Working with Mortgages

A mortgage is an instrument that pledges property as security for the payment of a debt or the performance of an obligation. Two distinct premises exist as to who retains legal title to a mortgaged property. Thirty states hold that the title remains with the owner (mortgagor) and the mortgage creates only a lien against the property. These states are referred to as Lien Theory States. The remaining states operate under the common law or Title Theory, which takes the position that the mortgage acts as a deed, conveying the entire estate to the lender (mortgagee). This conveyance becomes void only upon satisfying the terms of the mortgage.

A deed of trust is the instrument used in some states as a mortgage. The document is placed in the escrow with a third party trustee who holds it until the obligation is satisfied. When the debt is cleared, the third party delivers the deed of trust to the purchaser, freeing him of further responsibilities. It is also referred to as a Long Term Escrow or Trust Indentures.

States also vary as to the type of evidence of debt that accompany the mortgage. Each state's requisites should be studied before preparing a mortgage and its accompanying instruments.

Seller held mortgages are created when the seller agrees to act as the lender and hold a mortgage for all or a portion of the purchase price of the property. Seller held mortgages can be in the form of a first, second or even third mortgage secured by real estate. It basically means the seller agrees to receive the principal amount of the mortgage over time in payments at a specified interest rate and term vs. a lump sum of cash at the closing. If a seller is motivated to sell the property and doesn't need all their cash at closing, they can actually make more money in the long term by holding a mortgage and collecting monthly payments at a favorable interest rate. A mortgage is an asset, just like real estate, stocks or any other investment that can be bought and sold.

Discount mortgages are based on the time value of money. In simple terms, because of inflation money is worth more today than it will be in the future. Hence the phrase, a bird in the hand is worth two in the bush. Some of you may remember the days when you could buy a cup of coffee for 50 cents. That same cup of coffee now costs $1.50.

There is an entire pool of investors most people don't even know about that buy discount mortgages. Discount mortgage investors invest in paper mortgages vs. brick and mortar real estate. This type of investment produces high rates of return without the hassles of owning and managing real estate. What is a discount mortgage? Basically it's a seller held mortgage that is sold to an investor for cash today vs. monthly payments to be paid over time in the future. The cash amount the note investor pays for the mortgage is discounted based on the time value of money and several other factors such as the strength of the borrower, the property characteristics and other elements of the deal. Discount mortgage investors buy entire mortgages as well as payment streams over a specified number of years.

A balloon mortgage has level monthly payments, which are insufficient to amortize the loan so that a balloon, or lump sum payment is due at the end of the term. Frequently, balloon mortgages contain an opportunity to refinance when the balloon payment is due.

Let us assume a situation to understand this strategy and how it may help you buy or sell a property. The seller has a home that has a fair market value of $100,000 with $60,000 in an assumable mortgage (qualifying), at 8% interest and has $40,000 in equity. You may try to discount the property by 20% and get the owner to take back a second mortgage for the balance of the equity. This would keep your out-of-pocket cash to a minimum - a good objective. It may even be very atractive if the first mortgage is assumable and non-qualifying. But what happens if you cannot qualify? Perhaps you have bad credit or just not enough credit history, or too many properties already leveraged to qualify.

A solution could be the wrap mortgage. In this case, the owner of the property could establish a wrap-around mortgage on the property at your recommendation. The wraparound mortgage, sometimes called an all inclusive trust deed (AITD), is a mortgage on the property at whatever terms you agree to. Perhaps you can negotiate an $80,000 mortgage at 8% for the next 30 years. The homeowner is paid the monthly mortgage payment on the wrap-mortgage of $587.01. In turn, the owner pays the first mortgage of $440.26. The homeowner has a regular income of $146.75 and is really receiving 8% on their investment. Not too bad considering what they would get on a bank CD. Since the seller actually finances the deal, there is no qualifying. However, the seller may ask the buyer for references, accounts and checks.

Now, if you were the seller and smart, you would want to get a qualified buyer. Do your homework. Check references and bank accounts. Get guaranties. As the seller, you might consider this option if you have a qualified buyer and you can get some favorable terms. For example, since there is no qualifying for bank financing you might ask for a sizable down payment or you might increase the interest rate above the norm, thus getting a better return on you money. After all, the worst that might happen is that you would have to foreclose on the property and get it back.

The government has made lending a little easier for our nation's veterans. VA loans are guaranteed by the government in case of default and usually have a limited or no money down payment (i.e., on the original note/property. To qualify, the veteran must live in the property originally but can move out later. VA loans made prior to March 1, 1988, have the additional distinction of being easy to transfer. Transfer of a VA loan involves assuming the mortgage, non-qualifying (loans prior to Mar. 1, 1988), paying a $45 assumption fee. Loans originated after Mar. 1, 1988, require the new homeowner to qualify for financing. For individuals who can search out, find and negotiate a good deal, assumable VA properties can be a gold mine.

The Federal Housing Association is an agency of the government that helps new homeowners acquire property. The government essentially insures to the various lending institutions that if the homeowner-occupant defaults, the government will make good on the loan. There are limitations on the amount of funds insured and the process is time consuming. Nevertheless, there are some interesting benefits including the potential of a very low down payment. Prior to Dec. 15, 1989, FHA property and loans were fully assumable and non-qualifying. Again, there is an outstanding opportunity for acquiring the property with minimal qualifying and easy financing options. Loans originated after this date require the new owner to qualify for financing.