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Mortgage •
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By: Kenneth Jay
Gain, MAI, SRS, CCIM,CRE WHAT
ARE MORTGAGES?
The term Mortgage is a generic term referring to
debt obligations secured by real estate. As you
know there are many brands of photo copying
machines currently available, yet many of us still
refer to the process of making a copy as Xeroxing,
due to the fact that Xerox produced the first
widely available good quality copy machine. In the
same manner, we refer to debt obligations secured
by real estate as Mortgages, even though many
states, including Alaska, do not use Mortgages. The
term Mortgage is an English common law term and was
a form of security instrument used for hundreds of
years before the formation of our country
(if
you are a historically curious type, drop by our
office and see an actual old English Mortgage, hand
written on parchment with a wax
seal).
Because the laws in the United States of America
are based upon English Common Law, most of the
original colonies use Mortgages as a way of
pledging real estate as security for a loan. For
this reason we commonly use the term Mortgages
although you may often encounter the following
terms that mean essentially the same
thing: • Deeds of
Trust As mentioned
above, Alaska does not use Mortgages, although we
commonly refer to all real estate secured debt
instruments as Mortgages. The use of a Mortgage in
Alaska would not be illegal, but because they are
not defined by Alaska's statutes there is no good
reason to use them. Alaska is what is known as a
"Deed of Trust State", because our statutes define
and provide law governing the use of a Deed of
Trust to secure real estate debts and define the
methods of foreclosure in the event of default. All
Deeds of Trust actually consist of two
documents. The first
document is the Promissory Note, which outlines the
terms of the debt obligation. A Promissory Note
states the amount that is owed, the interest rate
that accrues on the unpaid balance, when and where
the payments are to be made, and the date from
which interest accrues. Other provisions contained
in a Note usually are the fact that the Note will
be accelerated (the full balance becoming due) in
the event of a default and provides for the Payor
to be responsible for attorney costs if suit is
filed to collect the Note. The Note may also
provide for late payment penalties and penalty
interest in the event of default. By itself, it is
a totally enforceable legal agreement and suit can
be brought to collect on a Note without having a
Deed of Trust or without regard to a Deed of Trust,
even if one exist. The Deed of Trust
is a separate agreement in which the property is
pledged as security for the Note. It usually
outlines additional obligations of the Payor, such
as the requirement to keep the property insured,
pay all property taxes before due, and maintain the
property in good condition. In addition, it
describes the process for foreclosure by the
Trustee. There are three
parties to every Deed of Trust. The Trustor is the
borrower (the Payor on the Promissory Note) who
pledges the property as security for the debt. The
Beneficiary is the person (or entity) to whom the
money is to be paid (the Payee on the Promissory
Note). The final party to the Deed of Trust is the
Trustee, which is usually a title company that is
granted nominal title for the purposes of
foreclosure only (see Default and Foreclosure
below), but the Trustor retains all rights of
beneficial ownership. The Deed of Trust defines the
rights and obligations of all three parties and
because these can vary greatly from transaction to
transaction, it is an instrument that should be
carefully read in detail. Although the
primary use of Deeds of Trust is to secure a debt
obligation, Deeds of Trust can also be used to
secure other forms of promises or obligations and
these types of Deeds of Trust are referred to as
Performance Based Deeds of Trust. You will often
see the term First Mortgage or Second Mortgage
(likewise for First Deed of Trust and Second Deed
of Trust). What this refers to is the priority
position of the Mortgage. A First Mortgage is the
first one recorded against the property and
therefore has first claim on the real estate for
settlement of the debt that it secures. A Second
Mortgage is in second position and is totally
subservient to the obligation secured by the First
Mortgage. For this reason a party foreclosing on a
Second Mortgage is obligated to satisfy the
obligation secured by the First Mortgage. Therefore
investment in Second Mortgages is considerably more
risky than investment in First Mortgages. Although
our firm does invest in Second Mortgages (and
occasionally Third Mortgages) we rarely sell
anything to Investors other than First Mortgages.
The only exception is when the Investor is someone
who has invested with us for a substantial period
of time, has demonstrated a high risk tolerance,
has considerable investment expertise and is known
by us to be wealthy. To let the public
know that the real estate has been secured by a
Mortgage, all Mortgages and Deeds of Trust include
a legal description of the property and the full
document is placed on record in the District
Recorder's Office. It is therefore possible for the
public to learn the full terms of a Mortgage or
Deed of Trust by going to the Recorder's Office and
acquiring a copy of the document. While the
Mortgage or Deed of Trust will show the initial
amount of the debt, the terms of repayment, which
are represented by the Promissory Note, are not
available for public scrutiny. Special Note
on Terminology: Because the term Mortgage is
the generic term in common use throughout the
United States to refer to debt obligations secured
by real estate, I have chosen to primarily use that
term throughout the information contained on this
website. However, when discussing certain legal
issues that are unique to Alaska, I will refer to
the correct legal instrument for Alaska which is a
Deed of Trust or a Note and Deed of Trust. Although
I plan to use the term Mortgage on this website as
the generic term, in other correspondence and
advertising material, I often use the generic term
"Notes" as referring to both the Promissory Note
and the Deed of Trust securing it. You will find it
common for professional investors in Mortgages to
use the term Notes as the generic description,
whereas, members of the public are more familiar
with the generic term Mortgages. INVESTMENT
BENEFITS:
The primary investment benefit of Mortgages is the
ownership of an investment that provides a higher
interest rate than is typically available from
other interest bearing investments, such as pass
book savings accounts, certificates of deposits,
money market funds, etc. Of course you must never
forget the important relationship between risk and
reward (the higher the reward the higher the risk).
To reduce risk is why Mortgages are secured by real
estate, so that in the event the debt is not paid
as agreed, the Investor (Payee on the Promissory
Note) can foreclose upon and become the owner of
the real estate. As discussed in our introductory
section - - "Why Invest in Mortgages", there
are a number of ways to invest in government
insured and conforming Mortgages that are quite
safe and have little risk of principal loss.
However, as Robert Kiyosaki discusses in his
"Rich Dad - - Poor Dad" series of books, the
secret of wealth is to find investments not widely
available to the general public and therefore enjoy
the opportunity of superior investment returns.
Private Mortgages (such as our Direct Loans and
Seller Financed Mortgages) provide yields that are
often double the yields on the widely available
conforming Mortgages. But with intelligent analysis
and careful selection, can be invested in with risk
that is not substantially greater than conforming
Mortgages. In summary, the
principal benefit of investing in Mortgages is the
ownership of high interest rate investments that
are secured by real estate. At the current time the
Mortgage Investments offered by our firm typically
yield from 9% to 15%. INVESTMENT
DRAWBACKS:
The principal drawback of an investment in a
Mortgage is the possibility of default in payment
or the loss of the real estate securing the debt by
failure to insure the improvements or paying real
property taxes. Certain conforming Mortgages are
guaranteed by the government (FHA or VA Loans) or
by private mortgage insurance companies. While
these guarantees significantly reduce risk they
also reduce the yield to about half of what can be
earned investing in Private Mortgages. In Private
Mortgages, the principal drawback is that they are
not guaranteed by any government agency or third
party insurer. In the event the borrower does not
make payments as agreed, the fall back position is
foreclosure on the real estate securing the debt.
If the initial loan amount is too high, or the
value of the real estate has decreased since the
loan was made, it may not be possible to resell the
property for enough to cover the debt (thus the
importance of Loan to Value and Investment to Value
as discussed below). Other drawbacks include risk
of loss due to failure to make certain that
improvements on the property are insured or to make
certain that real property taxes are paid.
SELLER
FINANCED
MORTGAGES:
This type of Private Mortgage is sometimes called
Seller Carry Back, Owner Carry Back, Seller
Financed Note, or Seller Financed Deed of Trust.
All terms mean the same thing and describe a debt
obligation secured by real estate where the debt
was created by the sale of the real estate. This
occurs when the Buyers, rather than acquiring a
Mortgage from a bank or other lender and paying the
Sellers all cash, have paid the Sellers a down
payment and given a Promissory Note for the balance
of the purchase price and secured that debt by a
Mortgage or Deed of Trust against the property
sold. Although certain
sophisticated Sellers, or financially well off
Sellers, will select this method of financing to
earn higher interest or avail themselves of
installment income tax reporting, by far the
majority of Seller Financed Mortgages are created
because there is no other attractive financing
alternative. This may mean that the Buyers have
weak credit and were not able to obtain a loan from
a bank or other lender, or that the property is not
considered a conforming property that meets the
requirement of banks and other lenders. Properties
that typically fall in this category are
recreational cabins, vacant land, small commercial
properties, mobile homes, and lots improved with
mobile homes. Most Sellers are fairly
unsophisticated and as a result there is usually
little underwriting of the terms of the Mortgage
and the interest rate and payment terms may not
reflect the real risk. As a result, to make
investments in Seller Financed Mortgages
attractive, it is necessary to purchase them at
less than their face value to provide a yield that
is attractive to an Investor. (Discounting)
Example:
Assume a Seller Financed Mortgage in which a
recreational cabin was sold for $100,000 with
$10,000 down and the Sellers carrying back a
$90,000 Mortgage at 7% interest payable at $697.76
per month (20 year amortization). After
investigation, the Investor determined that based
upon the Buyer's credit and other risk factors an
11.5% yield was necessary to make an investment in
this Mortgage attractive. After doing the yield
calculation, the Investor would determine that he
could pay the Sellers $65,430 for this $90,000
Mortgage and receive a 11.5% return on the
investment. Thus the Mortgage has been discounted
and that's why Seller Financed Mortgages are
sometimes referred to as Discounted Paper,
Discounted Notes, Discounted Mortgages, etc..
DIRECT
PRIVATE LOANS:
Another type of private Mortgage is one in which a
direct loan is made to the Borrowers to refinance a
property already owned or purchase a property. The
most common purpose for such direct loans is for
purchase of a property that provides great profit
potential after being renovated, or purchase of a
piece of land that can be subdivided and sold at a
profit. Other instances include situations in which
business Borrowers need additional capital for
their business and to secure that money take out a
Mortgage on property they already own. Because
these are direct loans, they are usually thoroughly
underwritten with requirements for Borrower's
financial statements, income information, full
credit reports, and inspection and/or appraisal of
the property before making the loan. As a result,
the Lender/Investor is well aware of the risk and
therefore makes the loan at an interest rate
commensurate with that risk. Example:
Again assume the same example as given above under
Seller Financing - - a recreational cabin selling
for $100,000 with $10,000 down. In the case of a
direct loan the Lender/Investor has determined that
the risk requires an 11.5% yield and that to reduce
risk, he is only willing to make a loan equal to
65% of the value ($65,000 in this case). So this
loan proposal would work only if the Borrowers
already owned the property with substantial equity
and were just looking to raise money for another
investment. But if it were a situation involving a
purchase, few Buyers would have $35,000 available
as a down payment. Therefore, the structure of the
sale in this case would probably involve a loan
from the Lender/Investor of $65,000 at 11.5%
interest, a down payment of $10,000 to the Sellers
and the Sellers carrying back a Seller Financed
Second Mortgage for the difference of $25,000
($100,000 -$10,000 -$65,000=$25,000). In this
example, the Lender/Investor would also look to the
Sellers as a second source of repayment in the
event of default, because if the Borrowers failed
to make the required payments and the
Lender/Investor foreclosed on the property the
Sellers would lose the security for their $25,000
Second Mortgage upon foreclosure. Therefore, the
Sellers may be willing to step into the Buyers'
position and cure the default on the
Lender/Investor's First Mortgage and then proceed
to foreclose on their Seller Financed Second
Mortgage to protect their $25,000 position.
LOAN
TO VALUE:
In the foregoing examples, for Seller Financed
Mortgages and Private Direct Loans, I gave examples
of Loan to Value. Loan to Value ("LTV") is merely
the ratio between the face amount of the Mortgage
and the selling price or value of the property. In
the first example for Seller Financed Mortgages,
the Mortgage was $90,000 and the selling price was
$100,000 and thus the Loan to Value Ratio was 90%
($90,000 / $100,000). In the second example, for
Private Direct Loans, the Lender/Investor's Loan to
Value Ratio was only 65% ($65,000 / $100,000). But
from the Buyers' perspective, the Combined Loan to
Value Ratio ("CLTV") was still 90%, because the sum
of the First Mortgage and the Second Mortgage was
$90,000. Knowing the Loan to Value Ratio of a
Mortgage Investment is very important, because it
determines how much the Borrower has at risk. A
Borrower who stands to lose $50,000 of equity in a
foreclosure will try much harder to cure the
default than a Borrower who stands to lose only
$5,000 of equity in a foreclosure. In the case of a
Direct Loan, it is also important to the
Lender/Investor because it shows what the property
will have to be sold for after foreclosure to
recover the amount of the investment in the
Mortgage. INVESTMENT
TO VALUE RATIO:
In the case of a Direct Loan, the Investment to
Value Ratio ("ITV") would be the same as the Loan
to Value Ratio from the Lender/Investors'
perspective. In the example above, for the Direct
Loan, the Investor invested $65,000 and holds a
Mortgage with a $65,000 face value, so both the LTV
and ITV are 65%. However, in the first example, for
the Seller Financed Mortgage, the LTV was 90%, but
since the Investor only paid $65,430 to purchase
that Mortgage, the ITV is 65.43%
($65,430/$100,000). Unlike LTV, ITV will not show
how much the Borrower/Owner stands to lose in the
event of a foreclosure, but it will show you how
much you would have to sell the property for after
foreclosure to recover your investment. Special
Note: Because the importance of LTV and ITV in
reducing risk, the maximum ITV never exceeds 70%
for improved properties and 50% for land loans, for
our Preferred Partial Interest program, and 65% and
45%, respectively, for our Preferred Fractional
Interest program. (Click: Investment
Examples) LOAN
UNDERWRITING:
Underwriting is just a technical industry term that
describes the process of evaluating a Mortgage
Investment. As such, underwriting encompasses the
due diligence investigation and the risk analysis
to determine the appropriate interest rate and
other terms of a Mortgage. Underwriting consist of
an evaluation of both the Borrower and the property
pledged as collateral. Evaluation of the
Borrower will usually consist of a minimum of
obtaining a financial statement from the Borrower,
the Borrower's credit report, and a search of
public records to obtain information about the
Borrower such as ownership of other real estate,
outstanding liens, lawsuits, etc.. In the case of
existing Seller Financed Mortgages, usually the
only information that can be obtained about the
Borrowers is their credit report and matters of
public record. However, if the Mortgage has been in
existence for sometime (seasoning) then an
important part of Borrower evaluation is analysis
of the payment record on the subject Mortgage.
CONFIRMATION
OF VALUE:
To make a realistic calculation of the LTV or the
ITV, it is first necessary to know the value of the
property. There are a number of ways of confirming
value, but since some can be fairly expensive, we
use a step approach to this process and usually
only require the most expensive form of
confirmation (an appraisal report) on properties
with loans in excess of $200,000. For Seller
Financed Mortgages, involving sale of the property
within the last several years, one important
confirmation of value is to obtain the closing
statement from the sale of the subject property to
verify what price was actually paid for the
property. If a relatively small loan is involved
and evaluation of other sources of information such
as comparable sales of similar properties in the
immediate area or tax assessments indicate that the
price is reasonable, that may be the limit of
confirmation of value. On loans a little larger,
the confirmation of value process may be further
supplemented by a Broker's Letter of Opinion or an
appraisal. For existing Seller Financed Mortgages,
it is usually not possible for the appraiser to
inspect the interior of the property, and therefore
the appraisal is based upon a drive-by inspection,
in which the appraiser views the exterior of the
property, photographs it and based upon information
on its size contained in assessment records, uses
the full appraisal process to form an opinion of
the current value of the property. A full appraisal
of the property would involve both an interior and
exterior inspection of the property. In the case of
a residential property a full formal appraisal is
usually done on a multi-page form that is accepted
throughout the United States by virtually all
lenders. In the case of a commercial property, the
report is usually a narrative report giving a
thorough description of the property and the
analysis used in arriving at the appraiser's
opinion of value. Appraisers use
three approaches to estimate the value of
property: The Cost
Approach, is based upon the Market Value of the
site (by the Sales Comparison Approach), plus the
cost of reconstructing a similar improvement, less
depreciation. The Cost Approach is primarily relied
upon for newer properties or special use properties
where there is not good comparable sales data
and/or where an Income Approach may not be
appropriate. The Sales
Comparison Approach is used to estimate the
value by comparison with sales of similar
properties and making adjustments for differences.
This approach is the most important approach in the
appraisal of residential property, but is somewhat
useful in the appraisal of commercial and income
properties, for property types where there are a
number of sales, such as apartments and warehouses.
It is usually the only approach that is applicable
for the appraisal of vacant land. The third
approach is the Income Approach which is
based upon analyzing the potential income that can
be obtained from renting the property. Next an
allowance for vacancy and collection and operating
expenses are deducted to calculate Net Operating
Income ("NOI"). The NOI is then capitalized into a
value estimate based upon rates of return derived
from analyzing the sales of other income producing
properties. It is the most important approach for
investment properties. The best form of
value confirmation is the verified recent sales
price of the subject property further confirmed by
a formal appraisal. However, because of the cost of
appraisals that process is usually feasible only on
larger loans. On any loan in excess of $200,000 we
always require a full appraisal. For smaller loans
we use less formal methods, but will in some cases
still require an appraisal if we are unable to get
enough confirming information from other sources to
make us feel comfortable about the value of the
property. Because I am both a State Certified Real
Estate Appraiser and a Member of the Appraisal
Institute ("MAI") and have access to a considerable
amount of comparable sales information, I am often
able to get enough reliable information to provide
an acceptable confirmation of value on smaller
loans without incurring the expense of an
appraisal. CONFIRMATION
OF TITLE:
Evaluation of the condition of the title involves a
process of confirming that the property is actually
owned by the Borrower and determining that the
subject Mortgage is a valid Mortgage represented by
a recorded Deed of Trust and determining the
priority of that Deed of Trust. Although a Mortgage
may be referred to as a First Mortgage it is not
actually a First Mortgage unless it is the first
one recorded. Although there may be no senior
Mortgages, certain liens and real estate taxes (see
more on this topic below) can have priority over a
First Mortgage. Therefore to make a reasonable risk
evaluation it is important to know what other
senior encumbrances are on title. Likewise, if
there are junior encumbrances such as Second
Mortgages or liens that are inferior to the claim
of the subject First Mortgage, these are
indications of other parties that may be secondary
sources of repayment in the event of a
default. The best
confirmation of title for a Mortgage is obtained
through purchasing a Mortgagee's Title Insurance
Policy. It is our policy to always obtain a
Mortgagee's Title Insurance Policy on all Direct
Loans and all Seller Financed Loans with balances
of $50,000 or greater. On purchases of Seller
Financed Mortgages, that we purchase at the closing
of the sale, we always get a Mortgagee's Title
Insurance Policy because the cost is very nominal.
However, for existing Seller Financed Mortgages,
with balances of less than $50,000, we may rely
upon informal confirmation of title, such as an
older title report and/or a review of public
records to determine what instruments have been
recorded against the subject property. While this
type of search of public records can provide an
accurate confirmation of the status of title, it
provides no insurance in the event of title claims
that were not found in this search and provides no
protection against forged documents and other items
covered by a Mortgagee's Title Insurance Policy.
For these reasons, a Mortgagee's Title Insurance
Policy is usually a good investment, except in the
case of smaller Mortgages in which the cost of the
title insurance is disproportionate to the
investment. CREDIT
REPORTS:
Credit Reports on the Borrower are one of the most
important steps in evaluating the Borrower. While
equity is the most important factor to protect a
Mortgage Investor from loss in the event of
default, the likelihood of default can be predicted
from a credit report. Credit Reports aren't perfect
predictors because there are people who have
incurred credit problems beyond their control such
as injury or unemployment. However, my experience
indicates that they are about 70% accurate, due to
the fact that people who have a long habit of not
paying their bills on time rarely
change. The important
thing to remember about credit reports is that they
are a lot like mortality tables. A mortality table
can tell how long the average 50 year old will
live, but it can't tell you how long you will live.
Likewise, credit reports may not be totally
accurate for one given individual, but for a large
group they are incredibly accurate in predicting
the likelihood of default. More and more
lenders are relying upon the so called FICO score
developed by the Fair Isaac Company. FICO scores
range from approximately 350 points to 875 points
and are available from all three national credit
bureaus. Each bureau calculates its score based
solely on the data within that bureau's credit
files. Each bureau also has it's own name for it's
version of the FICO score. For Equifax it's a
Beacon score, for Transunion it's an Empiria score
and for Experian it's called a Fair Isaac score.
Here are the
statistics relating to credit scores. If the score
is below 600 a lender will have 8 good loans for
each bad loan. However, if the score is above 800,
the lender will have 1,292 good loans for each bad
loan! With these kinds of statistics you can see
why lenders rely heavily on credit scores. Both
FNMA and FREDDIE MAC have agreed that a FICO score
of less than 620 indicates a need for cautious
review of the Borrower's credit history in order to
identify compensating strengths to offset the low
credit score (high income or large equity).
While it varies
from lender to lender, common terminology in the
Mortgage industry is to refer to a score of 651 or
greater as A credit; a score from 601 to 650 as B
credit; a score of 551 to 600 as C credit; and a
score of 525 to 550 as D credit. Persons who have
not had sufficient credit to have a FICO score
calculated are usually treated for underwriting
purposes as having a score of 551. Anyone with a
credit score of less than 600 will find it
virtually impossible to obtain a conventional loan.
These persons are therefore prime candidates for
Private Direct Loans or Seller Financed Mortgages,
but because they represent higher credit risk, it
is important to offset this factor by higher
interest rates and lower LTV's and/or ITV's.
REAL
ESTATE TAXES:
The government's lien for real property taxes is
superior to the rights of a Payee/Mortgagee or
Beneficiary of a Deed of Trust. Therefore, if the
Owner/Borrower does not pay the taxes, the
government could eventually foreclose on the
property and sell it for back taxes. This would
eliminate the real estate as security for the debt
(but would not prevent suit on the Promissory
Note). Fortunately there are a number of checks and
balances in tax foreclosures and it usually takes
several years before the Lender's lien would be
destroyed under the policies followed by most tax
jurisdictions in Alaska (I have been told that in
other states there is not as much protection and
the risk for nonpayment of taxes is far greater).
Even though you
will probably be notified by the government and
have the opportunity to pay the back taxes before
losing your position in a tax foreclosure, the
failure of the Owner to pay the taxes creates other
problems. An Owner who is not paying taxes is
usually not doing so because of a cash flow problem
and therefore, knowing that he hasn't paid the
taxes gives you an early warning of the possibility
of default. In addition, if you have to foreclose
and the taxes haven't been paid, paying the back
taxes will be an additional cost incurred before
you can resell the property (again a good reason
for low LTV and ITVs). The best solution
to the tax problem is to register with Alaska
Realty Tax Service at the time of sale and they
will provide you with periodic reports indicating
whether taxes have been paid or not. This gives
plenty of time to enforce the terms of your Deed of
Trust before being faced with a tax foreclosure.
PROPERTY
INSURANCE:
Next to the risk of default, the biggest risk is
the casualty loss on a property that is not covered
with insurance. While it seems only common sense
that any owner of improved property would have it
insured for replacement cost, my experience is that
at least 30% of Seller Financed Mortgages are not
insured. In other cases, while the property itself
may be insured, the Beneficiary of the Deed of
Trust has not been named on the policy. It is extremely
important that anytime a Mortgage is created, that
is secured by an improved property, that the
property be insured for it's full replacement costs
and the Lender be named as a Loss Payee on the
policy. That way if the policy is canceled the
Lender is notified and can take actions to get
replacement insurance in the event the owner fails
to do so. It is also
important to remember that most insurance policies
have a coinsurance clause so that the in the event
of partial loss the insurance company will not pay
the full amount of the loss unless the owner
carries full replacement cost coverage. It is
therefore important to make certain that the policy
limits are appropriate for the property insured. If
it is an income producing property the policy
should also cover loss of rents to continue the
income stream while the property is repaired or
replaced. DEFAULTS
AND FORECLOSURE:
The three most common forms of default are failure
to insure the property, failure to pay the property
taxes, and failure to make the payments in a timely
manner. In the event of failure to pay the taxes,
the standard Deed of Trust allows the Lender
(Beneficiary) to pay those taxes on the Borrower's
behalf and add the cost to the balance owed.
However, since it is usually about three years
before title to the property is put in jeopardy by
the failure to pay taxes there is usually plenty of
time to act. The best way to keep the amount of
taxes from becoming a large obligation, is to
enroll in a tax reporting service at the time of
sale so that you receive notification in the event
that property taxes are not paid. The standard
requirement in Deeds of Trust is that property
remain insured at all times with the Lender named
as Loss Payee. In the event the Borrowers fail to
pay the insurance or don't renew it, the insurance
company will notify the Lender. Under the terms of
the standard Deed of Trust, the Lender can purchase
insurance and add the cost to the balance owed.
The most common
form of default is failure to make payments in a
timely manner. If the Lender acts quickly and
notifies the Borrower of the default when it
occurs, most Borrowers begin paying on time. Some
people are just careless and only pay the squeaking
wheel. On the other hand if the Borrowers do have a
true problem such as illness, divorce or loss of
employment, by contacting them early the Lender
will learn the situation and can perhaps suggest
solutions. If the Borrowers are not able to make
payments, a Deed in Lieu of Foreclosure can be
negotiated. This will save the Lender the cost of
foreclosure and can be done in a manner so that the
Borrower's credit is not hurt by the action. If the
Borrowers' problem is only temporary, payments can
be restructured to something they can handle. (My
policy is always to ask for an increase in interest
anytime restructuring occurs). By acting quickly
and dealing with people on a personal basis, it is
often possible to resolve a default before it
becomes serious. While defaults
are seldom fun, a Lender who has the proper
knowledge and who acts quickly can usually keep
them from becoming a nightmare. In the event such
negotiations are not successful the Lender has two
foreclosure options and one non-foreclosure
litigation option. In the order of their most
common usage, these options are: Typical
Non-Judicial Foreclosure - In this type of
foreclosure the Lender invokes the right to
foreclose through a Trustee's Sale, without the
necessity for litigation. After a default has
occurred for at least 30 days (or more if required
by the Deed of Trust) the Lender closes the escrow
collection account (if one exists) and then turns
the file over to his attorney. The attorney
prepares a Beneficiary's Affidavit and a
Declaration of Default. This is then delivered to
the Trustee who executes a Notice of Default and
records it. This Notice of Default is mailed to the
defaulting Borrower (Trustor) and any other parties
in interest. The Trustee must also post a Notice of
Sale in three public places within 5 miles of the
sales location and must advertise the Notice of
Sale in a newspaper of "general circulation" four
times within 30 days prior to sale. Assuming that
the default is not cured by payment of all past due
payments and foreclosure costs, the property is
then sold by the Trustee to the highest bidder. The
Lender may enter a non-cash bid equal to the amount
owed, including accrued interest, late fees and
foreclosure costs. If this is the high bid, title
to the property then passes to the Lender. In this
type of foreclosure, the Borrower has no right of
redemption and the Lender has no right to
deficiency judgment in the event that the value of
the property has decreased. If all steps are
performed on a timely basis, such a foreclosure can
be accomplished in about 90 to 120 days and costs
typically fall in the range of $2,500 to
$3,500. Judicial
Foreclosure - Under this type of foreclosure, a
suit is actually filed with the court system and a
judge must approve the foreclosure and sale of the
property. After the court approves a foreclosure
sale, the property is sold to the highest bidder.
Again, the Lender may make a non-cash bid at a
"fair amount", which term is not precisely defined.
After the sale, the Lender petitions the court for
an order confirming the sale, subject to the
Borrower's one year right of redemption, and asks
the court for a judgment against the Borrower for
the difference between the amount owed less the
sale price of the property. After receipt of the
Deficiency Judgment, the Lender is free to pursue
normal judgment remedies such as attaching bank
deposits, garnishing wages and attaching and
forcing the auction of other assets. Due to the
chilling effect of the Borrowers having a one year
right of redemption, such sales are usually at less
than their current market value. As a result, the
Lender can usually get a deficiency judgment. This
type of foreclosure can often take up to a year to
complete, plus an additional year for the right of
redemption. I have heard of reported costs in the
range of $7,000 to $12,000. This remedy should only
be considered if the value of the property is less
than the amount owed, and there is belief that the
Borrowers have other liquid assets that can be
attached. Suit on
Note - With this remedy the Lender does not
foreclose on the property, but instead sues on the
Note, and after obtaining a judgment may pursue
normal judgment remedies, such as attaching bank
deposits, garnishing wages, and attaching and
forcing the sale of other properties. This type of
judicial action usually takes less time, and costs
less than a Judicial Foreclosure. It is useful only
if the Borrowers have liquid assets that can be
found and attached. This course of action is useful
when well-to-do Borrowers have abandoned the
property and/or have allowed its value to
deteriorate through lack of maintenance. Foreclosure
and/or litigation are never fun, and I always
recommend an attempt to negotiate, as discussed
above. However, if negotiation is not successful,
the Lender does have the advantage of choosing from
three courses of action, the one that he believes
will provide the best financial result. As a note
of caution, I point out that I am not an attorney
and the above explanations are only summary
descriptions of legal options available. None of
these three remedies should be attempted without
seeking legal advice. LOAN
SERVICING:
Although Mortgages are not management intensive
investments, they do require some management
efforts. Fortunately, the lion's share of this
management effort is the rather joyful process of
collecting a payment each month! However, as a
recipient of interest, a Lender is required by law
to report the interest received to the Internal
Revenue Service and if the amount received is
greater than $600 must a provide an IRS Form 1098
to the Payor. This means it is incredibly important
to keep very accurate records in which each payment
is recorded and allocated between principal and
interest. While this does not sound too
complicated, the fact is that there are a number of
ways to compute interest and it is often possible
for serious disputes to develop between the Lender
and the Payor over the allocation. Therefore,
unless you have a major enough participation in
Mortgage Investments to justify buying Mortgage
servicing software, I strongly recommend third
party Mortgage servicing. Alaska is very
fortunate in that it has several banks and several
private escrow companies that do most of the
Mortgage servicing. In addition to calculating
principal and interest and providing the government
reports, these escrow companies also hold the
reconveyance documents to be delivered to the Payor
when the Mortgage has been satisfied. The
credibility provided to the Payor by knowing that
reconveyance documents are protected by a reputable
company and knowing that principal and interest
will be calculated correctly, help to encourage on
time payments. The bad news is
that the bank escrow departments and escrow service
companies, while they do an excellent job of what
they do, do not do everything involved in Mortgage
servicing. While they will send delinquency
notices, they are not responsible for collections
and likewise do not enforce the provisions for
keeping the property insured or payment of real
property taxes. While some will collect reserve
payments to be used to pay taxes and insurance, and
may even pay those when due, they do not assume the
responsibility of reviewing the insurance to make
certain that it is properly written with the Lender
listed as Loss Payee. Also, in the event of a
default, they do not supervise the foreclosure
process. Therefore, the Lender always retains
certain management obligations to insure the
success of the investment. Because our
Company is in the business of servicing our own
Mortgage investment portfolio, on Mortgage
investments that we sell in which our company or
our affiliated company maintains a residual
interest, we do provide for Mortgage servicing
(this service is not provided on the sale of whole
Mortgages, but even in those cases we always remain
available to provide advice when
requested). Because we
provide full Mortgage servicing for our Preferred
Mortgage Interests, Preferred Fractional Interests,
and Securitized Preferred Fractional Interests, the
Investor in these Mortgage Investment products can
truly be an "Armchair Investor". TO
LEARN MORE ABOUT MORTGAGE
INVESTMENT:
This short tutorial was written to give only an
overview of Mortgage investing. If you want to know
more about the topic there are a number of ways to
obtain additional information. Since the ultimate
security of any Mortgage Investment is the real
estate that secures it, any additional knowledge
that you acquire concerning real estate law, real
estate principles and practices, and real estate
valuation will be useful. Fortunately every book
store has a multitude of books available on real
estate and real estate investing and most
universities and community colleges offer courses
in real estate investing. To get more specific
information related strictly to Mortgage
Investments, I recommend the following: "Note Owners
Manual": This is a booklet published by our
firm that is targeted toward owners of Seller
Financed Mortgages. You can obtain a free copy of
it by calling our office at (907) 279-8551.
"Owner Will
Carry": This book is written for Sellers of
property, who plan to take back a Seller Financed
Mortgage, and for real estate agents. However,
because it's purpose is to teach them how to create
safe legal Mortgages, it is also a useful reference
source for Mortgage Investors. This excellent book
can be previewed and ordered by going to
www.arnettbroadbent.com/ownerwillcarry.html "The Number
One Real Estate Investment No One Talks About",
by Sanford W. Hornwood: This book is about
investing in Seller Financed Mortgages but provides
information that is useful for all forms of
Mortgage Investments. I have seen copies of this
book in local bookstores and it is also available
from Amazon.com. "Smart Trust
Deed Investment in California", by George
Coats: Don't let the title fool you. Although
George wrote this book specifically for investing
in California, California's laws are similar enough
to Alaska's laws concerning Deeds of Trust so that
about 98% of everything said in this book is
applicable to Alaska. Unfortunately, although this
is one of the best books ever written on the topic,
it is no longer in print and therefore is very hard
to find. I did see one copy offered by a rare book
seller on the Amazon.com
site, for $170. However, I still have my copy of it
and if you would like to come by my office, I would
be happy to loan it to you for a couple of
weeks. "Noteworthy
Newsletter": This an excellent newsletter
targeted toward Mortgage Investors and Mortgage
Brokers. Information on the newsletter and lots of
other valuable information can be obtained by going
to Note Worthy's website (Click: www.noteworthyusa.com). "Paper Source
Newsletter": This is another excellent
newsletter and they also have lots of useful
information on their website (Click:
www.PaperSourceOnline.com). |
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