WEST’S LAW SCHOOL ADVISORY BOARD _ JESSE H CHOPER Professor of Law, University of California, Berkeley JOSHUA DRESSLER Professor of Law, Michael E Moritz College of Law, The Ohio State University YALE KAMISAR Professor of Law, University of San Diego Professor of Law, University of Michigan MARY KAY KANE Professor of Law, Chancellor and Dean Emeritus, University of California, Hastings College of the Law LARRY D KRAMER Dean and Professor of Law, Stanford Law School JONATHAN R MACEY Professor of Law, Yale Law School ARTHUR R MILLER University Professor, New York University Professor of Law Emeritus, Harvard University GRANT S NELSON Professor of Law, Pepperdine University Professor of Law Emeritus, University of California, Los Angeles A BENJAMIN SPENCER Associate Professor of Law, Washington & Lee University School of Law JAMES J WHITE Professor of Law, University of Michigan I REAL ESTATE FINANCE IN A NUTSHELL SIXTH EDITION By JON W BRUCE Professor of Law Vanderbilt University Mat #40617120 II Thomson/Reuters have created this publication to provide you with accurate and authoritative information concerning the subject matter covered However, this publication was not necessarily prepared by persons licensed to practice law in a particular jurisdiction Thomson/Reuters are not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney If you require legal or other expert advice, you should seek the services of a competent attorney or other professional Nutshell Series, In a Nutshell, the Nutshell Logo and West Group are trademarks registered in the U.S Patent and Trademark Office COPYRIGHT © 1979, 1985, 1991 WEST PUBLISHING CO © West, a Thomson business, 1997, 2004 © 2009 Thomson/Reuters 610 Opperman Drive St Paul, MN 55123 1–800–313–9378 Printed in the United States of America ISBN: 978–0–314–18354–5 III To my wife Barbara Edmonson Bruce * V PREFACE _ This book is a concise textual treatment of the law of real estate finance It is designed primarily to help law students negotiate a law school course on the subject Other members of the legal community may use this work as a general reference and starting point for research A table of secondary authorities is included to acknowledge sources and assist readers who desire more information about a topic introduced in this volume The material in this book is organized into detailed outline form for two reasons First, the format is utilized to give students a thorough overview of the subject and a set of pegs upon which to hang information gleaned from classroom discussion Second, the relative rigidity of this style helped me resist the urge to write a treatise-like work complete with mountains of footnotes Such a volume, of course, is inconsistent with the purpose of the Nutshell Series Exhaustive discussion, therefore, has been sacrificed in favor of summarization and clarity Readers are requested to keep this in mind while proceeding through these materials One final word about the book Real estate finance is like most property law, overgrown with rules The principles, of course, are stated here, but so are the underlying theories This approach is intended to afford VI readers a better understanding of doctrine as well as an opportunity to begin critically examining it I wish to say thanks to the following people—my wife Barb for her patience and understanding during the preparation of all six editions of this book; John Stark and Dan Sterner of the Indianapolis bar for giving me an excellent introduction to the practice of real estate finance law; Doug Mulligan, my research assistant on the first edition, for his tireless efforts; Jim Gillespie for his encouragement and helpful comments on the first edition; Scott Sartin, my research assistant on the fourth edition, for his conscientious assistance; Jim Ely, a Vanderbilt colleague, for his valuable suggestions about the third through sixth editions; law librarians, editors, faculty-support staff, and others for their help with this and prior editions JON W BRUCE Vanderbilt Law School November 2008 VII OUTLINE _ PREFACE Chapter Introduction to Law of Real Estate Finance I Mortgage Concept A Definition and Description B Obligation/Security Distinction C Statute of Frauds II Historical Development of Mortgage A Defeasible Fee as Financing Device B Equity of Redemption Creation and Growth Preservation/Clogging C Foreclosure Strict Foreclosure Foreclosure by Sale D Statutory Redemption III Mortgage Theories A Title Theory B Intermediate Theory C Lien Theory D Practical Significance of Mortgage Theories IV Modern Financing Formats VIII Chapter Mortgage Market I Purpose of Financing A General B Construction/Permanent Financing Descriptions and Distinction Relationship Between Construction Lenders and Permanent Lenders Construction Lender’s Special Risks a Nature of Risk and Minimizing It b Performance and Payment Bonds c Liability for Construction Defects C Residential/Commercial Property II Originating/Servicing/Holding III Sources of Real Estate Financing A Commercial Banks B Savings and Loan Associations C Mutual Savings Banks D Life Insurance Companies E Pension Funds F Real Estate Investment Trusts G Mortgage Banking Companies H Other Sources Credit Unions Sellers Syndications State Development Agencies IX Community Housing Authorities I Mortgage Brokers IV Obtaining Real Estate Financing A Application and Commitment B Mortgage Loan Contract Nonrefundable Commitment Fees Borrower’s Remedy for Lender’s Breach V Loan Participation and Mortgage–Backed Securities A Loan Participation B Mortgage–Backed Securities VI Secondary Financing A The Basics Creation of Junior Mortgages Importance of Mortgagor’s “Equity” Risk and Rate B Beyond the Basics/Wraparound Mortgages VII Federal Government Involvement in Financing Process A Housing Subsidies B Mortgage Insurance and Guaranty Programs C Secondary Mortgage Market Support Institutions D Other Government Involvement Truth in Lending X Interstate Land Sales Full Disclosure Act of 1968 National Flood Insurance Program Real Estate Settlement Procedures Act of 1974 Home Mortgage Disclosure Act of 1975 Comprehensive Environmental Response, Compensation, and Liability Act of 1980 Housing and Economic Recovery Act of 2008 Emergency Economic Stabilization Act of 2008 Future Involvement VIII Predatory Lending Chapter Real Estate Financing Devices I Mortgage A Purchase Money Mortgage B Tax Considerations II Deed of Trust III Equitable Mortgages A Absolute Deed Given as Security B Conditional Sale C Negative Pledge D Vendor’s and Vendee’s Liens IV Installment Land Contract A Traditional Contract Approach XI B Protecting Purchaser Period-of-Grace Statutes Compelling Equities View Equitable Mortgage View Restitution Waiver C Encumbering Purchaser’s Interest D Encumbering Seller’s Interest V Lease A Varieties Ground Lease Space Lease Acquisition Lease EQUITY OF REDEMPTION Amount required for, 180 274 Availability of, 179 Clogging, 5, 121, 181 Comparison to statutory redemption, 225–226 Enforcement of right, 181 Historical development of, 4–5 Omitted junior lienors, 215 Parties who may redeem, 179 Result of, 180–181 Waiver of, 5, 181 When right ends, 182 EQUITY PARTICIPATION, 90–91 ESCROW ACCOUNTS, 46, 96–98, 163, 201, 235 ESTOPPEL CERTIFICATE, 140–141 FANNIE MAE Conservatorship, 39 Federal Housing Finance Regulatory Reform Act, 39, 49 Foreclosure by, 221 Mortgage-backed securities, 27–28, 38 Mortgage forms, 239 Secondary mortgage market, 37–39 FEDERAL HOME LOAN BANK BOARD, 126, 129 FEDERAL HOME LOAN MORTGAGE CORPORATION (FHLMC) See Freddie Mac FEDERAL HOUSING ADMINISTRATION (FHA), 35–36, 38, 49 FEDERAL HOUSING FINANCE REGULATORY REFORM ACT, 39, 49 FEDERAL INCOME TAX LIENS, 201–202 FEDERAL MORTGAGE FORECLOSURE ACT (PROPOSED), 237 FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA) See Fannie Mae FEDERAL PREEMPTION, 51, 86, 93, 126–130, 237–239 FHA See Federal Housing Administration FHA MODERIZATION ACT, 36, 49 275 FHA MORTGAGE, 35, 38–39 FINAL LENDER See Permanent Financing FINANCIAL INSTITUTION REFORM, RECOVERY AND ENFORCEMENT ACT, 20 FIXTURES Defined, 105 Mortgage coverage, 105 Priority of liens, on, 105–106, 195–196 Uniform Commercial Code, 195–196 FLOOD DISASTER PROTECTION ACT, 44 FLOOD INSURANCE, 43–45 FORECLOSURE See Foreclosure by Judicial Sale; Foreclosure by Power of Sale; Strict Foreclosure FORECLOSURE BY JUDICIAL SALE Adequacy of sale price, 214 Alternatives to, 182–185 Availability of, 7, 207–208, 211 Confirmation of, 182, 214 Deficiency judgment, 216–217 Distribution of proceeds, 6–7, 216 Historical development of, 6–7 Mortgagor in bankruptcy, 208–210 Mortgagor in military service, 210 Omitted junior interest holders, 182, 212–213, 215 Parties defendant, 211–213 Purchaser at sale, 214–216 Purpose of, 6–7, 207–208 Sale procedures, 213 Statute of limitations, 208 Uniform Land Security Interest Act, 242 FORECLOSURE BY POWER OF SALE Alternatives to, 182–185 Availability of, 7–8, 207–208, 217–218 Comparison to judicial sale, 218–220 Constitutional issues, 220–222 Deed of trust, 7–8, 218 Deficiency judgment, 219–220 Form of security device, 7–8, 218 276 Historical development of, 7–8 Judicial review of, 220 Mortgagor in bankruptcy, 208–210 Mortgagor in military service, 210 Purchase by the lender, 219 Purchaser’s title, 219 Purpose of, 6–8, 207–208, 218 Sale procedures, 218–219 Statute of limitations, 208 Surplus, 219–220 Uniform Land Security Interest Act, 242 FORECLOSURE ESCALATION, 227 FREDDIE MAC Conservatorship, 39 Federal Housing Finance Regulatory Reform Act, 39, 49 Foreclosure by, 221 Mortgage-backed securities, 27–28, 38–39 Mortgage forms, 239 Secondary mortgage market, 37–39 Study of ARMs, 88 FUTURE ADVANCES Basic concept, 76–77 Construction lender’s dilemma, 82–84 Dragnet clause, 84–85 Methods of securing, 77 Obligatory, 78–79, 82–84 Optional, 79–84, 194 GARN-ST GERMAIN DEPOSITORY INSTITUTIONS ACT, 100, 127–130 GINNIE MAE See Government National Mortgage Association (GNMA) GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) Foreclosure by, 221 Mortgage-backed securities, 27–28, 38 Secondary mortgage market, 37–38 GRADUATED PAYMENT MORTGAGE, 95 GROWING EQUITY MORTGAGE, 95–96 277 HISTORICAL DEVELOPMENT OF MORTGAGE, 4–8 HOME EQUITY LOAN, 30–31, 77 HOME MORTGAGE DISCLOSURE ACT, 47 HOMEOWNERS PROTECTION ACT, 36 HOPE FOR HOMEOWNERS ACT, 36, 49 HOUSING AND ECONOMIC RECOVERY ACT, 48–49 HOUSING AUTHORITIES, 24 HOUSING SUBSIDIES, 34–35 HOUSING ASSISTANCE TAX ACT, 49 HUD See Department of Housing and Urban Development INDEXED MORTGAGE, 88–89 “IN REM” MORTGAGE, 74 INSTALLMENT LAND CONTRACT Encumbering purchaser’s interest, 64–66 Encumbering seller’s interest, 66–67 Protecting purchaser, 62–64 Tax considerations, 61 Traditional contract approach, 60–62 Uniform Land Security Interest Act, 241 INSURANCE Casualty, proceeds of, 106–108 Environmental, 48 Escrow accounts, 46, 96–98, 163, 235 Flood, 43–45 Mortgage, 35–37, 49 Title, 187 INTEREST Fixed rate, 85 Default, 98 Discount points, 85 Due-on-sale clause, 91 Norm, 85 Usury, 92–93 Variations from norm, Adjustable rate mortgage, 87–88 278 Alternative mortgage instruments, 86–90 Buy-down mortgage, 90 Contingent interest, 90–91 Equity participation, 90–91 Indexed mortgage, 88–89 Price level adjusted mortgage, 88–89 Revenue participation, 90–91 Shared appreciation mortgage, 89–90 Variable rate mortgage, 86–87 INTERIM LOAN See Construction Financing INTERMEDIATE THEORY Defined, Right to possession and rents, 8–10, 169–170 Uniform Land Security Interest Act, 242 INTERSTATE LAND SALES FULL DISCLOSURE ACT, 42–43 JUNIOR LEASES See Leases JUNIOR MORTGAGES Defined, 29–30 LAND CONTRACT See Installment Land Contract LATE CHARGES, 98, 164 LEASE Acquisition lease, 68–69 Assignment of rents, 175–176 Escalator clause, 69 Ground lease, 67–68 Junior lease, Attornment, 173–174 Intentionally omitted from foreclosure, 212–213 Mortgagee’s possession, effect on, 172–174 Non-disturbance agreement, 174 Receiver’s enforcement of, 178 Subordination of mortgage to, 174, 195 “Net” lease, 68–69, 71 Prior to mortgage, 172 Sale and leaseback, 71–73 Space lease, 68 279 Subordination of lease to mortgage, 195 LEASEHOLD MORTGAGE Lease provisions, 70–71 Nature of security, 69 Subordination of fee, 69, 195 LIEN THEORY Defined, 10 Right to possession and rents, 8, 10, 169–170 LIFE INSURANCE COMPANIES, 20–21 LIS PENDENS, 202–203, 213 LOAN PARTICIPATION See Participation (Fractional Assignments) MARSHALING Anti-marshaling clause, 206 Defined, 203 Sale in inverse order of alienation rule, 204–205 Two funds rule, 203–204 MECHANICS’ LIEN STATUTES Amount, 197 Constitutionality of, 199–200 Defined, 197 Other protection, 200–201 Priority, 197–199 MERGER, 122–123 MEZZANINE LOAN, 73 MODIFICATION See Obligation MORTGAGE Adjustable rate, 87–88 Alternative mortgage instruments, 86–90 Balloon loans, 96 Buy-down, 90 Conventional, 35, 38–39 Defined, Discharge, see Payment Equitable, see Equitable Mortgages FHA, 35, 38–39 280 Forms, 239 Graduated payment, 95 Growing equity, 95–96 Historical development of, 4–8 Holding, 17 Indexed, 88–89 “In rem”, 74 Insuring and guarantying, 35–37 Junior, 28–34 “Nonrecourse”, 74 Open-end, 79 Originating, 17 Pools, 27–28 Price level adjusted, 88–89 Purchase money, 52–53, 188–190 Release, 100–101 Reverse, 95 Risk, 25 Servicing, 17–18, 22, 46, 146–147 Shared appreciation, 89–90 Statute of frauds, 2–3 Statute of limitations, 101, 208 Subprime, 18, 25, 50 Tax considerations, 31, 49, 53–54, 61 Theories, 8–10, 169–170 Transfer of, see Assignment of Mortgage Loan VA, 35, 38–39 Variable rate, 87–88 Wraparound, 32–34 MORTGAGE-BACKED SECURITIES, 27–28, 38–39 MORTGAGE BANKING COMPANIES Mortgage warehousing, 22–23, 160 Operations described, 22–23, 160 MORTGAGE BROKERS, 24 MORTGAGE DISCLOSURE IMPROVEMENT ACT, 41, 49 MORTGAGE ELECTRONIC REGISTRATION SYSTEM (MERS), 136–137 MORTGAGE INSURANCE AND GUARANTY FHA, 35–36, 38–39 Government programs, 35–36 281 Homeowners Protection Act, 36–37 Private companies, 36–37 VA, 35–36, 38–39 MORTGAGE WAREHOUSING, 22–23, 160 MORTGAGED PROPERTY Description of, 103 Mortgagable interests, 102–103 Mortgaging separate interests, 102 Property covered, 103–108 Waste, 108–110 MORTGAGEE IN POSSESSION Defined, 170 Mortgage theories, significance of, 8–10, 169–170 Obligations, 171–172 Problem of leases existing at default, 172–174 Rights of, 170–171 Uniform Land Security Interest Act, 241–242 MORTGAGEE’S INTEREST, 132 MORTGAGOR’S INTEREST, 111 MULTIFAMILY MORTGAGE FORECLOSURE ACT, 237–238 MUTUAL SAVINGS BANKS, 20 NATIONAL FLOOD INSURANCE PROGRAM, 43–45 NEGATIVE AMORTIZATION, 87, 89 NEGATIVE PLEDGE, 57–58 NON-DISTURBANCE AGREEMENT, 174 “NONRECOURSE” MORTGAGE, 74 OBLIGATION Description of, 76 Discharge of, see Payment Extension of, 94, 120–121 Form of, 75–76 “In rem” loan, 74 Interest, see Interest Future advances, see Future Advances Modification of, 94 282 Necessity for, 74–75 “Nonrecourse” loan, 74 Payment of, see Payment Recovery on note alone, 184–185 Renewal of, 94 Substitution of, 94 OFFICE OF THRIFT SUPERVISION, 100, 126, 129–130 “ONE ACTION” RULE, 184–185 OPEN-END MORTGAGE, 79 PARTICIPATION (FRACTIONAL ASSIGNMENTS) Defined, 27, 150 Forms, 150 Priority of interests, 150–155 PAYMENT Amortized loans, 94 Balloon loans, 96 Default interest, 98 Effect on mortgage lien, 94 Escrow accounts, 96–98 Graduated payment mortgage, 95 Growing equity mortgage, 95–96 Late charges, 98, 164 Prepayment, 99–100 Problems after mortgage loan assigned, 141–147 Release of mortgage upon, 100–101 Reverse mortgage, 95 Statute of limitations, 101, 208 PENSION FUNDS, 21 PERMANENT FINANCING Condominiums, 234–235 Cooperatives, 229–230 Defined, 13 Relationship with construction financing, 13–14 Subdivisions, 234 POINTS, 85 POSSESSION Mortgagee’s right to, 8–10, 169–174 Mortgagor’s right to, 8–10, 169–170 283 Uniform Land Security Interest Act, 241–242 POWER-OF–SALE FORECLOSURE See Foreclosure by Power of Sale PREDATORY LENDING, 50–51 PREEMPTION See Federal Preemption PREPAYMENT, 99–100, 129 PREPAYMENT PENALTY, 41, 99–100, 129–130 PRICE LEVEL ADJUSTED MORTGAGE, 88–89 PRIORITIES After-acquired property, 103–104 Condominium assessment lien, 235 Conflicting assignments, 147–150 Dragnet clause, 84–85 Fixtures, 195–196 Fractional assignments (participation), 150–155 Future advances, 76–85 Lis pendens, 202–203, 213 Marshaling, 203–206 Mechanics’ liens and related matters, 197–201 Purchase money mortgages, 189–190 Recording statutes, 186–187 Subordination agreements, 190–195 Tax liens, 201–202 Title insurance, 187 PURCHASE MONEY MORTGAGE Defined, 52–53, 188–189 Preferred priority position, 189–190 REAL ESTATE INVESTMENT TRUSTS (REITS), 21–22 REAL ESTATE SETTLEMENT PROCEDURES ACT (RESPA), 45–46, 97–98 RECEIVERS Background, 176–177 Grounds for appointment, 177–178 Powers of, 178–179 RECORDING STATUTES, 186–187 284 REDEMPTION See Equity of Redemption; Statutory Redemption REDLINING, 46–47 REFINANCING, 36, 49 REFORM, 236–243 RELEASE OF MORTGAGE, 100–101 RENTS See Leases RESOLUTION TRUST CORPORATION, 20 RESTATEMENT (THIRD) OF PROPERTY–MORTGAGES, 157, 243 REVERSE MORTGAGE, 95 SALE AND LEASEBACK, 71–73 SALE IN INVERSE ORDER OF ALIENATION RULE See Marshaling SAVINGS AND LOAN ASSOCIATIONS, 19–20 SAVINGS ASSOCIATIONS See Savings and Loan Associations SAVINGS BANKS See Mutual Savings Bank SECONDARY FINANCING, 28–34 SECONDARY MORTGAGE MARKET, 37–39, 49–50, 137 SECURE AND FAIR ENFORCEMENT FOR (S.A.F.E.) MORTGAGE LICENSING ACT, 49 SERVICEMEMBERS CIVIL RELIEF ACT, 210 SERVICING, 17–18, 46, 146–147 SHARED APPRECIATION MORTGAGE, 89–90 “SHORT SALE”, 183–184 SINGLE FAMILY MORTGAGE FORECLOSURE ACT, 238 STATE DEVELOPMENT AGENCIES, 24 285 STATUTE OF FRAUDS, 2–3, 55 STATUTE OF LIMITATIONS Concerning mortgage, 208 Concerning obligation, 101 Effect on mortgage of barring obligation, 101, 208 STATUTORY REDEMPTION Amount required for, 224 Availability of, 8, 223–224 Comparison to equity of redemption, 225–226 Criticism of, 226–227 Parties who may redeem, 224 Result of, 225 Uniform Land Security Interest Act, 242 Waiver of, 225 STOP NOTICE STATUTES, 200–201 STRICT FORECLOSURE Availability of, 7, 222–223 Historical development of, Omitted junior lienors, 215 SUBDIVISION DEVELOPMENT, 233–234 “SUBJECT TO” CONVEYANCES See Conveyance of the Mortgaged Property SUBORDINATION AGREEMENTS Defined, 190 Subordinating fee to leasehold mortgage, 69–70, 195 Subordinating lease to mortgage, 195 Subordinating mortgage to lease, 174, 195 Subordinating purchase money mortgage to construction loan mortgage, 190–194 SUBPRIME MORTGAGE LOANS, 18, 25, 50 SUBROGATION Conventional, 158–160 Defined, 155 Parties for whom available, 155–158 Right to formal assignment, 160 SUPERFUND, 47 SYNDICATIONS, 23 286 TAX CONSIDERATIONS, 31, 49, 53–54, 61, 67, 72 TAX LIENS Federal income tax, 201–202 State and local real estate tax, 201 TITLE INSURANCE, 187 TITLE THEORY Defined, Right to possession and rents, 8–10, 169–170 TRANSFER BY MORTGAGEE See Assignment of Mortgage Loan TRANSFER BY MORTGAGOR See Conveyance of Mortgaged Property TRUST DEED See Deed of Trust TRUTH IN LENDING, 40–42, 49–51, 100 TWO FUNDS RULE See Marshaling UNDERLYING OBLIGATION See Obligation UNIFORM ASSIGNMENT OF RENTS ACT, 176 UNIFORM COMMERCIAL CODE Article 3, 50–51, 75–76, 88, 134, 138–140, 142–145, 147, 149, 165 Article 9, 66–67, 135, 147, 149–150, 196, 240 UNIFORM LAND SECURITY INTEREST ACT, 240–242 UNIFORM NONJUDICIAL FORECLOSURE ACT, 242–243 UNIFORM LAND TRANSACTIONS ACT, 240, 242 USURY Depository Institutions Deregulation and Monetary Control Act, 93 Exemptions, 92–93 Penalties, 93 Preemption of state law, 93 Rate, 92 287 VA See Department of Veterans Affairs VA MORTGAGE, 35, 38–39 VARIABLE RATE MORTGAGE, 87–88 VENDEE’S LIEN, 58–59 VENDOR’S LIEN, 58–59 WAREHOUSING See Mortgage Warehousing WASTE Default, 110, 163 Defined, 108 Mortgagee’s remedies for, 109–110 Receiver, ground for appointment of, 177 WORKOUT, 183 WRAPAROUND MORTGAGES, 32–34 † ... Originating/Servicing/Holding III Sources of Real Estate Financing A Commercial Banks B Savings and Loan Associations C Mutual Savings Banks D Life Insurance Companies E Pension Funds F Real Estate. .. SAVINGS AND LOAN ASSOCIATIONS Savings and loan associations, or savings associations, are also either state or federally chartered They are specialists in housing finance and heavily invest in. .. government involvement in the real estate financing process is found in the federal mortgage insurance and guaranty programs administered by the Federal Housing Administration (FHA) and the Department