REE4433-3

REE 4433

TEST 3

MARCH 22 2007

Pay particular attention to all the details of the terms and examples:

Chapter 21:

Real Estate Finance

Commercial Mortgage and Loan Document Provisions

I. Due on sale clause

a. History of the due on sale clause (In the 1970’s, lenders began including this clause in the mortgage contract)

i. Most borrowers would sign the contract without reading and think they were receiving an assumable mortgage. The first few times that lenders wanted to enforce this clause; they would be faced with challenges to get a judgment on their favor.

ii. In one year, during the case of Fidelity Federal Saving & Loan Association vs de la Cuesta, the supreme court approved the due on sale clause and said that mortgagors were responsible for reading their contracts and being aware of the due on sale clause.

iii. After this case, the due on sale clause still did not apply to all the loans. So, in the same year, Congress enacted the Garn-St Germain Act. This act stated that all mortgages could have a due on sale clause. The act had a phasing period because, at the moment of the enactment, there were still some outstanding mortgages without the due on sale clause.

iv. There might still be, today, an old mortgage without a due on sale clause that can be enforced as if it had a due on sale clause.

b. Most mortgages have a due on sale clause

i. This clause is a type of acceleration

ii. The clause states that when a property (that is mortgaged) is sold, the lender has the right to claim the remaining principal from the mortgagor.

1. A mortgage with a due on sale clause cannot be assumed (explained later on).

iii. Lenders like the due on sale clause because if the market interest rate increases they can lend the principal from the mortgage to somebody else and receive a higher interest on it.

1. Example: Owner gets a mortgage on a house at 6% interest rate. After two years, the market interest rate increased to 7%. Owner sells the house. If the mortgage had a due on sale clause, the lender would want the principal of the 6% mortgage paid back so he/she can loan it out to somebody else at 7% percent.

iv. Borrowers do not like the due on sale clause because a lower interest rate on their current mortgage is a selling point for someone to assume the mortgage.

1. An assumable mortgage is a mortgage that can be taken over by the new buyer of the property.

o Example: Owner 1 owns a house with a 6% mortgage on it. The current market interest rate is 7%. If the owner assumes his/her mortgage to Owner 2, Owner 2 would pay Owner 1 for the equity Owner 1 has on the house, and continue the payments on the 6% mortgage to the mortgagee. Owner 2 would want to do this because if he/she buys a house somewhere else, the interest rate would be a 7%.

2. When a person assumes their mortgage to someone else, he/she must try to get novation and be released from obligations to the original lender.

v. If the interest rates are lower than the interest rate stated on the mortgage the Lender would not want to enforce the due on sale clause.

1. It is most likely that a mortgage with a 6% interest rate, when the market rate is 5%, will not be assumed by any buyer. Nobody would someone assume a mortgage at 6% when they can get a mortgage at 5%.

o Closing costs should also be considered when receiving a mortgage at 5% as opposed to assuming a mortgage at 6% because the closing costs might offset the money the buyer would save if a 5% mortgage is signed.

c. Pre payment penalty vs. Due on sale Clause

i. Due on sale protects the lender if the interest rates go up

1. Lenders can call in the principal on a current loan and loan it out to someone else at a higher rate.

ii. Prepayment penalty protect the lender if the interest rates go down



	REE 4433 REE 4433 TEST 3 MARCH 22 2007 *Pay particular attention to all the details of the terms and examples:* Chapter 21: Real Estate Finance Commercial Mortgage and Loan Document Provisions I. Due on sale clause a. History of the due on sale clause (In the 1970’s, lenders began including this clause in the mortgage contract) i. Most borrowers would sign the contract without reading and think they were receiving an assumable mortgage. The first few times that lenders wanted to enforce this clause; they would be faced with challenges to get a judgment on their favor. ii. In one year, during the case of Fidelity Federal Saving & Loan Association vs de la Cuesta, the supreme court approved the due on sale clause and said that mortgagors were responsible for reading their contracts and being aware of the due on sale clause. iii. After this case, the due on sale clause still did not apply to all the loans. So, in the same year, Congress enacted the Garn-St Germain Act. This act stated that all mortgages could have a due on sale clause. The act had a phasing period because, at the moment of the enactment, there were still some outstanding mortgages without the due on sale clause. iv. There might still be, today, an old mortgage without a due on sale clause that can be enforced as if it had a due on sale clause. b. Most mortgages have a due on sale clause i. This clause is a type of acceleration ii. The clause states that when a property (that is mortgaged) is sold, the lender has the right to claim the remaining principal from the mortgagor. 1. A mortgage with a due on sale clause cannot be assumed (explained later on). iii. Lenders like the due on sale clause because if the market interest rate increases they can lend the principal from the mortgage to somebody else and receive a higher interest on it. 1. Example: Owner gets a mortgage on a house at 6% interest rate. After two years, the market interest rate increased to 7%. Owner sells the house. If the mortgage had a due on sale clause, the lender would want the principal of the 6% mortgage paid back so he/she can loan it out to somebody else at 7% percent. iv. Borrowers do not like the due on sale clause because a lower interest rate on their current mortgage is a selling point for someone to assume the mortgage. 1. An assumable mortgage is a mortgage that can be taken over by the new buyer of the property. o Example: Owner 1 owns a house with a 6% mortgage on it. The current market interest rate is 7%. If the owner assumes his/her mortgage to Owner 2, Owner 2 would pay Owner 1 for the equity Owner 1 has on the house, and continue the payments on the 6% mortgage to the mortgagee. Owner 2 would want to do this because if he/she buys a house somewhere else, the interest rate would be a 7%. 2. When a person assumes their mortgage to someone else, he/she must try to get novation and be released from obligations to the original lender. v. If the interest rates are lower than the interest rate stated on the mortgage the Lender would not want to enforce the due on sale clause. 1. It is most likely that a mortgage with a 6% interest rate, when the market rate is 5%, will not be assumed by any buyer. Nobody would someone assume a mortgage at 6% when they can get a mortgage at 5%. o Closing costs should also be considered when receiving a mortgage at 5% as opposed to assuming a mortgage at 6% because the closing costs might offset the money the buyer would save if a 5% mortgage is signed. c. Pre payment penalty vs. Due on sale Clause i. Due on sale protects the lender if the interest rates go up 1. Lenders can call in the principal on a current loan and loan it out to someone else at a higher rate. ii. Prepayment penalty protect the lender if the interest rates go down