Real Estate Finance Unit 10

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Real estate finance instruments

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Promissory notes and security instruments—legal documents that provide evidence of a debt and secure that debt with a collateral property. The lender holds the promissory note and the security instrument until the loan is repaid

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Promissory note

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The evidence of the debt. It states the amount of money borrowed and the terms of repayment. A written legal contract that obligates the borrower to repay a loan. Most lenders use a Fannie Mae/Freddie Mac Uniform Note

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Security instrument

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A document—mortgage, deed of trust, or security deed—that is the evidence of the pledge of real estate as collateral for the loa

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The maker (borrower) and the holder

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The parties in a promissory note are

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Maker

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The borrower who executes a note and becomes primarily liable for payment to the lender. The note states the personal obligation of the borrower and is a complete contract in itself between the borrower and lender. The lender is the party to whom a note is made payable

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Noteholder

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A subsequent owner of the note is a holder in due course and is called the

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Simple interest

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Interest paid only on the principal owed

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Nominal or named rate

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The interest rate stated in the note is called the

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Effective interest rate

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The rate the borrower is actually paying and is commonly called the annual percentage rate (APR). Lenders are compensated for their risk in the form of interest rates. If the lender thinks the borrower is a high risk, the lender will charge a higher interest rate for the privilege of borrowing the money. The lower the risk, the lower the rate

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Usury

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The act of charging a rate of interest in excess of that permitted by law. Each state sets a rate that is the highest amount of simple interest that can be legally charged to an individual for a loan

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Prepayment clause, also called an or more clause

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Allows a borrower to pay off a loan early or make higher payments without paying a prepayment penalty. The prepayment is applied first to any accrued or unpaid interest and then to principal

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Prepayment penalty

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Allows a lender to collect a certain percentage of a loan as a penalty for early payoff. Not allowed on conforming, FHA, and VA loans

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Acceleration clause

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Allows a noteholder to call the entire note due on occurrence of a specific event such as default in payment, taxes, insurance, or sale of the property

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Joint and several liability

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Means that each debtor (borrower) who signs the promissory note is responsible for the entire amount of the loan

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The right of presentment

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The borrower’s right to present the noteholder with a demand for payment of funds

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The right of notice of dishonor

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The right to require the noteholder to give notice that an amount has not been paid

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Alienation or due-on-sale clause

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Type of acceleration clause. A noteholder may call the entire note due if there is a transfer in property ownership from the original borrower to someone else. This clause protects the noteholder from an unqualified, unapproved buyer taking over a loan

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Assumption clause

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A buyer may assume responsibility for the full payment of a loan after obtaining the lender’s consent

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Change date

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The date on which the interest rate changes. The note reminds the borrower that after the first change date, the interest rate on the loan is tied to a particular index

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Negotiable instrument

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A written unconditional promise or order to pay a certain sum of money on demand or at a definite future date, payable either to order or to bearer and signed by the maker. It is freely transferable and may be transferred by endorsement or delivery

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Freely transferable

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Means a bank or other creditor may sell the negotiable instrument (promissory note) for cash

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Check

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An order to the bank to pay money to the person named. A note is the same thing. It can be transferred by endorsement (signature) just like a check. If correctly prepared, it is considered the same as cash

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Uniform Commercial Code (UCC)

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Governs negotiable instruments and is designed to give uniformity to commercial transactions across all 50 states

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Holder in due course

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Buyer of a note. One who takes an instrument for value in good faith. Must have accepted possession of the financial instrument in good faith and given something of value for it. Is presumed to be unaware that the financial instrument previously may have been overdue, been dishonored when presented for payment, or had a claim against it, if in fact such were the case

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Bona fide purchaser

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Because the holder in due course is a _________, he or she is entitled to payment by the maker of the note

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Setoff

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A claim that a person (or entity) who owes money to someone may reduce the amount he or she owes by the amount owed to him or her by the other person

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Straight Note

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This note calls for interest-only payments during the term of the note. The principal payment is due in one lump sum upon maturity. This type of note is not commonly used by institutional lenders but may be used between a buyer and seller or other private lenders

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Installment Note

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This note requires periodic payments on the principal with payments of interest made separately

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Installment Note with Periodic Payments of Fixed Amounts

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This fully amortized note consists of level, periodic payments of both interest and principal that pay off the debt completely at maturity

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Adjustable-Rate Note

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This note has an interest rate that adjusts with a movable economic index

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Demand Note

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This note does not become due until the noteholder makes a demand for its payment

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Fully Amortized Note

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This note is fully repaid at maturity by periodic reduction of the principal

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Partially Amortized Installment Note

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This note includes a repayment schedule that is not sufficient to pay off the loan over its term. This type of note calls for regular, periodic payments of principal and interest for a specified period of time. At maturity, the remaining unpaid principal balance is due as a balloon payment