Real Estate Terms

Ownership Instruments

Mortgage

A mortgage is a loan to finance the purchase of real estate, usually with specified payment periods and interest rates. The borrower gives the lender a lien on the property as collateral for the loan, giving the lender the right to take possession of the property if the loan is not repaid.

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Deed of Trust

A Deed of Trust transfers title of land to a “trustee”, usually a trust or title company, which holds the land as security for a loan. When the loan is paid off, title is transferred to the borrower. The trustee has no powers unless the borrower defaults on the loan; then the trustee can sell the property and pay the lender back from the proceeds, without first going to court. After the property has been sold on the courthouse steps, there may be a right of redemption, especially for homeowners.

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Mortgage vs. Trust Deed

• The basic difference between the mortgage as a security instrument and a Deed of Trust is that, in a Deed of Trust, there are three parties involved: the borrower, the lender, and a trustee. In a mortgage document, there are only two parties involved: the borrower and the lender. In a Deed of Trust, the borrower conveys title to a trustee who will hold title to the property for the benefit of the lender. The title remains in trust until the loan is paid.
• Often a title company, escrow company, or bank is listed as the trustee on the Deed of Trust. When the loan has been paid, the trustee will issue a release deed or trustee’s Reconveyance Deed. This deed of Reconveyance should be recorded at the county recorder’s office, to make public notice that the loan has been paid off and that the lender’s interest in the property has ended. Occasionally, the recording of a Reconveyance deed is forgotten. Typically, this is discovered when the property is sold.

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General Warranty Deed

The seller or grantor conveys the property with certain covenants or warranties. The grantor is legally bound by thee warranties. Whether expressly written into the deed or implied by certain statutory words, basic warranties include:

• Covenant of Seisin: Seisin means possession, and the grantor warrants that they own the property and have the legal right to convey it. (Seisin is the possession of such an estate in land as was anciently thought worthy to be held by a free man. Source: Wikipedia)
• Covenant Against Encumbrances: The grantor warrants that the property is free of any liens or encumbrances, unless they’re specifically stated in the deed.
• Covenant of Quiet Enjoyment: The buyer is guaranteed that the title will be good against third parties attempting to establish title to the property.
• Covenant of Further Assurance: The grantor promises, in order to make the title good, that they will deliver any document or instrument necessary.

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Statutory Warranty Deed

The statutory warranty deed is not nearly as protective of the buyer as is the general warranty deed. The grantor of a statutory warranty deed conveys the property with only two warranties:

• The grantor warrants that they have received title.
• The grantor warrants that, unless noted specifically in the deed, the property was not encumbered during their period of ownership.

The grantor of the statutory warranty deed, in effect, only warrants the title against their own actions or omissions. They warrant nothing prior to their taking title. If specifically stated in the deed, other warranties can be conveyed. Statutory warranty deeds are frequently used by executors and trustees. For obvious reasons, most transfers are accomplished using the statutory warranty deed.

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Quit Claim Deed

The quit claim deed is the least protective deed for the buyer. Basically, it only conveys whatever rights or interests the grantor has in the property. It provides no warranties or covenants to the buyer. If the grantor has good title, the quit claim deed is as effective as a general warranty deed, but with none of the guarantees. Quit claim deeds are frequently used to cure defects in the title and are also frequently used to transfer property between family members.

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Bargain and Sale Deed

This deed does not warrant against any encumbrances. It does imply that the grantor holds title to the property. Since it does not warrant good title from the grantor, the grantee could be in trouble if title defects appear at a later date. This type of deed is frequently used in tax sales and foreclosure actions. As with the statutory warranty deed, other warranties can be conveyed in a bargain and sale deed, if they are specifically stated.

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Financing Terms

Types of Prepayment Penalties

Step-Down Penalty

This is a gradually declining penalty over the term of the loan. For example, a ten-year term might look like the following: 5-5-4-3-2-1-1-0-0-0. Therefore, if you pay the loan off during the third year, you will be required to pay a penalty fee equivalent to 4% of the remaining loan balance.

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Yield Maintenance Penalty

This type of prepayment penalty protects the lender against a decline in interest rates. In an environment where interest rates are declining, borrowers typically try to refinance their loans to reduce the interest rate on their debt.

If the loan is paid off early at a lower interest rate than when the original loan was closed, the lender loses a high-yielding investment and gets, in return, a lower rate of return on it. To reduce the effect of an early payoff, lenders often require that the borrower provide compensation, called yield maintenance.

The yield maintenance prepayment penalty calculates the net present value of the remaining interest due on the loan, to the end of the prepayment period. The loan payoff discount rate would be the difference between the new interest rate and the original mortgage’s interest rate. The difference between the two cash flows for the remaining of the balance of the original loan term, discounted to the present, is the yield maintenance prepayment penalty.

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Defeasance

Defeasance is the substitution of the current collateral (the property) with U.S. Treasuries that exactly mimic the stream of payments promised at the origination of the loan. The borrower’s property is released in exchange for this new collateral.

If Treasury rates rise above the original mortgage rate, the borrower benefits from this, because the price of Treasuries will fall and the borrower will be able to set up a portfolio that mimics the original cash flows at a lower price than the amount that would have had to be repaid.

With yield maintenance, the note is paid off. But with defeasance, the note continues to term. Defeasance does not change anything about the cash inflows to the lender. While yield maintenance penalizes the lender when Treasury rates fall, fluctuations in the Treasury rates do not affect the lender using defeasance.

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Recourse Loans

Recourse loans give lenders the right, in the event of default by a borrower, to recover against the personal assets of a party who is secondarily liable for the debt (e.g., and endorser or grantor).

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Non-Recourse Loans

These kinds of loans bar a lender from seeking a deficiency judgment against a borrower in the event of default. The borrower is not personally liable if the value of the collateral for the loan falls below the amount required to repay the loan.

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Securitization

This is a structured finance process, which involves pooling and repackaging of cash flow, producing financial assets into securities that are then sold to investors. In its most basic form, it's a method of selling assets. Rahter than selling those assets "whole", the assets are combined into a pool, and then that pool is split into shares. Those shares are sold to investors who share the risk and reward of the performance of those assets.

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About Rates and Indices

Treasury Rates

Since investors in riskier investments command a higher return as compensation, the yields on many bonds and money market instruments are priced at a spread over the corresponding risk-free Treasury rate. Yields on money markets and certificates of deposit are often priced relative to yields on Treasuries of a similar length. Adjustable rate mortgages can be indexed to the one-year Treasury. Fixed mortgage rates are closely linked to movements in long-term Treasury yields, as mortgages are often packaged together and sold as mortgage-backed bonds. Yields on short-term Treasuries can behave differently from yields on longer-term Treasuries.

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Treasury Constant Maturities (CMT)

These rates are commonly referred to as "Constant Maturity Treasury" rates, or CMTs. Yields are interpolated by the Treasury from the daily yield curve. This curve, which relates the yield on a security to its time to maturity is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market. These market yields are calculated from composites of quotations obtained by the Federal Reserve Bank of New York. The yield values are read from the yield curve at fixed maturities, currently 1, 3 and 6 months and 1, 2, 3, 5, 7, 10, 20, and 30 years. This method provides a yield for a 10 year maturity, for example, even if no outstanding security has exactly 10 years remaining to maturity.

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Swap Spread

The difference between the swap rate on a contract and the yield on a government bond of the same maturity. It is used to represent the risk associated with the investment, since changes in interest rates will ultimately affect return. Swap spreads are based on LIBOR rates, the credit worthiness of the swap's parties, and other economic f actors that could influence the terms of the investment's interest rates.

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Swap Rate

In the case of an interest rate swap, the market interest rate paid by the party responsible for the fixed payments. In general, a well-defined market rate exists for this payment, and when a swap is initiated, the fixed rate paid is usually quite close to the market swap rate. However, as the swap matures the fixed rate paid on the swap stays constant, while the swap rate might change, and these two rates can diverge.

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12 MTA Index

This index is the 12 month average of the monthly average yields of U.S. Treasury securities adjusted to a constant maturity of one year. In plain English, this index is calculated by averaging the previous 12 rates of the 1 Year CMT. Because this particular index is an annual average, it is more steady than the 1 Year Treasury Index. It fluctuates slightly more than the 11th District Cost of Funds, although its movements track each other very closely, as shown on our comparison charts. The terms 12 MTA (12 month treasury average) and 12 MAT (12 month average treasury) are used interchangeably.

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11th District COFI (Index)

This index is calculated by the Federal Home Loan Bank of San Francisco, one of twelve Federal Home Loan Banks. The 11th district represents the SAIF-insured savings institutions (savings & loans and savings banks) in Arizona, California and Nevada. The cost of funds reflects the interest which these institutions pay on their sources of mortgage money, including savings accounts, FHLB advances, money borrowed from commercial banks, and other sources. Since the largest part of a cost of funds index is interest paid on savings accounts, this index may lag behind the economy; many accounts are time deposits with medium- to long-term maturities at fixed interest rates. This index is considered to be one of the most stable indexes available because it's a lagging indicator: changes in financial markets may not be fully reflected here for months after an event or new trend has appeared. That can be both good and bad; loans tied to the COFI will rise more slowly than those tied to more volatile indexes, but will fall more slowly than other market interest rates.

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5-Year FHLB Index

The Federal Home Loan Banks, as a U.S. Government-Sponsored Enterprise, have successfully supported U.S. housing for over 75 years. Created by Congress in 1932, the FHLBanks public policy mission is to support residential mortgage lending and related community investment through the sale of debt securities in the capital markets. These sales provide funds that are loaned to member financial institutions, which in turn provide mortgage credit to U.S. homebuyers and developers of affordable housing. By providing reliable, low-cost funding on demand to more than 8,000 member financial institutions, the FHLBanks support U.S. housing continuously, through all economic cycles.

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LIBOR

From the British Bankers Association: “Libor stands for the London Interbank Offered Rate and is the rate of interest at which banks borrow funds from each other, in marketable size, in the London interbank market.” LIBOR is the overseas rate for US Dollars. It’s basically equivalent to the Fed Funds market between banks domestically. The difference is that it deals in terms of Dollars on deposit outside the U.S. - eurodollars. Which brings us to another market.

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Other Terms

Promissory Note

In the law of negotiable instruments, written instrument containing an unconditional promise by a party, called the maker, who signs the instrument, to pay to another, called the payee, a definite sum of money either on demand or at a specified or ascertainable future date.

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Estoppel Certificate

A tenant estoppel certificate is used to verify the current status of the tenant and landlord’s rights and obligations under an existing lease when a landlord is seeking a loan on the leased property. The estoppel certificate identifies the tenant and landlord; the leased property location; the lease commencement date, termination date and option period, if any; the status of rent, prepaid rents and security deposits; status of any defaults by the landlord, among other information. It usually contains a statement by the borrower indicating the amount owed on their mortgage loan along with the interest rate.

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Subordination, Non-disturbance, and Attornment Agreement (SNDA)

A subordination, non-disturbance, and attornment agreement (SNDA) addresses the priority of the rights of tenants and lenders. It deals with how and when the rights of tenants will be subordinate to the rights of lenders or, sometimes at lender’s option, senior to the rights of lenders. The non-disturbance portion assures tenants that their rights to their premises will be preserved (“nondisturbed”) on specified conditions within their control, even if the landlord defaults on its loan and the lender forecloses. The attornment component of the SNDA agreement provides that the tenant will continue their obligations under the contract in the event that a new landlord takes over the contract and may also specify that the lender or such purchaser will have certain specified rights thereafter.

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Amortization

Amortization is the gradual elimination of a mortgage, in regular payments over a specified period of time. Such payments must be sufficient to cover both principal and interest. The loan amortization period sets the amount of periodic payments required to pay off a debt obligation. Each payment in the schedule is used to pay interest on the loan and reduce its principal.

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Debt Service Coverage Ratio (DSCR)

DSCR is the ratio of the actual net cash flow, divided by the annual debt service:

	Actual net cash flow	=	DSCR
	Annual debt service

The debt service coverage ratio (DSCR) measures the ability of a property to meet its regular debt obligations. DSCR is the ratio of the cash flow available for debt repayment to its total debt service. It indicates a margin of safety available, should the property rents or cash flows decline temporarily. Lenders usually require a minimum DSCR of 1.20 for apartments and a 1.25 or greater DSCR on all other property types.

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Conduit Lender

A conduit lender makes or purchases loans from third party correspondents under standardized terms, underwriting, and document requirements. Then, when sufficient volume has been obtained, they assemble them into pools used to create mortgage-backed securities.

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Mortgage-Backed Security

When investors buy a mortgage-backed security, which is similar to a bond, they are buying an undivided interest in a pool of mortgages. Income from the mortgages are used to pay off the security. Note: Conventional lenders do not pool together their loans to create mortgage-backed securities to sell to investors. They hold their loans in a portfolio, in-house.

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Actual/360 vs. 30/360

Historically, mortgage payments have been calculated based on a 30/360 basis. In other words, it is assumed that each month has 30 days and therefore each year 360 days. This allows for easy calculation of interest rates and amortization schedules. Your calculator or computer uses a 30/360 calculation for determining mortgage payments.

Actual/360 payments became popular in the 1990s. Not surprisingly, it is a way to make an interest rate sound better than it actually is. These call for the borrower to pay interest for the actual number of days in a month. This means you are paying interest for 5 or 6 additional days a year. Therefore a lender can quote you a lower spread and rate on a transaction but actually collect the same or greater amount of interest each year.

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Net Operating Income (NOI)

Net operating income is the net rental income of a property after operating expenses are deducted. These expenses would include property taxes, insurance, repairs and maintenance, utilities, on- and off-site management costs, and general and administrative expenses, etc. It does not include the interest expense from the mortgage payment.

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Loan-To-Value Ratio (LTV)

The loan-to-value ratio expresses the amount of the loan as a percentage of the estimated value of the property. For example, if a borrower borrows $2,000,000 to buy a property with a purchase price of $3,000,000, the LTV ratio is 66.7% ($2,000,000 ÷ $3,000,000). The LTV ratio is one of the key factors used by lenders to assess the risk of a borrower defaulting on a loan. Everything being equal, the higher the LTV the higher the probability of loan default. Lenders generally prefer a maximum LTV of 75% on apartments and 65% for all other property types.

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Capitalization Rate (or "cap rate")

The capitalization rate is the ratio between the net operating income generated from a property and it's current market value. The cap rate is calculated as follows:

Capitalization Rate	=	Net Operating Income
		Estimated Value

Cap rates are more often used to estimate a property's value. The estimated value of property is based on the property's net operating income divided by an appropriate cap rate. The formula is shown as follows:

Estimated Value	=	Net Operating Income
		Capitalization Rate

For example if a property has an NOI of $200,000 and properties of similar property type, size, age and location have sold recently for a 7.0% cap rate then the property has an estimated value of about $2,900,000 ($200,000 ÷ .07).