Real Estate Finance: Practice Questions & Explanations

A wraparound mortgage is a creative financing arrangement where the buyer takes ownership but the seller continues to be liable on the underlying first mortgage. Structure: (1) Seller owns property with an existing first mortgage of, say, $200,000 at 4% interest; (2) Seller sells to buyer for $350,000 with a wraparound mortgage of $300,000 at 5%; (3) Buyer makes payments to seller on the $300,000 wraparound at 5%; (4) Seller continues making payments to the original lender on the $200,000 first mortgage at 4%; (5) Seller pockets the spread (interest on the difference). Used when: existing mortgage has a below-market rate; existing mortgage prohibits assumption; buyer cannot qualify for conventional financing. Risks: (1) Due-on-sale clause — most modern mortgages have a clause that lets the lender call the loan if the property is sold, which the wraparound may trigger; (2) If seller stops paying the underlying mortgage, the lender forecloses and buyer loses the property despite making payments; (3) Complex legal and tax issues. Less common today because of due-on-sale clauses and stricter lending; still occasionally used in commercial transactions and seller financing.

Two distinct ways a buyer can take property with existing mortgage debt. Assumption: the buyer formally assumes the loan with the lender's approval. The buyer becomes personally liable; the seller is typically released from liability through a 'novation.' Lender qualifies the buyer (income, credit). The buyer takes title with the loan now in their name. Common with VA, FHA, and USDA loans (which are often assumable); rare with conventional loans (which usually have due-on-sale clauses prohibiting assumption). Subject To: the buyer takes title and makes payments on the existing mortgage, but the loan remains in the seller's name. No lender approval is sought (or obtained). Seller remains primarily liable to the lender. Buyer has no formal relationship with the lender. Risk for seller: if buyer stops paying, seller's credit is damaged and lender will pursue seller. Risk for buyer: due-on-sale clause may trigger if discovered, forcing immediate repayment. Risk for lender: their underwriting is circumvented. Subject to is legal but legally and ethically risky — most professionals avoid it. Assumption is preferable when available because all parties have clear legal positions.

RESPA (Real Estate Settlement Procedures Act of 1974) regulates settlement services in residential real estate transactions financed by federally-related mortgages. Key prohibitions: (1) Section 8(a) — payment of kickbacks or referral fees in exchange for referrals of settlement services (title insurance, mortgage services, escrow, home warranty, surveys, appraisals, pest inspection); (2) Section 8(b) — fee-splitting where no actual services are rendered (paying someone for a referral and labeling it a 'fee'); (3) Section 9 — sellers cannot require buyers to use a specific title insurance company. Disclosure requirements: (1) Loan Estimate within 3 business days of mortgage application; (2) Closing Disclosure at least 3 business days before closing; (3) Affiliated Business Arrangement disclosure if the broker has financial interest in any settlement service provider being recommended. Penalties: criminal fines up to $10,000 and 1 year imprisonment; civil penalties up to 3x the amount of fees; CFPB enforcement. Practical impact: brokers must be careful about gifts, marketing arrangements, and joint ventures with lenders, title companies, etc. Some 'marketing' arrangements may be prohibited referral fees in disguise.

Both mortgages and deeds of trust serve the same function — creating a security interest in real estate to secure a loan — but differ in structure and foreclosure process. Mortgage: two parties — borrower (mortgagor) gives a security interest to the lender (mortgagee). On default, lender must use judicial foreclosure (court process) to take the property. Judicial foreclosure can take 6-24 months and is expensive. Some states have non-judicial foreclosure available for mortgages. Common in: New York, Florida, New Jersey, Illinois, and other 'mortgage states.' Deed of Trust: three parties — borrower grants the property in trust to a trustee (neutral third party, often title company), to be held for the benefit of the lender (beneficiary). On default, the trustee can foreclose non-judicially (typically through notice and sale procedure) — faster (often 90-180 days), less expensive, no court involvement. Common in: California, Texas, Virginia, Arizona, and other 'deed of trust states.' Functionally similar for borrowers: same loan terms, same payments, similar recordation. Differences become important during default and foreclosure. Some states use both. Knowing which instrument applies in the state of transaction is essential for advising clients on consequences of default.

The loan-to-value ratio is the loan amount divided by the lesser of the property's appraised value or sale price, expressed as a percentage. For example, a $240,000 loan on a $300,000 home is an 80% LTV. LTV matters because it reflects how much equity the borrower has and therefore the lender's risk: a high LTV (small down payment) leaves the lender more exposed if the borrower defaults and the property must be sold, which is why high-LTV loans often require private mortgage insurance. Brokers and agents should understand LTV because it affects loan approval, down-payment requirements, and the financing advice clients receive.

The note (interest) rate is the percentage charged on the loan's principal balance and determines the base interest portion of the payment. The annual percentage rate (APR) is a broader figure required by the Truth in Lending Act that includes the interest rate plus certain finance charges and fees (such as some origination or mortgage-insurance costs) expressed as a yearly rate, so borrowers can compare the true cost of competing loans. Because APR folds in additional costs, it is usually slightly higher than the note rate. Brokers and agents should understand the distinction so they can help clients compare loan offers and so advertising of rates is accurate.