440, 452, 467, 472,
Discount points, 209, 211, 467, 489, 492, 499, 504, 505, 507
480
F
Discount rate, 176, 202, 480
Disintermediation, 23, 39, 155, Fair Credit Reporting Act, 456,
168, 172, 198, 200, 480 468, 489
Down payment, 480 Fair Employment and
Due-on-Sale Clause, 30, 99, 101, Housing Act, 489
112, 113, 467, 480 Fair Housing Act, 28, 459, 460,
461, 469, 485, 489
E Fair Market Value, 11, 489
Earnest money, 480, 486 Federal Home Loan Bank
Easement, 84, 86, 486, 487, 499 System, 155, 167, 169, 490
Economic obsolescence, 342, Federal Home Loan Mortgage
353 355, 481, 506 Corporation, 29, 169, 193, 202,
Effective age, 344, 481 359, 386, 490
Effective Gross Income, 345, Federal Housing
469, 489, 494 Administration, 9, 26, 28, 38,
Ejectment, 481, 487 190, 192, 203, 204, 221, 440, 490
Emblements, 46, 487 Federal National Mortgage
Encroachment, 84, 488 Association, 28, 29, 190, 192,
Encumbrance, 56, 488, 497 193, 201, 202, 359, 386, 490
Equal Credit Opportunity Act, Federal Reserve, 8, 27, 29, 33,
14, 379, 422, 425, 433, 439, 467, 37, 39, 151, 155, 175, 179, 181,
468, 470, 488 183, 184, 185, 186, 187, 198, 200,
Equity, 6, 14, 109, 210, 232, 448, 201, 386, 431, 432, 438, 439, 445,
454, 468, 488, 494 446, 448, 451, 452, 455, 464, 465,
Escalation clause, 488 484
Escrow, 244, 370, 383, 442, 443, Federal Trade Commission,
488 407, 438, 454, 484
507
Fee simple, 57, 484 Holden Act, 487
FICO Score, 485 Holder in Due Course, 96, 97,
Financial Institutions 117, 487
Reform, Recovery, and Home Equity Line of Credit
Enforcement Act (FIRREA), (HELOC), 106, 488
32, 35, 40, 157, 167, 416, 485 Homestead, 4, 76, 80, 484, 488
Finders fee, 491 Hypothecate, 488
First lien position, 491
Fixture, 3, 491 I
Forbearance, 400, 491 Impounds, 488
Foreclosure, 7, 71, 128, 129, 145, Income approach, 344, 348, 354,
147, 491 378, 472, 479
Forfeiture, 492 Income property, 228, 229, 330,
Functional obsolescence, 342, 327, 334, 353, 364, 489
355, 492 Income ratio, 299, 390, 392, 394,
489
G
Independent contractor, 489
Good faith deposit, 492 Institutional Lender, 15, 23, 37,
Goodwill, 492 90, 92, 149, 150, 161, 207, 220, 490
Government National Interim loan, 150, 165, 490
Mortgage Association, 29, Investment property, 104, 228,
192, 193, 202, 359, 386, 492 231, 235, 290, 490
Government Survey System, Involuntary lien, 60, 490
492, 493
Grantee, 457, 466, 469, 479, 481, J
487, 493 Joint tenancy, 64, 85, 86, 490
Granting clause, 493 Judgment, 127, 139, 488, 490
Grantor, 74, 75, 466, 478, 481, 487 Junior mortgage, 143, 144, 490
Gross Income Multiplier, 493
Guide Meridians, 476, 487 L
Land contract, 215, 224, 469, 489,
H 490
Hard Money Loan, 106, 487
508
Landlord, 424, 44, 48, 49, 241, Mechanics lien, 69, 70, 71, 363,
257, 275, 279, 286, 287, 290, 473, 493
491 Meridian, 51, 493
Leasehold estate, 44, 469, 491 Metes and bounds, 50, 55, 56,
Leasehold improvements, 491 471, 491
Legal description, 50, 55, 56, Mineral rights, 45, 468, 463
129, 330, 363, 366, 491 Mortgage, 2, 6, 7, 8, 9, 12, 13, 16,
Lessee, 44, 49, 491 17, 18, 20, 21, 22, 23, 25, 28, 29, 30,
Lessor, 44, 449, 491, 34, 39, 85, 110, 115, 118, 120, 137,
Leverage, 88, 491 140, 150, 163, 168, 169, 170, 173,
Lien, 497, 499, 509 190, 192, 193, 195, 196, 201, 202,
Life estate, 43, 57, 58, 327, 486, 203, 205, 210, 213, 215, 222, 223,
491 261, 262, 307, 312, 359, 367, 371,
Life tenant, 43, 491 376, 378, 384, 386, 387, 392, 398,
Lis pendens, 72, 85, 141, 492 400, 404, 438, 441, 454, 455, 468,
Loan Origination, 10, 213, 223, 474, 476, 478, 482, 490, 491, 492,
224, 492 493, 500, 501, 502, 503, 504
Loan package, 161, 363, 389, 390, Mortgagee, 135, 136, 138, 144,
399, 492 220, 472, 493, 495
Lock-in, 498 Mortgagor, 119, 135, 136, 137,
Lot and block number, 492 141, 403, 472, 474, 493, 495
Multiple Listing Service, 246,
M
252, 284, 456, 476
Margin, 92, 93, 119, 173, 177, 341,
361, 492 N
Market Data Approach, 492 Negative amortization, 93, 115,
Market price, 249, 267, 317, 318, 447, 494
324, 493 Negative cash flow, 67, 134, 238,
Market value, 116, 195, 232, 248, 364, 494
253, 267, 287, 317, 318, 319, 327, Negotiable instrument, 89, 90,
336, 346, 347, 348, 356, 477, 482, 96, 118, 470, 494
484, 493 Non-institutional lenders, 15,
Marketable title, 79, 492 36, 149, 161, 494
509
Note, 5, 43, 46, 89, 91, 92, 95, 198, Private lender, 91, 92, 496
212, 215, 270, 494 Probate, 64, 65, 67, 497
Promissory note, 64, 65, 67, 89,
O
90, 96, 112, 113, 117, 121, 122,
Obsolescence, 323, 342, 353, 355, 135, 136, 386, 489, 497, 500
479, 481, 494 Property, 3, 4, 5, 8, 23, 42, 44, 45,
Offer to purchase, 243, 363, 495 63, 64, 68, 69, 72, 83, 99, 196, 197,
Open listing, 495 211, 228, 229, 230, 232, 244, 248,
Open-end loan, 111, 120, 448, 250, 253, 255, 257, 258, 352, 363,
195 366, 367, 392, 398, 456, 474, 480,
Open-end mortgage, 501 495, 496, 502, 503, 500
Operating expenses, 234, 252, Proration, 497
259, 260, 261, 264, 265, 267, 268, Purchase capital, 497
270, 278, 280, 282, 295, 346, 364, Purchase money mortgage,
472, 488, 495 497
Option, 275, 288, 495
Optionee, 495 Q
Optionor, 495 Quiet title, 497
Overall capitalization rate, 495 Quitclaim deed, 478, 497
P R
Percentage lease, 496 Real estate investment trust
Physical depreciation, 496 (REIT), 149, 163, 498
Positive cash flow, 238, 277, 281, Real Estate Settlement
282, 283, 496 Procedures Act (RESPA), 14,
Premises, 496 29, 368, 408,437, 438, 416, 437,
Prepayment clause, 101, 102, 462, 498
496 Recording, 4, 61, 62, 78, 85, 126,
Prepayment penalty, 102, 209, 143, 147, 498
496 Recourse, 498
Primary mortgage market, Redlining, 387, 399, 498
187, 189, 496 Refinance, 498
Prime rate, 33, 108, 496
510
Regulation Z, 373, 416, 444, 445, Subdivision, 54, 75, 275, 285, 287,
446, 448, 451, 452, 453, 498 453, 471, 472, 475, 488, 499, 500
See Truth in Lending Law, Subordination clause, 101, 119,
Reinstatement, 127, 129, 138, 500
147, 498 Surety, 500
Release clause, 111, 498 Swing Loan, 111, 120, 447, 500
Rent, 233, 347, 498
T
Replacement cost, 214, 234, 499
Reproduction cost, 499 Tax sale, 500
Reserve requirement, 176, 182, Tax-free exchange, 231, 500
202, 499 Tenancy at sufferance, 500
Reversion, 43, 499 Tenancy at will, 500
Right of survivorship, 64, 65, Thrifts, 7, 15, 31, 36, 149, 151, 166,
67, 86, 490, 499, 499 168, 189, 494, 500, 501
Right of way, 499 Title, 4, 29, 59, 63, 80, 81, 82, 126,
Rollover mortgage, 116, 120, 138, 192, 193, 195, 370, 372, 383,
499 444, 459, 462, 489, 498, 501
Rumford Act, 471, 483, 499 Township, 3, 50, 51, 54, 56, 58,
501
S Trustees sale, 128, 129, 130, 132,
Sale-and-leaseback, 499 134, 437, 478, 486, 502
Sales comparison approach Trustor, 122, 125, 129, 147, 148,
to value, 338, 354, 474, 492, 499 508
Secondary mortgage market, Truth-in-Lending Law, 371,
27, 28, 29, 162, 187, 188, 189, 190, 441, 442, 445, 447, 448
191, 193, 194, 247, 308, 312, 387,
496, 500 U
Secondary trust deed, 500 Underwriting, 3, 12, 365, 375,
Security instrument, 98, 121, 388, 401, 502
140, 224, 467, 500 Unit in place method, 341, 502
Separate property, 66, 67, 500 Unruh Act, 502
Straight-line depreciation, Unsecured loan, 502
229, 343, 506 Utility, 280, 319, 321, 353, 356, 502
511
V W
Value, 9, 11, 12, 198, 223, 229, 232, Warranty, 493, 503
275, 285, 292, 294, 318, 334, 339, Without recourse, 503
343, 353, 391, 394, 395, 478, 502
Y
Verification of Deposit, 376,
377, 391, 503 Yield, 292, 503
Verification of Employment,
Z
374, 375, 377, 393, 402 503
Zoning, 82, 234, 330, 502, 503
512

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Finance

The Beginning ................................................................................16

The Great Depression ..................................................................22

Recovering from the Depression ..............................................24

Federal Governments Role in Real Estate Finance.............25

Last 20 Years of the 20th Century..............................................32

Chapter Summary .........................................................................36

Chapter Two: Real Property .................................41

Bundle of Rights ............................................................................41

Real Property vs. Personal Property........................................44

Real Property .................................................................................45

Land Description Underwriting Guidelines ..........................49

Chapter Summary .........................................................................55

Chapter Three: Land Titles and Estates ............59

Land Title ........................................................................................59

Ownership of Real Property.......................................................63

Limitations on Real Property: Encumbrances......................69

Homestead Exemption ................................................................76

Assuring Marketability of Title..................................................79

Chapter Summary .........................................................................82

Chapter Four: Instruments of Finance..............87

Adjustable Rate Mortgages (ARMs...........................................92

Property Transfers by the Borrower .......................................99

Clauses in Financing Instruments............................................100

Junior Trust Deed .........................................................................102

Other Loans Secured by Trust Deeds or Mortgages ............106

Alternative Financing ..................................................................114

Chapter Summary .........................................................................117

Chapter Five: Trust Deeds and Mortgages........121

Features of a Trust Deed .............................................................125

Trust Deed: Foreclosures............................................................128

Trust Deed: Benefits.....................................................................135

Mortgage Features ........................................................................137

Chapter Summary .........................................................................145

Chapter Six: Mortgage Lenders ...........................149

Institutional Lenders ...................................................................150

Chapter Summary .........................................................................165

Chapter Seven: The Mortgage Market ...............172

The Federal Reserve Banking System (The Fed....................175

The Mortgage Market...................................................................187

Real Property Loan Law ..............................................................196

Personal Property Secured Transactions...............................197

Chapter Summary .........................................................................198

Chapter Eight: Mortgage Insurance and

Mortgage Default Insurance ......................................................203

Private Mortgage Insurance (PMI ............................................215

Chapter Summary .........................................................................221

Chapter Nine: Real Estate as an Investment....226

Reasons for Investing in Real Estate .......................................227

The Investment Process ..............................................................235

Steps of Successful Investment .................................................235

Real Estate Analysis Tools ..........................................................259

Chapter Summary .........................................................................292

Choosing a Lender ........................................................................300

How Loans are Originated..........................................................303

Wholesale Lending as a Solution..............................................308

Chapter Summary .........................................................................309

Chapter Eleven: Appraisal ....................................315

Definition of Appraisal ................................................................316

The Appraisal Process..................................................................326

Chapter Twelve: Processing Loans .....................358

Loan Process Overview................................................................358

Steps for Obtaining a Real Estate Loan...................................364