Types of Mortgages or Trust Deeds
May 5, 2020
Types of Mortgages or Trust Deeds
There are many different types of mortgages and trust deeds that lenders and borrowers can use. Let's first discuss what is called a first mortgage. A first mortgage simply means that the lender was the first to record, thus making it the first. Likewise, the second mortgage is simply the second lender that records. Another type of mortgage is called a purchase money mortgage. For the purposes of the exam, whenever you see the term purchase money mortgage, think of the term owner financing. This is typically where a seller is going to help finance part of the real estate loan on behalf of the buyer. A blanket mortgage is simply a mortgage that covers more than one piece of property. Just envision a blanket that floats down from the heavens and lands on more than one property. This would typically be used in a development of a subdivision for lots of houses being built. The houses in a subdivision will be sold off one at a time, however. So normally with a blanket mortgage you will have what is called a partial release clause that allows each property to be released from the blanket mortgage as sold. A package mortgage simply uses real and personal property as security. So, if a house and a car were both used as security for a loan, we would call that a package mortgage. Another type of mortgage is called an open-end mortgage, which is similar to a line of credit. Think of a credit card example with revolving credit. With an open-end mortgage, a person can borrow again and again on the same loan. A home equity loan might be a type here. A growing equity mortgage is where the borrower makes extra payments toward principal, thereby paying off the loan quicker and thus growing equity quicker as well. And finally, a reverse annuity mortgage is where the lender pays the borrower each and every month a fixed amount of money. Since this is the reverse of normal, it is called a reverse annuity mortgage. This is used for senior citizens or retired folks who typically have their home paid off, but need money to help them live in their retirement years. So those folks can many times take out a reverse annuity mortgage.
Security for a Mortgage or Trust Deed – Different Clauses
Let's talk about the provisions of a mortgage or a trust deed. Recall that a mortgage or trust deed is simply security for the debt. There are typically several clauses that can be included in a mortgage or trust deed. One is called the prepayment penalty clause. Some states allow these, some states don't. The prepayment penalty clause is where the lender charges the borrower a penalty for paying off the loan early. Another clause is the acceleration clause. Acceleration means speed up. This is when a lender calls the loan due and payable upon non-payment. So, if a borrower misses two or three payments in a row, then the lender accelerates a note, calls the whole loan balance due and payable, then proceeds with a foreclosure sale. Another clause is the alienation clause which is also called the due-on-sale clause. Those two terms mean the exact same thing. The alienation, or due-on-sale clause, is where the lender calls the loan balance due and payable upon selling or transferring the property, thereby making the loan non-assumable. So, if a seller sells the property, the lender would call that seller's loan due and payable and the buyer would have to obtain their own, brand new loan. A subordination clause is where a first and second mortgage will switch places. In other words, the first becomes a second, a second becomes a first. Subordination means to take a lesser position, so someone in the first position would agree to subordinate and become a second lien holder. Another clause is called the defeasance clause, which is the null and void clause. What this clause does is it voids the security once the loan is paid off. A way to recall that for the test is that the word defeat and defeasance sound similar. So, if a borrower completely pays off the home loan and the lender never got a chance to foreclose, then the borrower had defeated the lender. So, when you defeat the lender, that is a defeasance clause, which voids the security. Another clause is the escalator clause, which allows the lender to raise the interest rate on a particular loan. This will probably be used with an adjustable rate mortgage. Those are some various clauses you can find in a mortgage or a trust deed.
“Subject To” versus Assumption of a Loan
A couple of other terms to note would be what's called a “subject to” versus an assumption. Let's say a seller sells a property to a buyer and the buyer wants to take over on the seller's loan. One way to do that is on a “subject to” basis, which means the buyer takes over payments only, while the seller remains solely liable on the debt. This is not very common today. More commonly used is a loan assumption. With an assumption of a loan, the buyer not only takes over the payments, but also primary liability for the debt, but the seller still remains secondarily liable on the debt, so both parties will be liable. Many times, a seller will try to get a release of liability from the lender making the buyer solely liable. If the lender is willing to do this, it’s called a novation, which means there is a new contract that takes the place of the old contract.
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