Financing

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Financing THERESE L. O’BRIEN O’Brien Law Group, P.C. Orland Park

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RESIDENTIAL REAL ESTATE

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I. [21.1] Introduction II. [21.2] Financing Devices A. Alternative Financing Devices 1. [21.3] Installment Contracts 2. [21.4] Purchase-Money Mortgage 3. [21.5] Assignments of Beneficial Interest in Land Trust 4. [21.6] Absolute Deed B. [21.7] Mortgages 1. [21.8] Theories of Mortgage Law: Title, Lien, and Intermediate 2. [21.9] Types of Mortgage Loans a. [21.10] Conforming Loans b. [21.11] Nonconforming Loans (1) [21.12] Jumbo loans (2) [21.13] Subprime loans c. [21.14] Conventional Mortgage Loans d. [21.15] Adjustable-Rate Mortgage Loans e. [21.16] Balloon Loans f. [21.17] Bridge Loans g. [21.18] Construction Loans C. Government Loans 1. [21.19] FHA Loans 2. [21.20] VA Loans 3. [21.21] HUD §203(k) Loans 4. [21.22] FmHA Farm Loans 5. [21.23] Government Loans in General D. [21.24] Junior Mortgage Loans 1. [21.25] Home Equity Loans 2. [21.26] Wraparound Mortgage Loans E. [21.27] Reverse Mortgages III. [21.28] Mortgage Insurance/Private Mortgage Insurance IV. [21.29] Sources of Financing A. [21.30] Primary and Secondary Sources B. [21.31] Contract Issues Affecting Financing

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V. The Loan Process A. Preliminary Considerations 1. [21.32] Type of Loan 2. [21.33] Residential Mortgage Licensee 3. [21.34] Preapproval 4. [21.35] Predatory Lending 5. [21.36] Anti-Predatory Lending Database Program B. Formal Requirements 1. [21.37] Application 2. [21.38] Good-Faith Estimate 3. [21.39] Processing 4. [21.40] Underwriting 5. [21.41] Appraisal 6. [21.42] Commitment and Conditions 7. [21.43] Closing the Loan 8. [21.44] Loan Package 9. [21.45] Fees C. Post-Loan Closing Considerations 1. [21.46] Prepayments 2. [21.47] Escrows and Impounds 3. [21.48] Termination of Private Mortgage Insurance 4. [21.49] Payoff and Release VI. [21.50] State and Federal Regulation of the Mortgage Industry A. [21.51] Federal Regulation 1. [21.52] Truth in Lending Act 2. [21.53] Fair Credit Reporting Act 3. [21.54] Equal Credit Opportunity Act 4. [21.55] Real Estate Settlement Procedures Act 5. [21.56] Home Mortgage Disclosure Act 6. [21.57] Housing and Economic Recovery Act B. [21.58] State Regulation VII. [21.59] Distressed Real Estate Sellers A. [21.60] Loan Modification B. [21.61] Short Sale C. [21.62] Deed in Lieu of Foreclosure

RESIDENTIAL REAL ESTATE


D. [21.63] Income Tax Consequence E. [21.64] Impact on Credit Scores VIII. Appendix — Forms A. [21.65] Sample Note B. [21.66] Sample Security Instrument (Mortgage)

FINANCING §21.1


I. [21.1] INTRODUCTION This chapter is intended as a primer on the principles and procedures commonly encountered in conjunction with financing the purchase of residential real estate. It is a foundation from which persons unfamiliar with residential real estate transactions can develop an understanding of the role financing plays in a typical residential transaction. This chapter explores sources of financing, types of loans available, the mortgage loan process, closing the mortgage loan, and regulation of the mortgage industry. It is not intended as a discussion of the mortgage industry, the mortgage markets, or the recent financial crisis as it relates to the mortgage markets. It is a practical resource addressing one critical aspect of the residential real estate transaction. But for the requisite financing, the transaction will not close. In the purchase and sale of residential real estate, a cash deal is always preferred. Unfortunately, it is the exception, not the rule. Most often, a purchaser will need to obtain financing in order to consummate the transaction. Although alternative financing devices exist, the device most often utilized is a mortgage loan. Historically, mortgages were obtained from neighborhood banks at fixed interest rates paid over 30 years. In recent years, the financial services industry witnessed the expansion of residential mortgage lending, resulting in a dramatic increase in the types of mortgage loans offered and their being obtained through, most rarely, the neighborhood bank. Mortgage loans were readily available as underwriting standards were minimal at best. This overzealous lending environment led to an abundance of subprime, interest-only, and adjustable-rate loans being made to persons unable to repay the debt. A high default percentage of these loans contributed to the financial crisis of 2008. In response, creditors have tightened underwriting standards, and funds available to finance the purchase of residential real estate are available to only the most creditworthy borrowers. Today’s borrowers are faced not only with a limited choice of lenders but also with less funds available to borrow, fewer loan products to choose from, and stringent underwriting guidelines. In addition, they are faced with financial obstacles stemming from the abundance of distressed and real estate owned (REO) properties (bank-owned properties) available. As a result of the financial loss associated with these properties, these sellers typically shift customary seller contractual obligations and closing costs to the purchaser, thereby further burdening the purchaser. The financial crisis impacted not only the nature of the transaction and the responsibilities of the parties but also the regulatory aspect of financing the transaction. The most notable changes include those made to the Truth in Lending Act (TILA), 15 U.S.C. §1601, et seq., and the Real Estate Settlement Procedures Act of 1974 (RESPA), 12 U.S.C. §2601, et seq., and the creation of the Housing and Economic Recovery Act of 2008 (HERA), Pub.L. No. 110-289, 122 Stat. 2654. Under TILA and RESPA, the U.S. Department of Housing and Urban Development (HUD) has implemented simplified disclosure requirements in a new, easy to understand Good Faith Estimate form and a new HUD-1 and HUD-1A Settlement Statement, which are available at www.hud.gov/offices/hsg/rmra/res/gfestimate.pdf and http://portal.hud.gov/hudportal/HUD?src=/ program_offices/administration/hudclips/forms (case sensitive), respectively. In addition, HERA authorized the creation of a conservatorship for Fannie Mae and Freddie Mac, the two government-sponsored entities that play a crucial role in mortgage financing. See §21.30 below.

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The financial crisis and the resulting regulatory changes have created a challenging credit environment for borrowers. Unless the purchaser has cash in hand, prepare for a time-consuming and tedious undertaking. II. [21.2] FINANCING DEVICES In a typical residential transaction, a purchaser will secure a mortgage loan from a third-party lender. However, alternatives do exist. These include installment contracts, purchase-money mortgages, assignments of beneficial interests, and absolute deeds. Throughout history, alternative financing devices have been utilized by creditors for reasons that include circumventing the judicial mortgage foreclosure proceeding and the debtor’s equity of redemption. Currently, however, the use of alternative financing devices occurs most often when a purchaser is unable to obtain a mortgage loan and looks to the seller to finance a portion of the purchase price. A. Alternative Financing Devices 1. [21.3] Installment Contracts The installment contract (also referred to as the “contract for deed”) is a form of seller financing. It is a transaction in which the parties agree that (a) the buyer will take immediate possession of the property, (b) the buyer will pay the purchase price over time (in installments), and (c) the seller will retain title to the property until the buyer completes its purchase obligation. The buyer typically assumes responsibility for property taxes and maintenance, and the contract typically provides that, upon default, the buyer will forfeit all money paid and the seller will regain possession. The installment contract is an executory contract — a contract that is yet to be fully completed or performed. It is a contract on which performance remains due to some extent on both sides. In re Liquidation of Inter-American Insurance Company of Illinois, 329 Ill.App.3d 606, 768 N.E.2d 182, 263 Ill.Dec. 422 (1st Dist. 2002). In general, an installment contract vests equitable title in the buyer, while the seller maintains legal title until such time as the contract is paid in full. Shay v. Penrose, 25 Ill.2d 447, 185 N.E.2d 218 (1962). The contract may specifically provide that there is no transfer of even equitable title. Eade v. Brownlee, 29 Ill.2d 214, 193 N.E.2d 786, 788 (1963). However, even when the contract provides that no equitable title will pass, courts still find that the buyer has a recognizable beneficial interest in the property. Ruva v. Mente, 143 Ill.2d 257, 572 N.E.2d 888, 157 Ill.Dec. 424 (1991). For information on the termination of installment contracts, see REAL ESTATE LITIGATION (IICLE, 2008, Supp. 2010). 2. [21.4] Purchase-Money Mortgage Similar to the land installment contract, a purchase-money mortgage (PMM) is a form of seller financing wherein the mortgage secures the indebtedness from the buyer to the seller of real estate. With a PMM, the seller conveys legal title of the property to the purchaser, who is obligated to pay all of the property-related expenses and obtains risk of loss in the event of a casualty. The purchaser usually pays a significant down payment to the seller at closing and then

FINANCING §21.7


makes interest and principal payments on the purchase-money financing over a period of time that usually lasts one to five years. If there is a default by the purchaser in making the payments or otherwise performing under the loan agreement, the seller may reacquire the property and retain the down payment and portion of the purchase-money financing paid to date. The benefit of a land installment contract and a PMM is that they allow the purchaser to obtain property with a relatively small amount of cash and may present an opportunity for a purchaser with questionable credit to acquire property while preparing to secure permanent financing. 3. [21.5] Assignments of Beneficial Interest in Land Trust An assignment of beneficial interest (ABI) in an Illinois land trust can be pledged as collateral security for the payment of a debt. The documentation executed to effect an ABI includes an assignment, an acceptance, and a consent of the beneficial interest in the land trust. A note and security agreement that pledge the beneficial interest as collateral will accompany the ABI. Once the assignment and acceptance are acknowledged by the trustee, the lender’s interest is perfected without any other filing or recording requirements. 4. [21.6] Absolute Deed The absolute deed as a financing device contemplates a deed given to the lender as security on a loan with an agreement between the parties that the lender (creditor) will reconvey the property to the borrower (debtor) only if the debtor pays the debt. A question may arise as to whether a deed was intended as a conveyance or merely as a security device. “Every deed conveying real estate, which shall appear to have been intended only as a security in the nature of a mortgage, though it be an absolute conveyance in terms, shall be considered as a mortgage.” 765 ILCS 905/5. Under the doctrine of equitable mortgage, in order for a court to convert a deed that is absolute on its face into a mortgage, it is essential for a mortgage that there be a debt relationship. Nave v. Heinzmann, 344 Ill.App.3d 815, 801 N.E.2d 121, 279 Ill.Dec. 829 (5th Dist. 2003). The factors to consider in determining whether a deed that is absolute in form was intended to be a mortgage include the relationship of the parties, the circumstances surrounding the transaction, the adequacy of the consideration, and the situation of the parties after the transaction. 801 N.E.2d at 126. Agreements to reconvey property are an indication that the parties intended the transaction to be a mortgage under the Mortgage Act, 765 ILCS 905/0.01, et seq., and not a conveyance. 801 N.E.2d at 127. B. [21.7] Mortgages A “mortgage” is an interest in land created by written instrument providing security in real estate to secure the payment of a debt. Aames Capital Corp. v. Interstate Bank of Oak Forest, 315 Ill.App.3d 700, 734 N.E.2d 493, 248 Ill.Dec. 565 (2d Dist. 2000). The debt is the principal obligation, and if there is no valid existing debt, there can be no mortgage. Thus, a debt relationship is essential to a mortgage. McGill v. Biggs, 105 Ill.App.3d 706, 434 N.E.2d 772, 61 Ill.Dec. 417 (3d Dist. 1982). See also Evans v. Berko, 408 Ill. 438, 97 N.E.2d 316 (1951). The obligation to repay the amount financed is evidenced by a promissory note requiring repayment of the funds borrowed, plus interest, in regular monthly installment payments referred to as “amortization.” The promissory note is secured by a mortgage held as security for the



performance of repayment of the loan. The mortgage is recorded in the office of the recorder in the county where the property is located, creating a lien on the property in favor of the lender (mortgagee). If the borrower (mortgagor) defaults on the loan, the mortgagee can foreclose its lien, have the property sold, and apply the proceeds toward the repayment of the debt. Lenders are secure in knowing that if the borrower does not repay the debt, the lender can obtain title to the property. Conversely, the borrower knows that when the debt is paid in full, the mortgage lien will be released and the borrower will hold an unencumbered title to the property. Because a mortgage involves a transfer of an interest in real estate, it is subject to the statute of frauds. The court in Enos v. Hunter, 9 Ill. (4 Gilm.) 211, 219 (1847), stated, “As a general rule, the policy of the law requires that everything which may affect the title to real estate, shall be in writing; that nothing shall be left to the frailty of human memory.” In Corbridge v. Westminster Presbyterian Church & Society, 18 Ill.App.2d 245, 151 N.E.2d 822, 831 (2d Dist. 1958), the court, quoting Wiley v. Dunn, 358 Ill. 97, 192 N.E. 661, 663 (1934), stated, “[E]verything which affects the title to real estate shall be in writing.” Similarly, mortgages are the subject of state law. Because mortgages are concerned with transactions relating to real property and are governed by the same general principles as conveyances of real property, in general the validity of a mortgage on realty is determined by the law of the state where the land is located. 16 AM.JUR.2d Conflict of Laws §45 (1998). 1. [21.8] Theories of Mortgage Law: Title, Lien, and Intermediate American courts have traditionally recognized one of three theories of mortgage law — title, lien, and intermediate. Under the title theory, legal “title” to the mortgaged real estate remains in the mortgagee until the mortgage is satisfied or foreclosed. In lien theory jurisdictions, the mortgagee is regarded as owning a security interest only, and both legal and equitable title remain in the mortgagor until foreclosure. Under the intermediate theory, legal and equitable title remains in the mortgagor until a default, at which time legal title passes to the mortgagee. These three mortgage law theories are the product of several centuries of English and American legal history. RESTATEMENT (THIRD) OF PROPERTY: MORTGAGES §4.1 (1997). The substantial majority of American jurisdictions follow the lien theory. Under this theory, the mortgagee acquires only a “lien” on the mortgaged real estate, and the mortgagor retains both legal and equitable title and the right to possession until foreclosure or a deed in lieu of foreclosure. Id. The general view is that Illinois adopted the lien theory in 1984. See Harms v. Sprague, 105 Ill.2d 215, 473 N.E.2d 930, 85 Ill.Dec. 331 (1984); Kelley/Lehr & Associates, Inc. v. O’Brien, 194 Ill.App.3d 380, 551 N.E.2d 419, 141 Ill.Dec. 426 (2d Dist. 1990) (referring to Illinois as “lien theory” state). However, under legislation enacted in 1987, as to residential real estate, “the mortgagor shall be entitled to possession of the real estate.” 735 ILCS 5/15-1701(b)(1). However, if the mortgage so authorizes and “the court is satisfied that there is a reasonable probability that the mortgagee will prevail on a final hearing [in foreclosure and the mortgagee shows good cause for being placed in possession], the court shall upon request place the mortgagee in possession.” Id.

FINANCING §21.13


2. [21.9] Types of Mortgage Loans There are a number of mortgage products available to a purchaser of residential real estate. The options vary depending on the circumstances of the transaction. Circumstances may include the type of property purchased, the purpose of the loan (owner occupied or investment), the loan-to-value ratio (amount of funds borrowed as compared to the value of the property), the desired term of the loan, the creditworthiness of the borrower, and the desire for a fixed versus variable rate. Notwithstanding the foregoing, due to the recent collapse of the subprime mortgage market, certain types of mortgages may no longer be available as investor skepticism has lessened the availability of credit in the mortgage market. At a minimum, all mortgage loans are considered either conforming or nonconforming. a. [21.10] Conforming Loans A conforming loan is a mortgage loan that conforms to the guidelines of a government-sponsored enterprise (GSE). GSEs are a group of financial services corporations created by the U.S. Congress whose function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient. The desired effect of the GSE is to enhance the availability and reduce the cost of credit to the targeted borrowing sectors, including residential home finance. The residential home finance segment is by far the largest of the borrowing segments in which the GSEs operate. The GSEs of this residential home finance segment are Fannie Mae and Freddie Mac. b. [21.11] Nonconforming Loans A nonconforming loan is any loan that does not meet the underwriting guidelines of Fannie Mae or Freddie Mac and is typically categorized as either a jumbo loan or a subprime loan. (1) [21.12] Jumbo loans A jumbo mortgage loan is a loan in which the amount borrowed exceeds the industry-standard definition of conventional conforming loan limits as set annually by the two largest secondary market lenders, Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac, as the largest government-sponsored agencies that purchase the bulk of residential mortgages in the U.S., set limits on the maximum dollar value of any mortgage they will purchase. Thus, jumbo mortgages apply when Fannie Mae and Freddie Mac limits do not cover the full loan amount. Jumbo loans are commonly provided by large investors, including insurance companies and banks. The average interest rate on a jumbo is typically greater than is normal for conforming mortgages due to the higher risk to the lender. The spread depends on the current market price of risk. Typically, the spread fluctuates between 0.25 percent and 0.5 percent; however, at times of high investor anxiety, it can exceed a full percentage point. (2) [21.13] Subprime loans A loan that does not meet the underwriting standards of either Fannie Mae or Freddie Mac for reasons other than the loan amount is called subprime. Subprime loans have a higher credit risk



that may be the result of a borrower’s prior bankruptcy, high debt, slow or bad payment history, or any other factors that result in a low credit score. Although subprime loans serve a legitimate purpose, counsel should be aware that this market is also seen by some lenders as an opportunity for predatory lending that can include an unreasonable markup in the interest rate or lender fees passed on to the borrower. Subprime mortgages emerged on the financial landscape more than two decades ago but did not gain popularity until mid-1990. This expansion was fueled by several factors including the development of credit scoring (means by which a lender assesses price and risk), as well as the ongoing growth in the secondary mortgage market that increased the ability of lenders to sell mortgages to various intermediaries instead of carrying the loans on their books. The intermediaries or “securitizers” pooled large numbers of mortgages and sold the rights to the cash flow to investors. This “originate to distribute” process allowed lenders to share the risk more broadly and increased the supply of mortgage credit. Many lenders will not deal with borrowers who apply for nonconforming loans, while other lenders specialize in this market. Private, nongovernment-chartered enterprises buy nonconforming loans, securitize them in pools, and issue mortgage-backed securities, which are sold on the open market. The abundance of subprime mortgages resulting in default have been identified as one of the major factors contributing to the financial crisis of 2008 and are virtually nonexistent today. c. [21.14] Conventional Mortgage Loans A conventional mortgage loan is any mortgage loan that is not guaranteed or insured by the federal government. The mortgage is conventional in that the lender looks only to the credit of the borrower and the security of the property and not to the additional backing of another. d. [21.15] Adjustable-Rate Mortgage Loans An adjustable-rate mortgage (ARM) is a mortgage loan in which the interest rate is not fixed but is tied to a commercially acceptable standard referred to as an “index.” The rate is periodically adjusted as the index moves up or down. The borrower’s monthly payment is then adjusted at predetermined intervals to reflect the rate of adjustment. The index rate is used as the starting point to which the adjustment margin (the number of points that the loan interest rate can be increased or decreased on the adjustment date) is added to set the interest rate of the ARM. The ARM may contain a cap on either the amount the rate can change at each adjustment interval or a cap on the change of the rate over the lifetime of the loan or both. Many ARMs carry an introductory rate (teaser rate), which is a low interest rate for an initial period of time. At a predetermined date, the interest rate adjusts to the market rate. Examples of the types of ARMs available include fixed-period adjustable-rate and interest-only loans. The fixed-period adjustable-rate mortgage has an initial fixed-rate period, after which the rate may adjust either upward or downward annually based on the cap structure and the index chosen. The interest-only feature allows borrowers to make lower payments on an ARM by offering an interest-only period during the early years of the loan, followed by a fully amortizing period. Generally speaking, mortgages with the interest-only feature are intended for financially informed borrowers who are prepared for the increased mortgage payment when the loan converts to a fully amortizing payment.

FINANCING §21.19


e. [21.16] Balloon Loans A balloon-payment mortgage is a mortgage that does not fully amortize over the term of the note, thereby leaving a balance due at maturity larger than the previous monthly installments. The interest rate may be fixed or variable, and the final payment is called a “balloon” payment because of its large size. Since a borrower may not have the resources to make the balloon payment at the end of the loan term, a two-step mortgage plan may be utilized. Under a two-step plan, also known as a “reset option,” the mortgage note resets using current market rates and a fully amortized payment schedule. This option is not automatic and may be available only if the borrower is still the owner/occupant of the property, has no 30-day late payments in the preceding 12 months, and has no other liens against the property. A balloon differs from an adjustable-rate mortgage in that a balloon will require payoff or refinance (absent a reset option), while an ARM most often will adjust automatically at the end of the applicable period with no refinancing needed. f. [21.17] Bridge Loans A bridge loan is a form of interim financing commonly used when a borrower purchases a new home prior to selling his or her existing home. It is a short-term balloon loan, usually for a number of months, that carries a higher interest rate than permanent financing and requires interest-only payments until the end of the short term, at which time the balance is due. A buyer’s mortgage commitment may require that a borrower sell an existing home before permanent financing will be funded. g. [21.18] Construction Loans Construction loans provide funds to a developer during the period of construction of improvements on the real estate and are usually secured by a first mortgage on the real estate. A construction loan agreement sets forth the conditions precedent to funding the loan and establishes procedures for periodic payments. Lenders typically utilize a construction escrow, either in-house or through a title company, that requires a general contractor and subcontractors to submit lien waivers to support the periodic draws. Upon completion of the improvements, the construction loan is converted to permanent financing. C. Government Loans 1. [21.19] FHA Loans Federal Housing Administration (FHA) loans are government-insured loans made through FHA-approved lenders. The FHA is a unit of the Department of Housing and Urban Development, which administers various programs of mortgage insurance under the National Housing Act, 12 U.S.C. §1701, et seq. 42 U.S.C. §3533. There are several FHA loan programs that make loans available to first-time home buyers of one- to four-family dwellings, mobile home buyers, condominium unit buyers, low- and moderate-income families, and co-op units. The lender must apply for FHA insurance on each loan, showing that the loan meets the criteria for one of the available insurance programs. Although FHA-insured loans are commonly



available, they are not available from all financial institutions. Only those institutions approved by the FHA that are willing to provide relatively small loan amounts, tolerate the FHA’s authority to mandate repairs to the property as a condition of a loan, and endure the extended time it takes to close an FHA loan can offer an FHA-insured loan. 2. [21.20] VA Loans The U.S. Department of Veterans Affairs (VA) provides assistance in obtaining mortgage loans to qualified military veterans for the acquisition, construction, improvement, or refinance of a primary residence. See 38 U.S.C. §3701, et seq. These benefits are intended to enable veterans to obtain housing on more favorable terms and to protect the veteran and the lender against loss on foreclosure. United States v. Shimer, 367 U.S. 374, 6 L.Ed.2d 908, 81 S.Ct. 1554 (1961). The benefits include the possibility of no down payment, competitive interest rates, and the ability to prepay a loan without penalty. In addition, the VA requires a VA appraisal and compliance inspections to ensure the reasonable value of the property. 3. [21.21] HUD §203(k) Loans The Department of Housing and Urban Development’s Federal Housing Administration makes available loans through FHA-approved lending institutions for the rehabilitation and repair of single-family homes. These loans, known as §203(k) loans, which are intended to enable HUD to promote and facilitate the restoration and preservation of the nation’s existing housing stock, are authorized under 12 U.S.C. §1709(k), as amended by §101(c) of the Housing and Community Development Amendments of 1978, Pub.L. No. 95-557, 92 Stat. 2080. See also 24 C.F.R. §§203.50, 203.440 – 203.494. As explained on HUD’s website at www.hud.gov/offices/hsg/sfh/203k/203kabou.cfm:

Most mortgage financing plans provide only permanent financing. That is, the lender will not usually close the loan and release the mortgage proceeds unless the condition and value of the property provide adequate loan security. When rehabilitation is involved, this means that a lender typically requires the improvements to be finished before a long-term mortgage is made. When a homebuyer wants to purchase a house in need of repair or modernization, the homebuyer usually has to obtain financing first to purchase the dwelling; additional financing to do the rehabilitation construction; and a permanent mortgage when the work is completed to pay off the interim loans with a permanent mortgage. Often the interim financing (the acquisition and construction loans) involves relatively high interest rates and short amortization periods. The Section 203(k) program was designed to address this situation. The borrower can get just one mortgage loan, at a long-term fixed (or adjustable) rate, to finance both the acquisition and the rehabilitation of the property. To provide funds for the rehabilitation, the mortgage amount is based on the projected value of the property with the work completed, taking into account the cost of the work. To minimize the risk to the mortgage lender, the mortgage loan (the maximum allowable amount) is

FINANCING §21.25


eligible for endorsement by HUD as soon as the mortgage proceeds are disbursed and a rehabilitation escrow account is established. At this point the lender has a fully-insured mortgage loan.

Additional information about §203(k) loans may be found on the FHA’s website and in HUD HANDBOOK 4240.4, www.hud.gov/offices/adm/hudclips/handbooks/hsgh/4240.4/index.cfm. 4. [21.22] FmHA Farm Loans The Farmers Home Administration (FmHA) is an agency of the U.S. Department of Agriculture that provides credit to rural residents who are unable to obtain financing for housing at reasonable rates and terms from other sources under Title V of the Housing Act of 1949, 42 U.S.C. §1471, et seq. The FmHA also provides loans to acquire and operate small farms. 7 U.S.C. §1921, et seq. Under both programs, the direct or insured loans may include loans that provide for low initial installment payments and larger subsequent installment payments when the borrower otherwise would not qualify for a loan in a sufficient amount but has the potential to increase his or her income in the future. 7 U.S.C. §1934; 42 U.S.C. §1473. For further discussion on this topic, see 6 ILLINOIS REAL PROPERTY SERVICE §37.29 (1989). 5. [21.23] Government Loans in General

PRACTICE POINTER

The time it takes a borrower to secure an unconditional loan commitment for a government-insured loan typically is longer than for a conventional loan. Whereas a conventional loan can be processed, underwritten, and cleared close in an average of 30 calendar days, a government-insured loan can take upwards of 45 to 60 calendar days. Thus, counsel should be mindful of the time allotted in the financing contingency of the real estate contract for the buyer to secure an unconditional loan commitment.

D. [21.24] Junior Mortgage Loans Junior mortgage loans, or second mortgages, enable a borrower to access the equity in the property without having to refinance a first mortgage. A junior mortgage, recorded subsequent to the recording of a first or senior mortgage, results in a lower priority. A junior mortgage is usually for a lesser amount than a first mortgage, is for a relatively short term, and typically has a higher interest rate than the first mortgage because it poses an increased risk to the mortgagee. A default by a borrower followed by a foreclosure of the senior mortgage would eliminate the junior mortgage as a lien on the property. Although there is typically no limit to the number of junior mortgages that may be placed against a property, the terms of a senior mortgage may consider the recording of a junior mortgage against the property a default. 1. [21.25] Home Equity Loans A home equity loan (HEL) is a consumer credit plan that provides for any extension of credit that is secured by the borrower’s principal dwelling. 15 U.S.C. §1637a(a). An HEL is a closed-



end loan in which the borrower receives funds in a lump sum at the time of closing and cannot borrow further. An HEL may also take the form of a line of credit referred to as a “home equity line of credit” (HELOC). A HELOC is a revolving credit loan in which the borrower can choose when and how often to borrow against the equity in the property, with the lender setting an initial limit to the credit line based on criteria similar to those used for closed-end loans. HELs usually bear a slightly higher interest rate than the first or senior mortgage. 2. [21.26] Wraparound Mortgage Loans A wraparound mortgage is a second mortgage that wraps around or exists in addition to a first or other mortgages. In a wraparound mortgage, the lender assumes the first mortgage obligation and also loans additional funds, taking back from the mortgagee a junior mortgage in the combined amount at an intermediate interest rate. E. [21.27] Reverse Mortgages A reverse mortgage is a loan used to convert a portion of a homeowner’s equity in the property into cash. It is the reverse of a traditional mortgage, as here the lender pays the borrower, and the homeowner’s obligation to repay the loan is deferred until the owner dies, the home is sold, or the owner no longer uses the property as a primary residence (e.g., moves into aged care). Under the Illinois Banking Act, 205 ILCS 5/1, et seq., a reverse mortgage loan shall be a loan extended on the basis of existing equity in homestead property. 205 ILCS 5/5a. A bank, in making a reverse mortgage loan, may add deferred interest to principal or otherwise provide for the charging of interest or premium on the deferred interest. Id. Before borrowing, applicants may seek free financial counseling from a source that is approved by the Department of Housing and Urban Development. The counseling is a safeguard for the borrower and his or her family to make sure the borrower completely understands what a reverse mortgage is and how one is obtained. III. [21.28] MORTGAGE INSURANCE/PRIVATE MORTGAGE INSURANCE Section 10 of the Mortgage Insurance Limitation and Notification Act, 765 ILCS 930/1, et seq., defines “mortgage insurance” as “including any mortgage guaranty insurance, against the nonpayment of, or default on, a mortgage or loan involved in a residential mortgage transaction, the premiums of which are paid by the mortgagor.” 765 ILCS 930/10. “Private mortgage insurance” (PMI) means mortgage insurance other than mortgage insurance made available under the National Housing Act, Title 38 of the U.S. Code (veterans’ benefits), or Title V of the Housing Act of 1949. It is insurance against loss to the mortgagee in the event of default by the mortgagor and a failure of the mortgaged property to satisfy the balance owing plus costs of foreclosure. PMI premiums are paid monthly and are included in the monthly mortgage payment. When a borrower enters into a transaction for a mortgage and PMI may be required, the lender is required to disclose in writing

FINANCING §21.30


a. whether PMI will be required; b. the period during which the insurance shall be in effect; and c. the conditions under which the mortgagor may cancel the insurance. 765 ILCS 930/15. Likewise, the lender must notify the mortgagee no less than once a year whether the insurance may be terminated, the conditions and procedure for termination, and a contact person. Id. The borrower has the right to request termination of PMI payments when the loan reaches 80 percent of the original value of the property, and the mortgagee will automatically terminate PMI when the loan reaches 78 percent of the original property value.

PRACTICE POINTER

Historically, a borrower could avoid the PMI requirement by structuring the financing as a piggyback loan, i.e., an 80/20 loan, 80/10/10 loan, or 80/15/5 loan. In each of these scenarios, a borrower takes out an 80-percent first mortgage and a second mortgage (home equity loan) for the balance (less the down payment), thereby eliminating PMI payments on a loan exceeding conventional limits. These options are rarely available today.

IV. [21.29] SOURCES OF FINANCING Depending on the type of financing device utilized, the source of funds will vary. When an alternative option is used, the source of funds comes from a private party — most often, the seller. When a mortgage from a third-party lender is obtained, the funds come from two general sources commonly referred to as “primary” and “secondary” sources. A. [21.30] Primary and Secondary Sources Primary, or institutional, sources of first mortgage loans include commercial banks, savings and loan associations, credit unions, savings banks, life insurance companies, and pension funds. Primary sources originate mortgages and provide the initial funding to the borrower. After the loan is closed, a primary source may retain the loan in its portfolio or may sell the loan to a secondary source in the secondary mortgage market. Secondary sources include three federally chartered institutions: the Federal National Mortgage Association (Fannie Mae), 12 U.S.C. §1717; the Federal Home Loan Mortgage Corporation (Freddie Mac), 12 U.S.C. §1452; and the Government National Mortgage Association (Ginnie Mae), 12 U.S.C. §1717. Secondary sources are part of the secondary mortgage market and are the most active buyers of residential loans originated by primary sources. The secondary market for mortgage loans comes into play after the mortgage loan has been originated and funded by a primary source. These three institutions have standard underwriting guidelines, and any loan that meets these guidelines is considered a conforming



loan. Once a primary source has originated and funded a loan, it may keep the note and mortgage in-house in its own portfolio, assign the note and mortgage to another institution (i.e., sell the loan), or place the loan in a pool with other mortgages having similar characteristics and securitize the loans. These securitized loans, which meet the standard underwriting guidelines of Fannie Mae, Freddie Mac, or Ginnie Mae, are salable on the secondary market. Fannie Mae, www.fanniemae.com, is a government-sponsored enterprise authorized to make loans and loan guarantees. Fannie Mae plays a central role in mortgage financing. Originally founded in 1938 as a government agency, its purpose was to create liquidity in the mortgage market. In 1968, Fannie Mae was converted to a private corporation and ceased to be the guarantor of government-sponsored loans. That responsibility was transferred to Ginnie Mae. Fannie Mae makes money by charging a guarantee fee on loans it has pooled and securitized into mortgage-backed securities (MBSs) that are purchased by investors. Fannie Mae guarantees the investor repayment of the underlying principal and interest even if the borrower on the underlying debt defaults. The investors who purchase MBSs pay the guarantee fee in lieu of accepting the underlying risk on the debt. Fannie Mae is not backed or funded by the United States Government, nor does it benefit from any government protection or guarantee. However, there is a perception by investors that the government would prevent Fannie Mae from defaulting on their debt. Freddie Mac, www.freddiemac.com, is a GSE that is publicly owned and authorized to make loans and loan guarantees. Freddie Mac, like Fannie Mae, plays a central role in mortgage financing. Freddie Mac was created in 1970 for the purpose of expanding the secondary mortgage market. Freddie Mac buys mortgages on the secondary market, pools them, and sells them to investors in the open market. Like Fannie Mae, Freddie Mac is not backed or funded by the United States Government, nor does it benefit from any government protection or guarantee. Ginnie Mae, www.ginniemae.gov, guarantees investors the timely payment of principal and interest on MBSs backed by federally insured or guaranteed loans, mainly, those loans insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Other guarantors or issuers of loans eligible as collateral for Ginnie Mae MBSs include the Department of Agriculture’s Rural Housing Service (RHS) and the Department of Housing and Urban Development’s Office of Public and Indian Housing (PIH). Ginnie Mae is the only MBS that enjoys the full faith and credit of the United States government. On September 7, 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac in conservatorship. As conservator, the FHFA has full powers to control the assets and operations of the firms. Dividends to common and preferred shareholders are suspended but the U.S. Treasury has put in place a set of financing agreements to ensure that the GSEs continue to meet their obligations to holders of bonds that they have issued or guaranteed. This means that the U.S. taxpayer now stands behind trillions of GSE debt. This step was taken because a default by either of the two firms, which have been battered by the downturn in housing and credit markets, could have caused severe disruptions in global financial markets, made home mortgages more difficult and expensive to obtain and had negative repercussions throughout the economy. See Baird Webel and Edward V. Murphy, Congressional Research Service, The Emergency Economic Stabilization Act and Current Financial Turmoil: Issues and Analysis (CRS Report for Congress Order Code RS 22950), www.fas.org/sgp/crs/misc/RL34730.pdf (case sensitive).

FINANCING §21.31


B. [21.31] Contract Issues Affecting Financing The mortgage contingency provision of a contract is critical. It governs the terms and conditions of the loan to be obtained by a purchaser. As such, the terms of the mortgage contingency must be realistic, ascertainable by the borrower (given the borrower’s economic status), and available within current market conditions. The following excerpt from the Multi-Board Residential Real Estate Contract 5.0 exemplifies the extent of terms and conditions to be considered:

This Contract is contingent upon Buyer obtaining a firm written mortgage commitment (except for matters of title and survey or matters totally within Buyer’s control) on or before_______________, 20____ for a [check one] fixed adjustable; [check one] conventional FHA/VA (if FHA/VA is chosen, complete Paragraph 35) other __________________ loan of _____% of Purchase Price, plus private mortgage insurance (PMI), if required. The interest rate (initial rate, if applicable) shall not exceed _____% per annum, amortized over not less than _____ years. Buyer shall pay loan origination fee and/or discount points not to exceed _____% of the loan amount. Buyer shall pay the cost of application, usual and customary processing fees and closing costs charged by lender. (Complete Paragraph 33 if closing cost credits apply.) Buyer shall make written loan application within five (5) Business Days after the Date of Acceptance. Failure to do so shall constitute an act of Default under this Contract. If Buyer, having applied for the loan specified above, is unable to obtain such loan commitment and serves Notice to Seller within the time specified, this Contract shall be null and void. If Notice of inability to obtain such loan commitment is not served within the time specified, Buyer shall be deemed to have waived this contingency and this Contract shall remain in full force and effect. Unless otherwise provided in Paragraph 31, this Contract shall not be contingent upon the sale and/or closing of Buyer’s existing real estate. Buyer shall be deemed to have satisfied the financing conditions of this paragraph if Buyer obtains a loan commitment in accordance with the terms of this paragraph even though the loan is conditioned on the sale and/or closing of Buyer’s existing real estate. If Seller at Seller’s option and expense, within thirty (30) days after Buyer’s Notice, procures for Buyer such commitment or notifies Buyer that Seller will accept a purchase money mortgage upon the same terms, this Contract shall remain in full force and effect. In such event, Seller shall notify Buyer within five (5) Business Days after Buyer’s Notice of Seller’s election to provide or obtain such financing, and Buyer shall furnish to Seller or lender all requested information and shall sign all papers necessary to obtain the mortgage commitment and to close the loan. [Emphasis in original.]

The website of the Illinois Real Estate Lawyers Association (IRELA) is the repository of the Multi-Board Residential Real Estate Contract 5.0. A fillable sample of the contract is available at www.irela.org/developments_contract_alert.asp. The form is also reprinted in Chapters 2 and 13 of this handbook.



PRACTICE POINTER

Consult with the borrower-client to ensure that the terms stated in the financing

contingency are ascertainable given the borrower’s current economic status and mortgage market conditions. In the event the terms are unrealistic, seek modification of the same during the attorney approval period.

It is common for the seller to agree to provide a closing cost credit to the purchaser. Pursuant to the disclosure requirements of the Real Estate Settlement Procedures Act, such credits must be disclosed on the HUD-1 Settlement Statement, which is available HUD’s website at http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case sensitive).

PRACTICE POINTER

Despite the fact that the contract calls for the seller to provide a specific credit (either in the form of a percentage of the purchase price or a sum certain), it is ultimately the end lender who dictates the type and amount of the credits allowable on the HUD-1 at closing. A buyer may expect the disallowed portion to be paid outside of closing; however, payments made outside closing are prohibited by RESPA and should be avoided.

V. THE LOAN PROCESS A. Preliminary Considerations 1. [21.32] Type of Loan The initial decision confronting a borrower is the type and amount of loan to apply for. Factors influencing the type of loan include the purpose (owner-occupied versus investment property), the loan-to-value ratio (amount borrowed as compared to the value of property), the borrower’s credit history, the borrower’s current economic condition, how long the borrower intends to remain in the property, the current interest rate market, and the overall availability of credit. Factors influencing the amount of the loan include the purchase price of the property, the amount of the borrower’s down payment, amounts needed to improve or repair the property, sums for payment of any debts the lender requires the borrower to pay, and payment of any loan fees and closing costs. The second decision confronting a borrower is from whom to get the loan. 2. [21.33] Residential Mortgage Licensee In Illinois, a mortgage license is required when in the business of brokering, funding, originating, servicing, or purchasing residential mortgage loans, unless otherwise excepted out. The Residential Mortgage License Act of 1987, 205 ILCS 635/1-1, et seq., is designed to protect

FINANCING §21.34


Illinois consumers seeking residential mortgage loans and to ensure that the residential mortgage lending industry is operating fairly, honestly, efficiently, and free from deceptive and anticompetitive practices; to regulate residential mortgage lending to benefit the citizens of Illinois by ensuring the availability of residential mortgage funding; to benefit responsible providers of residential mortgage loans and services; and to avoid requirements inconsistent with legitimate and responsible business practices in the residential mortgage lending industry. 205 ILCS 635/1-2(b). It specifically provides the following:

No person, partnership, association, corporation or other entity shall engage in the business of brokering, funding, originating, servicing or purchasing of residential mortgage loans without first obtaining a license from the Commissioner in accordance with the licensing procedure provided in this Article I and such regulations as may be promulgated by the Commissioner. 205 ILCS 635/1-3(a).

The Act applies to all entities doing business in Illinois as residential mortgage bankers, existing residential mortgage lenders, or residential mortgage brokers, whether or not previously licensed. 205 ILCS 635/1-3(h). The Act applies to real property located in Illinois “upon which is constructed or intended to be constructed a dwelling.” 205 ILCS 635/1-4(a). A mortgage broker is an intermediary who sources mortgage loans on behalf of individual borrowers. A mortgage broker neither originates nor funds the loan but negotiates a mortgage loan with lenders (also referred to as “investors” or “end lenders”). Brokers are compensated by commissions, paid by the lender but earned as a result of selling a higher interest rate to a borrower, referred to as a “yield spread premium.” A yield spread premium is a payment from the lender to the broker for delivering a loan with an interest rate above a preset “par” rate. The amount of the premium is determined from a rate sheet provided by the lender. The higher the interest rate is above the par (or market rate), the higher the yield spread premium that the broker receives. Watson v. CBSK Financial Group, Inc., No. 01 C 4043, 2002 WL 598521 (N.D.Ill. Apr. 18, 2002). See Johnson v. Matrix Financial Services Corp., 354 Ill.App.3d 684, 820 N.E.2d 1094, 290 Ill.Dec. 27 (1st Dist. 2004). A mortgage banker commonly uses its own source of capital to originate mortgage loans that are then sold to institutional lenders. Banks, via their loan officer employees, originate mortgage loans that are then either held in the bank’s portfolio or sold on the secondary mortgage market. A mortgage broker shall be considered to have created an agency relationship with the borrower in all cases. 205 ILCS 635/5-7(a). A mortgage broker shall act in a borrowers’ best interests and deal with the borrower in good faith. 205 ILCS 635/5-7(a)(1). A mortgage broker must disclose all material facts to a borrower and must use reasonable care in carrying out his or her duties. 205 ILCS 635/5-7(a)(3), 635/5-7(a)(4). 3. [21.34] Preapproval Although not a universal practice, it is common for a buyer to obtain a prequalification or preapproval letter. Preapproval means that the buyer has made an attempt to ensure that the buyer can afford the property and will qualify for a mortgage before an offer is made. It is an opinion by a residential mortgage licensee that is based on the information furnished by the buyer that the



buyer will qualify for a mortgage of a stated amount if the collateral value is sufficient. A preapproval is limited to a buyer’s qualification, based on the buyer’s representations, and is not limited to a particular parcel of property. It is not a commitment by a lender to make a mortgage and should not be relied on by buyer’s counsel as fulfillment of a buyer’s obligation under a contractual financing contingency.

PRACTICE POINTER

A preapproval letter has no legal significance. 4. [21.35] Predatory Lending The term “predatory lending” is not defined by Illinois law but most closely refers to a number of restricted practices for state licensed or chartered residential mortgage brokers and lenders under the High Risk Home Loan Act, 815 ILCS 137/1, et seq., which is commonly referred to as the “Illinois predatory lending law.” This Act, which took effect January 1, 2004, protects borrowers who enter into high-risk home loans from abuses that occur in the credit marketplace. Its express purpose is

to protect borrowers who enter into high risk home loans from abuse that occurs in the credit marketplace when creditors and brokers are not sufficiently regulated in Illinois. This Act is to be construed as a borrower protection statute for all purposes. This Act shall be liberally construed to effectuate its purpose. 815 ILCS 137/5.

It contains a number of consumer-oriented protections designed to prohibit high-cost loans that borrowers cannot afford to pay back. P.A. 93-561, which adopted the High Risk Home Loan Act, also amended §2Z of the Consumer Fraud and Deceptive Business Practices Act (Consumer Fraud Act), 815 ILCS 505/2Z, so that any person who knowingly violates the High Risk Home Loan Act also commits an unlawful practice under the Consumer Fraud Act. Further, P.A. 93-561 amended the Illinois Fairness in Lending Act, 815 ILCS 120/1, et seq., authorizing the Illinois Attorney General to file an action to enjoin any person from violating the Fairness in Lending Act. 5. [21.36] Anti-Predatory Lending Database Program Started as a pilot program, the Anti-Predatory Lending Database Program has been established under §70, et seq., of the Residential Real Property Disclosure Act. 765 ILCS 77/70, et seq. The purpose of the Program, which is administered by the Illinois Department of Financial and Professional Regulation, is to reduce predatory lending practices by assisting the borrower in understanding the terms and conditions of the loan for which he or she has applied. Based on information submitted by the mortgage broker or loan originator, the Department may require the borrower to attend HUD-certified mortgage counseling. 765 ILCS 77/70(c). The broker or originator and the borrower may not take any legally binding action concerning the loan transaction until the later of (a) the Department issuing a determination not to recommend HUD-

FINANCING §21.37


certified counseling for the borrower or (b) the Department issuing a determination that HUD-certified credit counseling is recommended for the borrower and the credit counselor submits all required information for the database in accordance with 765 ILCS 77/70(d). 765 ILCS 77/70(e). The Program began July 1, 2008, in Cook County and July 1, 2010, in Kane, Peoria, and Will Counties. 765 ILCS 77/70(a-5). A completion certificate or a certificate of exemption must be recorded with the mortgage. 765 ILCS 770/70(g). All owner-occupied, one- to four-unit residential property is subject to the Residential Real Property Disclosure Act. 765 ILCS 77/5. Exempt property (not subject to the Act) includes non-owner-occupied property, commercial property, residential property of more than four units, and government property. In addition, reverse mortgages are exempt. 765 ILCS 77/78. Any entity not required to be licensed under the Residential Mortgage License Act, such as banks and other depository financial institutions, as well as certain limited private lenders (such as an individual making a loan to a family member), are exempt from the Program. 765 ILCS 77/70(a). Exempt entities are not required to enter information into the database but must obtain a certificate of exemption from the closing agent to record their mortgages. Loans by these entities may go directly to closing upon approval. If an exempt entity, such as a bank, chooses to close its own loans, it must register as a closer. See the Anti-Predatory Lending Database Program website at www.ilapld.com/overview.aspx. B. Formal Requirements 1. [21.37] Application The first step in obtaining financing is the application process. After selecting a residential mortgage licensee, the borrower completes a mortgage application, e.g., Fannie Mae Form 1003/Freddie Mac Form 65, Uniform Residential Loan Application, www.efanniemae.com/sf/formsdocs/forms/1003.jsp. The loan application requires information from which the lender can make a preliminary credit analysis. However, before a licensee may accept an application or application fee, the licensee must give the borrower a “borrower information document.” This document operates to inform the borrower of the specific information the licensee is required to provide and what information must be available upon borrower’s request. The document states:

This document is being provided to you pursuant to the Residential Mortgage License Act of 1987 and Rules promulgated thereunder (38 Ill. Adm. Code 1050). The purpose of this document is to set forth those exhibits and materials you should receive or be receiving in connection with your residential mortgage loan application with (name of licensee), holder of License (license number) and regulated by the State of Illinois, Division of Banking, under the aforesaid Act. 38 Ill.Admin. Code §1050.1110(a).

The documents included are the federal settlement cost booklet required under the Real Estate Settlement Procedures Act (see §21.38 below), the good-faith estimate of costs required under 12



C.F.R. pt. 226 (see id.), a copy of the Mortgage Escrow Account Act, 765 ILCS 910/1, et seq. (if applicable), and the Federal Reserve Board’s Consumer Handbook on Adjustable-Rate Mortgages as required under 12 C.F.R. §535.33 (if applicable) (see www.federalreserve.gov/pubs/arms/armsbrochure.pdf). 38 Ill.Admin. Code. §§1050.1110(c) – 1050.1110(g). In addition, the following documents must be made available to the borrower upon request: a sample of the form of note and mortgage that will be executed if the loan applied for is approved; a sample copy of the commitment letter; and a general description of the underwriting standards that will be considered in evaluation of the application. 38 Ill.Admin. Code §1050.1110(h). The application entails the submission of a borrower’s financial information in anticipation of a credit decision relating to a mortgage loan. The application itself includes the borrower’s name, the borrower’s monthly income, the borrower’s social security number (for obtaining a credit report), the property address, an estimate of the value of the property, the mortgage loan amount sought, and any other information deemed necessary by the loan originator. The balance of the application package typically consists of a number of documents to be completed by the borrower, which are then submitted to the licensee along with an application fee. The purpose of the application fee is to ensure a borrower is serious about wanting a loan and acts as compensation to the lender in the event the loan is rejected or the borrower walks. Some lenders credit this fee back to the borrower at closing on the HUD-1 Settlement Statement, available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case sensitive). Although paid prior to settlement, it is required to be disclosed by the lender on the HUD-1 and labeled “POC” (paid outside closing). If the application fee is used to pay other fees, such as the cost of the appraisal or credit report, those separate costs should also be disclosed, but a footnote should be used to show that those charges were paid from the application fee. These items likewise should be marked “POC.” The application does not constitute a contract to make a mortgage loan and does not create a fiduciary relationship between the lender and borrower. However, the lender may be liable in a fraud action for misrepresentations as to its actions on, or the status of, the application and may be liable in negligence if the lender fails to process the loan application with due care. High v. McLean Financial Corp., 659 F.Supp. 1561 (D.D.C. 1987). In addition, the borrower may be held criminally liable if the borrower knowingly provides false information in order to influence a lender that has accounts insured by Federal Deposit Insurance Corporation, the Federal Home Loan Bank System, the Farm Credit System Insurance Corporation, or the National Credit Union Administration Board. 18 U.S.C. §1014. The borrower may also be convicted of obtaining money from a bank under false pretenses. 18 U.S.C. §2113(b); United States v. Bradley, 812 F.2d 774 (2d Cir. 1987). 2. [21.38] Good-Faith Estimate In certain residential transactions, a creditor must make a good-faith estimate (GFE) of the costs of the settlement services. The GFE required by the Real Estate Settlement Procedures Act is intended to give borrowers sufficient information to allow them to make informed choices as to providers of settlement services and to avoid surprises at settlement (i.e., closing). The obligation to provide the GFE falls on the lender or the mortgage broker and is to be given to all applicants

FINANCING §21.39


for the loan. The GFE must be provided no later than 3 business days after a mortgage broker or lender receives an application or information sufficient to complete an application. 24 C.F.R. §3500.7(a)(1). The lender cannot charge any fee for an appraisal, inspection, or other settlement service as a condition for providing the GFE; however, the lender may collect a fee equal to the cost of obtaining a credit report. 24 C.F.R. §3500.7(a)(4). The actual charges at settlement may not exceed the amounts included on the GFE. 24 C.F.R. §3500.7(e). Certain “tolerances” for specific costs are allowed (id.), but if changed circumstances affecting the settlement costs exceed the allowable tolerances, then the loan originator must provide a revised GFE within 3 business days of receiving the information. 24 C.F.R. §3500.7(f)(1). If the changed circumstances affect a borrower’s eligibility for a specific loan, the originator likewise must provide a revised GFE within 3 business days of receiving the information. 24 C.F.R. §3500.7(f)(2). If settlement is expected to occur more than 60 calendar days from the time the GFE is provided, the originator may provide an updated GFE to the borrower at any time provided the original GFE contained a clear and conspicuous disclosure statement. If not, a revised GFE may be made only as otherwise provided in 24 C.F.R. §3500.7(f). 24 C.F.R. §3500.7(f)(6). The Department of Housing and Urban Development’s revised Good Faith Estimate form is available at www.hud.gov/offices/hsg/rmra/res/gfestimate.pdf.

PRACTICE POINTER

A revised version of Shopping for Your Home Loan: HUD’s Settlement Cost Booklet (rev. Jan. 6, 2010) is available at www.hud.gov/offices/hsg/ramh/res/settlement-cost-booklet01062010.cfm. This booklet includes a simple, step-by-step, line-by-line explanation of the GFE form that can be used as a valuable learning tool for a practitioner who is unfamiliar with the GFE. Additionally, since the figures disclosed on the GFE transfer to the identical line on the HUD-1 Settlement Statement, http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case sensitive), the practitioner can use this same simple tool to further his or her understanding of the HUD-1.

3. [21.39] Processing Loan processing is the period of time during which the lender evaluates the borrower’s loan application and credit history. The lender will obtain the borrower’s credit report and corresponding credit score. A credit score, developed by FICO (formerly known as Fair Isaac Corporation), is a numerical expression based on a statistical analysis of a person’s credit files, which represents the creditworthiness of that person and the likelihood that the person will pay his or her debts in a timely manner. Credit reporting agencies collect information about consumers and consumers’ credit history from public records, creditors, and other reliable sources. These agencies make consumer credit history available to current and prospective creditors and employers as allowed by law. Credit reporting agencies do not grant or deny credit; they merely supply information. Credit reporting agencies are governed by the Fair Credit Reporting Act (FCRA), 15 U.S.C. §1681, et seq. The FCRA protects consumers from the circulation of inaccurate or obsolete information and ensures that credit reporting agencies



exercise their responsibility fairly and equitably and respect consumers’ right to privacy and confidentiality. 15 U.S.C. §1681. The three main credit reporting agencies are Equifax, Experian, and TransUnion. For an in-depth discussion of the FCRA, see CREDITORS’ RIGHTS IN ILLINOIS, Ch. 7 (IICLE, 2009). 4. [21.40] Underwriting Underwriting is the process during which the lender evaluates the borrower’s financial condition and credit history to determine whether credit will be extended. The lender must ascertain the borrower’s ability to repay the loan and considers factors such as the borrower’s income, reliability of the sources of income, record of making payments on other debts, ratio of income to payments on the loan, payments on other long-term obligations, and payments for property taxes, insurance, and assessments, as well as the borrower’s ability to obtain cash for a down payment and closing costs. In addition, the lender must ascertain a borrower’s willingness to repay the loan and considers such factors as the borrower’s credit history, loan references with other creditors, and history of prior residency and mortgage and/or rental payments. Also considered are information and circumstances or events that could materially and adversely affect either the borrower’s ability or willingness to repay the loan or the value, ownership, or marketability of the security property. In addition to evaluating a borrower’s loan application, the lender evaluates whether the property is sufficient to secure the loan. This is accomplished through a duly licensed appraiser. 5. [21.41] Appraisal An appraisal is a valuation or an estimation of value of property by disinterested persons of suitable qualifications. It is the process of ascertaining a value of an asset or liability that involves expert opinion rather than explicit market transactions. The Real Estate Appraiser Licensing Act of 2002, 225 ILCS 458/1-1, et seq., governs persons engaged in the appraisal of real estate in connection with a “federally related transaction,” which is defined as “any real-estate related financial transaction in which a federal financial institution’s regulatory agency, the Department of Housing and Urban Development, Fannie Mae, Freddie Mac, or the National Credit Union Administration engages in, contracts for, or regulates and requires the services of an appraiser.” 225 ILCS 458/1-10. The cost of the appraisal is borne by the borrower and must be disclosed at closing on the HUD-1 Settlement Statement, which is available at http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case sensitive). The borrower is entitled to a copy of the appraisal, which is delivered prior to or at closing or may be requested by the borrower, in writing, within 90 days post-closing. See Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report, www.efanniemae.com/sf/formsdocs/forms/1004.jsp. 6. [21.42] Commitment and Conditions Once the lender has determined that a borrower is an acceptable credit risk, the lender will issue a conditional loan commitment. The purpose of a conditional commitment is to provide assurance to the borrower that if the conditions of the commitment are satisfied and the lender obtains a valid security interest in the property, the loan will be funded. Borrower and counsel alike should utilize the conditional commitment as a guide to prepare for the closing.

FINANCING §21.44


7. [21.43] Closing the Loan Closing the loan consists of executing the loan documents and disbursing the loan proceeds. This typically occurs at the title company but may occur at either the lender or the seller’s attorney’s office. It is the borrower’s responsibility to understand what he or she is signing. The lender generally owes no duty to a person signing the mortgage documents to explain their contents or the effect of the person’s signature. State Bank of Geneva v. Sorenson, 167 Ill.App.3d 674, 521 N.E.2d 587, 118 Ill.Dec. 305 (2d Dist. 1988). If the borrower executes the note, the mortgage, or any other loan documents without reading them, the borrower is bound by the provisions of the documents, including those that vary from the terms of the commitment or disclosure documents. American Savings Ass’n v. Conrath, 123 Ill.App.3d 140, 462 N.E.2d 849, 78 Ill.Dec. 730 (5th Dist. 1984). The lender may fill in blanks in the note according to the loan commitment if the borrower fails to do so. 810 ILCS 5/3-407; West Chicago State Bank v. Rogers, 162 Ill.App.3d 838, 515 N.E.2d 1261, 113 Ill.Dec. 954 (2d Dist. 1987), appeal denied, 119 Ill.2d 576 (1988). 8. [21.44] Loan Package The bulk of the documents included in a typical loan package consist of standardized forms; however, the terms and conditions will vary according to the specific terms of the loan. At a minimum, every loan package will contain a note, mortgage, and a truth-in-lending disclosure. In addition, a first payment letter and disclosures pertaining to impounds and escrows may be included. Note. The note evidences the indebtedness of the borrower to the lender and is a promise to repay the amount borrowed. It is a binding contract signed by the borrower. The provisions of the note include the borrower’s promise to pay in return for the loan received, the interest rate to be charged on the principal, the time, place, and amount of payments to be made under the note, a statement of the borrower’s right to prepay (and corresponding prepayment penalty, if any), a statement that the charges on the loan shall comply with state law, a statement defining late charges and default in the event of the borrower’s failure to timely pay, a notice provision, a statement of joint and several liability if more than one person executes the note, a waiver of presentment and dishonor, and a statement that the note gives the note holder rights under the note and under the security instrument (i.e., mortgage) executed simultaneously with the note. See Multistate Fixed Rate Note — Single Family — Fannie Mae/Freddie Mac Uniform Instrument Form 3200, www.freddiemac.com/uniform/doc/3200-MultistateFRNote.doc (case sensitive). Mortgage. The mortgage is an interest in land created by written instrument providing security in real estate to secure the payment of a debt. Aames Capital Corp. v. Interstate Bank of Oak Forest, 315 Ill.App.3d 700, 734 N.E.2d 493, 248 Ill.Dec. 565 (2d Dist. 2000). It is recorded in the county where the property is located, creating a lien on the property. The mortgage is the security instrument that governs how and under what conditions the borrower may be required to make immediate payment. The mortgage must specify the events that constitute a default by the borrower since only those events justify acceleration of the mortgage debt and enforcement of the mortgage. Federal National Mortgage Ass’n v. Bryant, 62 Ill.App.3d 25, 378 N.E.2d 333, 18



Ill.Dec. 869 (5th Dist. 1978). Acceleration is permissible if the mortgage and note give the lender the option to declare the entire principal balance of the mortgage loan (plus accrued, unpaid interest) due before the maturity date of the mortgage debt for the borrower’s default. Acceleration clauses are legal and enforceable. Damen Savings & Loan Ass’n v. Heritage Standard Bank & Trust Co., 103 Ill.App.3d 301, 431 N.E.2d 34, 59 Ill.Dec. 15 (2d Dist. 1982); Zalesk v. Wolanski, 281 Ill.App. 54 (1st Dist. 1935). Common events of default include the borrower’s failure to pay the note, property taxes, or assessments; transfer of the property or restoration of the property after it has been damaged or destroyed; and maintaining of insurance policies, among others. See Illinois — Single Family — Fannie Mae/Freddie Mac Uniform Instrument Form 3014, www.freddiemac.com/uniform/doc/3014-IllinoisMortgage.doc (case sensitive). Federal truth-in-lending disclosure statement. The truth-in-lending statement discloses the actual cost of the consumer credit (the finance charge) in terms of dollars and as a percentage (i.e., annual percentage rate). Notice of assignment, sale, or transfer of servicing rights. Pursuant to 24 C.F.R. §3500.21(d), a lender must notify a borrower that the right to collect payments has been assigned. Impounds and escrows. The Mortgage Escrow Account Act, 765 ILCS 910/1, et seq., governs the terms and conditions of the accumulation of funds for payment of property taxes and insurance via an escrow account. A lender may require a borrower to establish an escrow account for payment of property taxes and insurance as a condition of the mortgage loan. 765 ILCS 910/2. Notice of the requirements of the Mortgage Escrow Account Act shall be furnished in writing to the borrower at the date of closing. 765 ILCS 910/11. A mortgage lender must give notice at least annually to the borrower of tax payments made from an escrow account. 765 ILCS 910/15. Mortgage payment letter. Timely payment is the responsibility of the borrower. A typical loan package will include a first payment letter that delineates the components of the payment, consisting of principal, interest, taxes, and insurance, commonly referred to as “PITI.” Notwithstanding the foregoing, a payment may be interest only, may not include tax and/or insurance escrows, and may include mortgage insurance (MI) or private mortgage insurance (PMI), as well. Loan documents will vary among lenders. However, a typical loan package may include a. general and specific closing instructions; b. the loan commitment; c. the note and riders; d. the mortgage; e. the federal truth-in-lending disclosure statement and itemization of amount financed;

FINANCING §21.45


f. the first payment letter and address certification; g. a notice of assignment and sale or transfer of servicing rights; h. notice of the Mortgage Escrow Account Act requirements and initial escrow account

disclosure statement; i. a collateral protection insurance notice, hazard insurance requirements, and tax record

information sheet; j. flood certification; k. the borrower’s certification and authorization; l. IRS Forms W-9, Request for Taxpayer Identification Number and Certification, and

4506-T, Request for Transcript of Tax Return (both of which are available at www.irs.gov), and a request for a copy of the tax return;

m. Fannie Mae Form 1003/Freddie Mac Form 65, Uniform Residential Loan Application,

www.efanniemae.com/sf/formsdocs/forms/1003.jsp; n. the federal Equal Credit Opportunity Act notice; o. the borrower’s certification: false statement/employment/occupancy form; p. name, occupancy, and financial status affidavits; q. the compliance agreement (errors and omissions); r. the customer identification verification and name affidavit; and s. a consumer credit score disclosure and a notice concerning the furnishing of negative

information to consumer reporting agencies. 9. [21.45] Fees Sections 8 – 10 and 12 of the Real Estate Settlement Procedures Act, 12 U.S.C. §§2607 – 2610, regulate the charges that may be charged on loans subject to the Act. Fees included in the application and origination of the loan may include an application fee, origination fee and/or discount points, appraisal fee, credit reporting fees, flood certification fees, tax service fees, underwriting fees, processing fees, document preparation fees, hazard insurance and property tax impounds and escrows, prepaid interest, recording fees, and title insurance fees. The above fees are paid prior to or at closing and are usually deducted from the loan proceeds before distribution to the borrower. Lender charges are delineated on the HUD-1 Settlement Statement, http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case sensitive), at closing in the 800 series titled “Items Payable in Connection with Loan.” Charges



required by the lender to be paid in advance (interest, mortgage insurance premium, hazard insurance premium, or VA funding fee) are delineated in the 900 series, and the reserves to be deposited with the lender (escrows for property taxes and insurance) are delineated in the 1000 series. C. Post-Loan Closing Considerations 1. [21.46] Prepayments Long-term real estate mortgages frequently contain stipulations that payment of the principal debt may be made prior to its due date but that in order to entitle the mortgagor to make such prepayment, he or she must pay the mortgagee an additional sum, which additional payment is termed a “prepayment penalty.” When a borrower desires to prepay the loan, there is no absolute right to do so. As stated in LaSalle National Bank v. Illinois Housing Development Authority, 148 Ill.App.3d 158, 498 N.E.2d 697, 101 Ill.Dec. 373 (1st Dist. 1986), the borrower has no absolute right to prepay a mortgage loan, i.e., to pay all or a portion of the balance of the loan before the date it is due. The right to prepay must be stated in the mortgage to be enforceable. Brenner v. Neu, 28 Ill.App.2d 219, 170 N.E.2d 897 (4th Dist. 1960). The amount and timing of the prepayment may be limited in those instruments. The mortgage should specify whether partial prepayments alter the due date or amount of future installments. Smith v. Renz, 122 Cal.App.2d 535, 265 P.2d 160 (1954). In Illinois, the Notice of Prepayment of Federally Subsidized Mortgage Act, 765 ILCS 925/1, et seq., protects the mortgagor:

It is the purpose of this Act to preserve and retain to the maximum extent practicable, as housing affordable to low and moderate income families or persons, those privately owned dwelling units that were provided for such purposes with federal assistance, to minimize the involuntary displacement of tenants currently residing in such housing, to ensure that the appropriate governmental authorities are given adequate notice to respond to the potential problems created by conversions of subsidized rental units to nonsubsidized rental units and to ensure that the subsidized rental unit occupants are provided with information and assistance, in the event of conversions. 765 ILCS 925/2.

2. [21.47] Escrows and Impounds A borrower is entitled to terminate escrows and assume liability for payment of property taxes and insurance when the loan reaches 65 percent of its original value, as follows:

When the mortgage is reduced to 65% of its original amount by payments of the borrower, timely made according to the provisions of the loan agreement secured by the mortgage, and the borrower is otherwise not in default on the loan agreement, the mortgage lender must notify the borrower that he may terminate such escrow account or that he may elect to continue it until he requests a termination thereof, or until the mortgage is paid in full, whichever occurs first. 765 ILCS 910/5.

FINANCING §21.50


3. [21.48] Termination of Private Mortgage Insurance A borrower may request the termination of private mortgage insurance when the loan reaches 80 percent of the value of the property. A lender shall automatically terminate private mortgage insurance when the loan reaches 78 percent of the value of the property. A lender must notify the mortgagee no less than once a year of whether the insurance may be terminated, the conditions and procedure for termination, and a contact person for the mortgagee to determine whether the insurance may be terminated and the conditions and procedures for termination. 765 ILCS 930/15. 4. [21.49] Payoff and Release A borrower who desires to pay a mortgage loan in full must first obtain a payoff statement as governed by the Mortgage Certificate of Release Act, 765 ILCS 935/1, et seq. A “payoff statement” is a statement for the amount of (a) the unpaid balance of a loan secured by a mortgage, including principal, interest, and any other charges due under or secured by the mortgage; and (b) interest on a per-day basis for the unpaid balance. 765 ILCS 935/5. A borrower who is selling his or her property for less than the payoff amount may consider a short sale. A “short sale” occurs when the lender agrees to write off the portion of a mortgage that is higher than the fair market value of the home, provided there is a willing purchaser. A short sale is the result of a property sale with a value less than the amount owed to the lender. Finally, upon receipt of payment in full, the mortgage shall be released.

Every mortgagee of real property . . . having received full satisfaction and payment of all such sum or sums of money as are really due to him from the mortgagor . . . shall . . . make, execute and deliver to the mortgagor . . . an instrument in writing executed in conformity with the provisions of this section releasing such mortgage . . . which release shall be entitled to be recorded or registered. 765 ILCS 905/2.

The lien release shall be issued within one month after payment in full, or the lender may be liable for damages. 765 ILCS 905/4. Likewise, “[r]eceipt of payment pursuant to the lender’s written payoff statement shall constitute authority to record a certificate of release. A certificate of release shall be delivered for recording to the recorder of each county in which the mortgage is recorded . . . by the title insurance company or its duly appointed agent.” 765 ILCS 935/10. VI. [21.50] STATE AND FEDERAL REGULATION OF THE MORTGAGE

INDUSTRY Local real estate law, a blend of state and federal statutory law, and common law regulate real estate lending. The law represents a balance of rights between borrower and lender that has taken centuries to evolve.



A. [21.51] Federal Regulation The Consumer Credit Protection Act, 15 U.S.C. §1601, et seq., is the controlling piece of federal legislation regulating the manner in which lenders approve or disapprove residential mortgage loans. The regulation covers not only access to credit and control of the dissemination of credit information but also the information required to be disclosed to the borrower and the manner of this disclosure. The Consumer Credit Protection Act includes, among others, the Truth in Lending Act (Title I), the Fair Credit Reporting Act (Title III), and the Equal Credit Opportunity Act (Title VIII). See §§21.52 – 21.54 below. Other federal legislation regulating residential mortgage loans includes the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, and the Housing and Economic Recovery Act of 2008. See §§21.55 – 21.57 below. 1. [21.52] Truth in Lending Act Title I of the Consumer Credit Protection Act is commonly known as the Truth in Lending Act, 15 U.S.C. §1601, et seq. TILA, implemented through Regulation Z, 12 C.F.R. pt. 226, issued by the Federal Reserve Board, is a disclosure statute that requires that creditors provide specific information to consumers in a uniform, accurate, and meaningful manner so as to ensure that consumers can make informed choices. TILA covers any consumer credit transaction in which (a) credit is extended to a natural person, not a corporation, partnership, government, or other entity; (b) credit is extended by one who regularly extends consumer credit; (c) the extension of credit is primarily for personal, family, or household purposes; (d) the extension of credit is subject to a finance charge or repayable in more than four installments; and (e) the extension of credit is for $25,000 or less, unless it is secured by real estate or personal property used as the consumer’s principal dwelling, in which case no limit applies. 15 U.S.C. §1602; 12 C.F.R. §§226.1(c), 226.3(b). There is a specific requirement for timing of disclosures in residential mortgage transactions that apply when a mortgage or other consensual security interest is created or retained in the consumer’s principal dwelling. 12 C.F.R. §226.19. TILA requires two types of disclosure: (a) disclosures of certain basic information in all credit transactions and (b) disclosures that in form and content are dependent on the type of transaction. The former disclosures are encompassed in a general requirement to set forth the finance charge and annual percentage rate of that charge. The disclosures of the finance charge and the APR are the essence of TILA because they represent the actual cost of consumer credit — the finance charge as the dollar amount and the APR as a yearly percentage rate. 15 U.S.C. §§1605 and 1606 control what shall be included in the finance charge and how the annual percentage rate shall be computed. When the creditor is required to disclose the finance charge and the annual percentage rate with a corresponding amount or percentage, they must appear more conspicuously than any other disclosures except the creditor’s identification. 15 U.S.C. §1632; 12 C.F.R. §226.17(a)(2). TILA defines “finance charge” as “the sum of all charges, payable directly or indirectly by the person to whom the credit is extended, and imposed directly or indirectly by the creditor as an incident to the extension of credit.” 15 U.S.C. §1605(a).

FINANCING §21.55


See 12 C.F.R. §226.4. The finance charge is the cost of credit to the consumer and must be measured in those terms. TILA specifies those charges that shall be included in the calculation of the finance charge as well as those charges that are excluded. 15 U.S.C. §1605(a); 12 C.F.R. §§226.4(b), 226.4(c). Likewise, the APR must be disclosed. The APR is the measure of the cost of credit that relates the amount of credit, the finance charge, and the timing and amounts of payments to be made by the consumer. For an in-depth discussion of TILA, see CREDITORS’ RIGHTS IN ILLINOIS, Ch. 7 (IICLE, 2009). 2. [21.53] Fair Credit Reporting Act The Fair Credit Reporting Act, 15 U.S.C. §1681, et seq., applies to consumer reporting agencies that issue consumer reports to users. See 15 U.S.C. §1681 (addressing applicant privacy during the transaction, placing substantial limitations on access to applicant information, and requiring notice to the applicant when additional information is to be obtained). Its purpose is to protect consumers from the circulation of inaccurate or obsolete information and to ensure that the consumer reporting agencies exercise their responsibilities in a manner that is fair and equitable to consumers and that respects their right to privacy and confidentiality. Id. It extends only to consumer’s eligibility for personal credit and not to the consumer’s business transactions. Matthews v. Worthen Bank & Trust Co., 741 F.2d 217 (8th Cir. 1984). 3. [21.54] Equal Credit Opportunity Act The Equal Credit Opportunity Act (ECOA), 15 U.S.C. §1691, et seq., mandates that lenders must evaluate applicants based on creditworthiness only and not on factors that do not affect their ability to repay the debt. The ECOA expressly prohibits a lender from rejecting applicants based on a number of protected bases (race, color, religion, national origin, age, sex, and marital status) and is intended to ensure that illegal discrimination does not otherwise prevent creditworthy applicants from applying. The ECOA applies to both the application process and the evaluation process and further prohibits lenders from requesting certain information during the application process on the theory that if a lender does not obtain prohibited information, it cannot be used to discriminate when the credit decision is made. The ECOA and the regulations issued thereunder require lenders to notify prospective borrowers within 30 days after the creditor’s receipt of a completed application of any adverse action and the reasons therefore. “Adverse action” is defined as a “denial or revocation of credit, a change in the terms of an existing credit arrangement, or a refusal to grant credit in substantially the amount or on substantially the terms requested.” 15 U.S.C. §1691(d)(6). 4. [21.55] Real Estate Settlement Procedures Act The Real Estate Settlement Procedures Act of 1974, 12 U.S.C. §2601, et seq., was enacted to enable consumers to better understand, through disclosure, the home purchase and settlement process and the costs associated with settlement. Its requirements are implemented through Regulation X, 24 C.F.R. pt. 3500, issued by the Department of Housing and Urban Development. RESPA applies to all federally related mortgage loans unless otherwise excepted. 24 C.F.R. §3500.5(a). RESPA requires disclosures in the form of the special information booklet at the time of application for a loan, the good-faith estimate of settlement services given within three days of



receipt of the loan application, the one-day advance inspection of the HUD-1 Settlement Statement (at the borrower’s option), and the Settlement Statement itself, http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case sensitive), which is delivered at or before settlement. RESPA also contains additional regulatory provisions such as a prohibition against referral fees or unearned fees, a prohibition against requiring use of a specific title company, and limitations on payments to escrow accounts. RESPA applies when there is an application for a federally related mortgage loan, which encompasses a loan (a) secured by a first or subordinate lien, (b) on residential property containing a one- to four-family structure, when (c) the lender is a federally related lender or a creditor under the Consumer Credit Protection Act or the loan is federally related. Since RESPA is aimed at protecting consumers, its reach extends only to residential property designed for occupancy by one to four families. The term “federally related lender” is broad in its coverage. It encompasses a lender whose accounts are insured by any federal agency or that is regulated in any way by the federal government. The term “creditor” under the Consumer Credit Protection Act is similarly broad. It means a creditor who regularly extends consumer credit payable in more than four installments or for which a finance charge is paid. 15 U.S.C. §1602(f). Finally, the term “federally related mortgage loan” includes loans made, insured, guaranteed, or assisted in any way by the federal government or those intended to be sold to Fannie Mae, Ginnie Mae, or Freddie Mac. 12 U.S.C. §2602(1). RESPA, originally passed in 1974, is a derivative legislative result of the Emergency Home Finance Act of 1970, Pub.L. No. 91-351, 84 Stat. 450, which required the Secretary of HUD and the Administrator of Veterans Affairs to “prescribe standards” for settlement costs that may be incurred in connection with Federal Housing Authority and VA-insured loans. Standards were proposed to Congress that led to additional consideration and debate and failed legislation for purposes of regulating settlement costs. RESPA, when initially passed, was intended to enable consumers to understand better the home purchase and settlement process and, when possible, to bring about a reduction in settlement costs. As time progressed, new complaints led to new legislation, resulting in a host of amendments to the original legislation. It is the filing of an application for a federally related mortgage loan that triggers RESPA disclosure requirements. 5. [21.56] Home Mortgage Disclosure Act The Home Mortgage Disclosure Act of 1975 (HMDA), 12 U.S.C. §2801, et seq., requires public disclosure of loans originated to ensure lending institutions are not guilty of disinvestments toward certain communities. The Act is implemented through Regulation C, 12 C.F.R. pt. 203, issued by the Federal Reserve Board. HMDA requires compilation and annual reporting of lending activity regarding home purchase and home improvement loans. The lending institution is required to maintain a register of all loans for which application is made and final action on such applications, as well as all loans purchased. The register is submitted to the applicable regulatory agencies. It is also available for inspection by the public. The institution is also required to make its loan data disclosure statement, prepared by the Federal Financial Institutions Examination Council, available to the public.

FINANCING §21.57


HMDA’s obligations are imposed on “depository institutions.” However, the definition of this term is broad. It includes any bank or savings association and any other person “engaged for profit in the business of mortgage lending.” 12 U.S.C. §2802(4). Regulation C does, however, exempt certain institutions based on size. The Act requires compilation and disclosure of information on “mortgage loans” to purchase or improve residential real property. Regulation C uses the terms “home purchase loans” and “home improvement loans” to describe the covered transactions. It defines “home purchase loan” as any loan secured by or made for the purpose of purchasing a “dwelling.” 12 C.F.R. §203.2(h). It also defines “home improvement loan” as one for repairing, rehabilitating, remodeling, or improving a “dwelling” or the real property on which it is located. 12 C.F.R. §203.2(g). The term “dwelling,” in turn, is defined as a “residential structure.” 12 C.F.R. §203.2(d). The definition goes on to state explicitly that individual condominium units and individual cooperative units are included within the term “dwelling.” Id. Obviously, commercial units, e.g., medical offices, do not fall within the term. It is not clear if residential units purchased but leased to third parties for their residential occupancy fall within the term. However, staff commentary to Regulation C states that such rental property does fall within the term “dwelling.” 12 C.F.R. pt. 203, supp. I, Section 203.2, 2(d) Dwelling. Time-share interests are also difficult to classify, since the term “dwelling” and the phrase “residential structure” do not usually connote short-term occupancy for leisure purposes. However, the staff commentary to Regulation C states that the term “dwelling” is not limited to the principal or other residence of the loan applicant or borrower and that vacation or second homes fall within the term. Only recreational vehicles such as boats or campers are expressly excluded. Id. 6. [21.57] Housing and Economic Recovery Act The Housing and Economic Recovery Act of 2008, Pub.L. No. 110-289, 122 Stat. 2654, was enacted July 30, 2008, and provides the authority for the government’s takeover of the government-sponsored enterprises. HERA created a new GSE regulator, the Federal Housing Finance Agency (FHFA), with authority to take control of either GSE to restore it to a sound financial condition. According to the FHFA website, www.fhfa.gov, the FHFA was created when President George W. Bush signed into law the Housing and Economic Recovery Act of 2008:

The Act created a world-class, empowered regulator with all of the authorities necessary to oversee vital components of our country’s secondary mortgage markets — Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. In addition, this law combined the staffs of the Office of Federal Housing Enterprise Oversight (OFHEO), the Federal Housing Finance Board (FHFB), and the GSE mission office at the Department of Housing and Urban Development (HUD). With a very turbulent market facing our nation, the strengthening of the regulatory and supervisory oversight of the 14 housing-related GSEs is imperative. The establishment of FHFA will promote a stronger, safer U.S. housing finance system. As of June 2008, the combined debt and obligations of these GSEs totaled $6.6 trillion, exceeding the total publicly held debt of the USA by $1.3 trillion. The GSEs also purchased or guaranteed 84% of new mortgages. Considering the impact of these GSEs on the U.S. economy and mortgage market, it is critical that we intensify our focus on oversight of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. See About FHFA, www.fhfa.gov/Default.aspx?page=4 (case sensitive).



B. [21.58] State Regulation The following acts regulate real estate lending in Illinois and are discussed in this chapter. For the Residential Mortgage License Act of 1987, see §21.33 above. For the Notice of Prepayment of Federally Subsidized Mortgage Act, see §21.46 above. For the Mortgage Insurance Limitation and Notification Act, see §21.28 above. For the Mortgage Certificate of Release Act, see §21.49 above. For the Illinois Fairness in Lending Act, the High Risk Home Loan Act, and the Consumer Fraud and Deceptive Business Practices Act, see §21.35 above. Other acts that regulate real estate lending in Illinois but that are not discussed in this chapter are briefly outlined below. The Mortgage Act, 765 ILCS 905/0.01, et seq., provides that

[e]very mortgagee of real property . . . having received full satisfaction and payment of all such sum or sums of money as are really due to him from the mortgagor . . . shall, at the request of the mortgagor . . . make, execute and deliver to the mortgagor . . . a deed of trust in the nature of a mortgage . . . an instrument in writing . . . releasing such mortgage . . . which release shall be entitled to be recorded or registered and the recorder or registrar upon receipt of such a release and the payment of the recording fee therefor shall record or register the same. 765 ILCS 905/2.

The Mortgage Escrow Account Act, 765 ILCS 910/1, et seq., “regulate[s] certain practices of mortgage lenders in the administration of escrow accounts.” P.A. 79-625. The Mortgage Payment Statement Act, 765 ILCS 920/0.01, et seq., relates to “periodic payments with respect to real estate mortgages, trust deeds, and contracts for deed.” P.A. 86-1324. Effective January 1, 2010, §26 of the Title Insurance Act provides that a title insurance company, title insurance agent, or independent escrowee shall not make disbursements in connection with any escrows, settlements, or closings out of a fiduciary trust account or accounts unless the funds in the aggregate amount of $50,000 or greater received from any single party to the transaction are “good funds” as defined by the statute and are unconditionally held by and credited to the fiduciary trust account of the title insurance company, title insurance agent, or independent escrowee. 215 ILCS 155/26. This is commonly referred to as the “Good Funds Law.” Under the statute, the following funds are considered “good funds” as defined under 215 ILCS 155/26(c):

(1) lawful money of the United States; (2) wired funds unconditionally held by and credited to the fiduciary trust account . . . ;

FINANCING §21.59


(3) cashier’s checks, certified checks, bank money orders, official bank checks, or teller’s checks drawn on or issued by a financial institution chartered under the laws of any state or the United States . . . ; (4) a personal check or checks in an aggregate amount not exceeding $5,000 per closing, provided that the . . . escrowee has reasonable grounds to believe that sufficient funds are available for withdrawal in the account upon which the check is drawn at the time of disbursement; (5) a check drawn on the trust account of any lawyer or real estate broker licensed under the laws of any state, provided that the . . . escrowee has reasonable grounds to believe that sufficient funds are available for withdrawal in the account upon which the check is drawn at the time of disbursement; (6) a check issued by [the State of Illinois], the United States, or a political subdivision of this State or the United States; or (7) a check drawn on the fiduciary trust account of a title insurance company or title insurance agent, provided that the . . . escrowee has reasonable grounds to believe that sufficient funds are available for withdrawal in the account upon which the check is drawn at the time of disbursement.

If “good funds” are not provided as set out above, then the funds must be “collected funds” as defined in 215 ILCS 155/26(d). “Collected funds” means funds deposited, finally settled, and credited to the title insurance company, title insurance agent, or independent escrowee’s fiduciary trust account. Id. These good funds guidelines are a minimum of what is required by law for funding in the State of Illinois. Requiring funds to be tendered electronically reduces the risk but does not completely eliminate the risk that the funds are uncollectible. VII. [21.59] DISTRESSED REAL ESTATE SELLERS The 2008 recession has impacted real property owners from all walks of life. Not only has the subprime mortgage market led to an abundance of foreclosures, but unemployment and the decline in residential real property values have left many responsible homeowners either upside down (loan exceeds value of property) and/or otherwise unable to meet their monthly mortgage debt. The result is an increase in mortgage defaults on all types of homes in all areas of the country. Although much can be written on this topic, this paragraph is intended to inform the reader that resources for rescue exist. Before a distressed seller concedes to the inevitable judicial foreclosure, counsel should explore alternatives that may allow the client to remain in his or her property. In the alternative, if the client cannot remain in his or her property, options exist that may result in a lesser impact on the client’s credit score. These options, and other issues related to distressed sellers, are discussed in §§21.60 – 21.64 below.



A. [21.60] Loan Modification A loan or mortgage modification is a process whereby the mortgagee (lender) agrees to permanently change one or more of the terms of a mortgage loan (interest rate, term, principal) resulting in a payment the mortgagor (borrower) can afford. This allows the borrower to remain in his or her property provided continual, timely payments are made. A borrower should consult with his or her mortgagee to obtain a modification. Notwithstanding the foregoing, the government also plays a role. The Home Affordable Modification Program (HAMP) is the result of a $75 billion dollar federal program established in February 2009 to help responsible homeowners avoid foreclosure by providing affordable and sustainable loans. For details on HAMP, visit www.makinghomeaffordable.gov. B. [21.61] Short Sale A short sale occurs when a property is sold for less than the seller (borrower) owes on his or her outstanding mortgage. This is also referred to as a short payoff. The difference between the outstanding mortgage debt and the short payoff is called the deficiency. The borrower remains liable for the deficiency unless negotiated otherwise. A lender may forgive the deficiency, settle for a reduced one-time lump sum payment, or require that the borrower execute a new note for the deficiency to be paid over a period of time. In order to initiate a short sale, the borrower, individually or through his or her attorney, must contact the mortgagee’s loss mitigation department and obtain the specific procedures for submission and negotiation. Procedures differ by lender both in documents required and means of submission (some require fax submissions, while others, such as the Bank of America, require submissions via Equator, a Internet-based short-sale system). However, all require one complete short-sale package be submitted in lieu of sending documents piecemeal. At a minimum, the short-sale submission must include the following: (1) a written offer to purchase or a contract with a short-sale addendum; (2) a listing agreement; (3) the borrower’s recent pay stubs; (4) the borrower’s recent bank statements; (5) a financial affidavit disclosing the borrower’s income and liabilities; (5) a hardship letter from the borrower; (6) the borrower’s prior year tax return; and (7) a preliminary HUD-1 Settlement Statement, showing all closing costs and net proceeds to be sent to the mortgagee. (The Settlement Statement is available at HUD’s website, http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case sensitive).) If the borrower is having a third party negotiate the short sale, the borrower must execute an authorization for the negotiator to talk to the third party. Once the complete short-sale package is submitted, the mortgagee will assign a negotiator. The negotiator will review the package for completeness, request additional documentation if needed, order a broker price opinion (BPO), and evaluate the short-sale request, which may include eliminating or reducing certain closing costs. That is, the mortgagee may agree to the short-sale request but not agree to pay for unnecessary expenses, including but not limited to a termite inspection, survey, municipal transfer taxes, delinquent association dues, excessive broker commission, and/or attorneys’ fees, and challenge the real estate tax proration credits. It is critical that the borrower discuss the deficiency with the negotiator. Specifically, will the mortgagee require the borrower to execute an unsecured note at closing for the deficiency amount? Will the mortgagee forgive the deficiency, potentially resulting in a taxable event to the borrower? Or will the mortgagee agree to settle the

FINANCING §21.63


deficiency for a lump-sum payment of a lesser amount at closing? Counsel should explore the potential deficiency issues with the client. If the client is unwilling to execute a promissory note, counsel should modify the contract, allowing the seller a right to terminate if the mortgagee requires the seller to sign a promissory note. Once the short sale has been agreed to, the mortgagee will issue a payoff letter. The letter will mandate that the final figures on the preliminary HUD-1 Settlement Statement cannot change and that the closing and payoff occur by a certain date. If the closing does not timely occur, the payoff letter will expire. Finally, when a seller has multiple mortgage liens, all lienholders must consent to the short sale and agree to release their liens. Usually, the junior lienholder is paid a nominal amount to release its lien.

PRACTICE POINTER

When representing a seller in a short-sale transaction, counsel should confirm that the contract includes a short-sale provision making the seller’s performance contingent upon approval from the seller’s mortgage holder. This provision is included in some form contracts, but not all. Thus, counsel must modify the contract via the attorney modification provision to adequately protect his or her client.

C. [21.62] Deed in Lieu of Foreclosure The mortgagor and mortgagee may agree on a termination of the mortgagor’s interest in the mortgaged real estate after a default by a mortgagor. Any mortgagee or mortgagee’s nominee may accept a deed from the mortgagor in lieu of foreclosure subject to any other claims or liens affecting the real estate. Acceptance of a deed in lieu of foreclosure shall relieve from personal liability all persons who may owe payment or the performance of other obligations secured by the mortgage, including guarantors of such indebtedness or obligations, except to the extent a person agrees not to be relieved in an instrument executed contemporaneously. A deed in lieu of foreclosure, whether to the mortgagee or mortgagee’s nominee, shall not effect a merger of the mortgagee’s interest as mortgagee and the mortgagee’s interest derived from the deed in lieu of foreclosure. The mere tender of an executed deed by the mortgagor or the recording of a deed by the mortgagor to the mortgagee shall not constitute acceptance by the mortgagee of a deed in lieu of foreclosure. 735 ILCS 5/15-1401. D. [21.63] Income Tax Consequence Generally, if a consumer borrows money from a commercial lender and the lender later cancels or forgives the debt, the consumer may have to include the cancelled amount in income for tax purposes, depending on the circumstances. An obligation that is subsequently forgiven is reportable as income because the consumer no longer has an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to the IRS on Form 1099-C, Cancellation of Debt. See www.irs.gov for a sample Form 1099-C. However, cancellation of debt is not always taxable. The Mortgage Forgiveness Debt Relief Act of 2007, Pub.L. No. 110-142, 121 Stat. 1803, generally allows taxpayers to exclude income from the discharge of debt on their principal



residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for this relief. This provision applies to debt forgiven in calendar years 2007 – 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition. The amount excluded reduces the taxpayer’s cost basis in the home. Further information, including detailed examples, can be found in IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

PRACTICE POINTER

Unless counsel is a CPA, a client should be advised to seek tax advice from his or her CPA prior to choosing a loan modification, short sale, or deed in lieu of foreclosure.

E. [21.64] Impact on Credit Scores Foreclosures, short sales, mortgage modifications, and deeds in lieu of foreclosure each have different effects on credit. Exactly how each affects credit depends on credit history as well as how the lender reports the situation to the credit bureaus. There is no credit score advantage to a short sale or deed in lieu over a foreclosure. However, if a borrower is reapplying for a loan, under Fannie Mae’s updated underwriting guidelines for new mortgage applications for individuals with various types of foreclosure history on their credit, short sales have only a two-year waiting period with no additional requirements. With a foreclosure on a credit record, a borrower must wait five years in order to get new funding and is subject to additional credit and down payment requirements for five to seven years. Deeds in lieu warrant a four-year wait, with additional requirements for four to seven years. See, e.g., Fannie Mae Announcement SEL-2010-05, Underwriting Borrowers with a Prior Preforeclosure Sale or Deed-in-Lieu of Foreclosure (Apr. 14, 2010), www.efanniemae.com/sf/guides/ssg/annltrs/pdf/2010/sel1005.pdf. So short sales and mortgage modifications will enable the borrower to purchase another home within a shorter period of time than if there is a foreclosure or deed in lieu of foreclosure on the credit report history or a bankruptcy. A mortgage modification has far less adverse credit implications than a foreclosure or short sale. It is to a borrower’s advantage to choose a mortgage modification to help save his or her home and credit if in a financial position to make the new, adjusted monthly payment.

FINANCING §21.66


VII. APPENDIX — FORMS A. [21.65] Sample Note FORM(S) AVAILABLE BY PURCHASING HANDBOOK OR BY SUBSCRIBING TO SMARTBOOKS® OR SMARTBOOKSPLUS. B. [21.66] Sample Security Instrument (Mortgage) FORM(S) AVAILABLE BY PURCHASING HANDBOOK OR BY SUBSCRIBING TO SMARTBOOKS® OR SMARTBOOKSPLUS.

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