The Fannie/Freddie Uniform Instruments (Note and Mortgage/Deed of Trust)

Transcription

1 The Fannie/Freddie Uniform Instruments (Note and Mortgage/Deed of Trust) Who Are Fannie and Freddie? Fannie Mae was founded by the U.S. government in 1938, in the wake of the mortgage foreclosure crisis occasioned by the Great Depression Purpose: to make home mortgage credit widely available (at time, today s 30-year mortgage didn t exist) In 1968, Fannie Mae was re-chartered as a for-profit, publicly-traded corporation In the old days, a mortgage was a local transaction; banks and thrifts (S&Ls) made loans using funds on deposit Once lender made a mortgage loan, it held it in its portfolio until repaid Supply of mortgage funds was limited; only high-credit borrowers could get mortgages (low rates of homeownership) Jimmy Stewart as George Bailey, It s a Wonderful Life (1945) Fannie Mae s Role Increase the supply and availability of mortgage credit (and thus rates of homeownership) Fannie Mae agreed to buy mortgage loans that met certain underwriting criteria (i.e., it created a secondary market for mortgage loans) Once banks/thrifts could sell mortgage loans to Fannie, their capacity to make loans was no longer limited by the amount they held on deposit!

2 Over time, Fannie and Freddie began to facilitate the securitization of mortgage loans E.g., Fannie buys 100,000 home mortgage loans which are pooled together and placed in a trust, which then securities (e.g., bonds) to private investors Through a loan servicer, Trustee of trust collects mortgage P&I payments from mortgagors Trustee uses those sums to pay bond principal and interest payments to the private investors (an obligation secured by the underlying mortgage loans) Ostensible Benefits of Securitization Has increased the flow of investment capital into the mortgage market (disintermediation) Private investor would be reluctant to buy a single loan or a small pool of loans (undiversified risk) By creating huge pools, the risks (i.e., risk of mortgagor default) are spread, attracting private investment Greater supply of mortgage money leads to lower interest rates, higher homeownership rates Uniform Instruments Note: evidences borrower s obligation to repay the debt, sets forth terms of that obligation (governed by UCC Article 3 or common law of Contracts) Mortgage/Deed of Trust: conveyance in which owner (mortgagor) grants lien to lender (mortgagee) to secure repayment of debt evidenced by the Note Uniform Instruments Fannie/Freddie drafted Uniform instruments for lender use; lenders can modify the forms based on negotiation with the borrower, BUT If Lender modifies the form, Fannie/Freddie won t buy loan! Thus, lender typically won t modify the forms (to preserve its ability to sell loan on secondary market)

3 On the one hand, this limits borrowers from negotiating for different/more favorable terms (other than the interest rate, loan term) On the other hand, many of the standard terms are very borrower-favorable, e.g., Right to prepay mortgage debt, without fee [Note 4] Right to reinstate loan after acceleration [DOT 19] Right, in some cases, to use insurance proceeds for rebuilding in event of casualty [DOT 5] Why a Separate Form for Each State? First reason is state-to-state custom in loan documentation Some states use the mortgage, which is a two-party agreement between Lender ( mortgagee ) and Borrower ( mortgagor ) Other states (e.g., Missouri) use the deed of trust, a three-party agreement between Lender ( beneficiary ), Borrower ( trustor ) and a trustee Why a Separate Form for Each State? Second reason is state-to-state variation in mortgage law rules (especially with respect to remedies) Uniform Covenants 1-21 are the same in all 50 states Covenants 22 et seq. vary by state, b/c of state variation in substantive law Most significantly, judicial vs. nonjudicial foreclosure (only ½ of states allow nonjudicial foreclosure) Occupancy [ 6 DOT] Why does 6 require the Borrower to occupy the Property w/in 60 days and use it as his/her principal residence for one year? Would this prevent Borrower from obtaining mortgage loan for a second (vacation) home?

4 Lenders (and investors buying loans on the secondary market, or buying mortgage-backed securities) have different standards for underwriting an owner-occupied home loan vs. a rental home An owner-occupied home loan is underwritten based on borrower s income (e.g., salary) A loan for a rental home is underwritten based on net cash flow generated by renting the home (e.g., gross rent property expenses) Which is a riskier loan? Secondary market investors would require a larger return to invest in securities backed by riskier loans (e.g., rental homes) as compared to securities backed by owner-occupied home loans To attract capital at the lowest rates, Fannie and Freddie must assure secondary market investors that loans being purchased and securitized as owner-occupied home loans really are home loans, not commercial loans Uniform Covenant 6 operationalizes this concern (reflects underwriting mandated by secondary market investors) What if Borrower lied (and was planning to flip the house or rent it)? Failure to comply with 6 is a default 22 would allow lender to accelerate the maturity of the debt and demand FULL payment of the entire debt (even if Borrower was actually current on its payments!) Other consequences of lying: (1) lying on loan application is punishable as crime under both federal and state laws; (2) lying on loan application could render the debt nondischargeable if Borrower later filed for bankruptcy Second/Vacation Homes Suppose Abrams applies for a loan to buy a vacation home in ND The Uniform Instrument would be unsuitable for the Lender to use for this loan, if 6 is not removed/modified In this case, lender can have Abrams sign both the Uniform Instrument and the Second Home Rider [Def. H] Second Home Rider modifies Uniform Instrument by deleting 6 and replacing it with second home covenant

5 Other Riders (DOT Def. H) Other Riders are used if the Uniform Instrument lacks a provision needed for the specific transaction E.g., Condo Rider: includes covenants to pay all condo association fees, comply with condo rules, etc. E.g., 1-4 Family Rider : b/c owner will likely be renting the units he/she is not occupying, the Rider has an Assignment of Rents/Leases (granting Lender a lien on rents payable by the Owner s other tenants, and allowing Lender to collect those rents directly from the other tenants if owner defaults) Mortgage Insurance [DOT 10] Lender typically requires private mortgage insurance (or PMI ) for any mortgage loan where the original principal amount of the debt >>> 80% of fair market value (FMV) of mortgaged land PMI allows someone to buy a home with a smaller downpayment, rather than having to wait to accrue 20% cash for a downpayment The higher the loan-to-value (LTV) ratio, the greater the risk that a foreclosure sale may produce a deficiency (i.e., not enough to pay off the debt) Low down-payment borrower has to pay for PMI to protect lender against this risk (so that mortgage-backed securities will get favorable risk ratings) If borrower defaults, and foreclosure sale results in a deficiency, lender can recover this loss from PMI insurer Once borrower builds up enough equity (20-23%, depending on loan type), borrower has right to cancel PMI coverage [Homeowner s Protection Act of 1998] PMI Insurance Rates Rates vary from between 0.3% to 1.5% of original principal amount per year, depending upon Amount of downpayment (i.e., original loan-to-value ratio) Borrower s credit score Insurer E.g., for $180,000 loan by Borrower who paid 10% down (90% loan), w/credit score = 740, rate = 0.44% This would be $792/year, or $66/month

6 Escrow [DOT 3] In addition to P&I each month, borrower must also pay into escrow 1/12th of the estimated annual cost of (a) real estate taxes + (b) casualty insurance premiums + (c) PMI premiums This escrow is held by the lender (or loan servicer), who uses the escrow funds to pay taxes and insurance premiums directly, as they come due If taxes, insurance premiums, and PMI premiums are not paid by Borrower, Lender s lien is threatened Nonpayment of real estate taxes = tax lien in favor of taxing authority (e.g., city or county), which lien has priority over all other interests, including the Lender s mortgage! Nonpayment of casualty insurance = cancelled insurance = risk of uninsured loss Nonpayment of PMI = loss of recourse to PMI insurance if borrower defaults and foreclosure results in deficiency Escrow enables Lender to minimize/avoid these risks Waiver of Escrow 3: Lender may waive Borrower s obligation to pay to Lender Funds for any or all Escrow Items at any time. Any such waiver may only be in writing. Do Lenders agree to waive escrow? Why would they, since they re earning float off the escrow funds? Unless state law requires, the lender does not have to pay borrower any interest on the escrowed funds 3: Unless an agreement is made in writing or Applicable Law requires interest to be paid on the Funds, Lender shall not be required to pay Borrower any interest or earnings on the Funds. Essentially, Borrower is making interest-free loan to Lender! Residential borrowers rarely obtain waivers (RESPA limits excess cushion lender can require) In commercial loans, where escrow requirements might result in huge escrow amounts, borrowers more often negotiate for and obtain waivers

7 Loan Charges [ 14 DOT] Lender may charge Borrower fees for services performed in connection with Borrower s default... including, but not limited to, attorneys fees, property inspection and valuation fees What s the point? If the debtor is in default and can t pay, what s the point of allowing this charge? Loan contracts commonly obligate Borrower to pay all costs of collection incurred by Lender See Uniform Note 6(E), page 1435 (Borrower agrees to pay costs of enforcement of note) DOT 14 also relates to DOT 9 (Protection of Lender s Interest in the Property) Under 9, amounts/costs incurred by Lender in enforcement for purpose of protecting Lender s interest shall become additional debt of Borrower, secured by this Security Instrument If Borrower doesn t pay, and Lender forecloses, Lender can recover those costs from foreclosure sale proceeds Payment of Debt/Offsets [ 1 DOT] DOT 1: No offset or claim which Borrower might have now or in the future against Lender shall relieve Borrower from making payments due under the Note and this Security Instrument... What is this provision trying to address when referring to a Borrower s offset or claim? Common Law Right of Offset At common law, mutual debts that are liquidated and undisputed can be set off E.g., Nelson owes Wells Fargo $200,000 on mortgage loan Nelson then obtains a judgment against Wells Fargo for $50,000 for unpaid consulting fees At common law, unless Nelson had agreed otherwise, he could simply set off the unpaid judgment against his debt obligation (reducing the mortgage debt to $150,000)

8 Why would 1 require Borrower to waive its common law right of offset? This loan will be sold and pooled with other loans to serve as collateral for mortgage-backed securities Buyers of MBS expect the underlying loans will obligate the borrowers to pay off the full amount of the loans Theoretically, offsets by borrowers could result in the pool of mortgages not generating enough income to repay the investors holding mortgage-backed securities Offset waiver protects against that risk Co-Signers [Note 8, DOT 13] What is the form DOT saying with respect to co-signer liability in paragraph 13? Does it differ from what the Note provides in 8? The Note reflects personal liability for repayment of debt Anyone who signs Note is jointly/severally liable to repay the debt (although Lender can get only 1 recovery) Lender could get a judgment against each signer of Note and enforce that judgment from any of their assets DOT 13 addresses the possibility that someone signs the DOT but NOT the underlying note E.g., Margaret Freyermuth gets $100,000 mortgage loan from Bank to buy a home She will live there, but title will be held by her and her son, Richard, as joint tenants with right of survivorship Richard does not sign the Note, but he signs the DOT This will allow Bank to foreclose and sell full fee simple title if Margaret defaults But, Bank could not get a personal judgment against Richard Lease of the Property [DOT 25] Trustee hereby leases the property to Borrower until this Security Instrument is either satisfied and released or until there is a default... Rent is stated as one cent per month What s the purpose of this. Legally speaking, is the mortgagor really only a Tenant?

9 Acceleration [Note 6(C), DOT 22] Q: If a person can t make a payment it seems highly unlikely they could pay off the entire debt. Am I misunderstanding the point or effect of the acceleration clause? Practically, Lender must accelerate before it forecloses its mortgage lien (Lender can only foreclose once; foreclosure sale will extinguish Lender s mortgage lien) If debt is not accelerated, all that is due are the unpaid installments (not the full principal amount)