Report the estimate of value to the client in writing. There are several types of documents that may be prepared

■ The narrative appraisal report provides a lengthy discussion of the factors considered in the appraisal and the reasons for the conclusion of value.

■ The form report is used most often for single-family residential appraisals. A Uniform Residential Appraisal Report (URAR) is required by various agencies and organizations. Computerized appraisal generation is possible and is increasingly expected by banks and other lenders.

■ Reports may be written in other formats, which are defined by the Uniform Standards of Profes-sional Appraisal Practice (USPAP). The self-contained report is as complete as the narrative appraisal report and should include explanations of the methods used during appraisal and the appraiser’s conclusion. The summary report is less detailed than the self-contained report, and the restricted report, which reveals only minimal information and should be used only by clients, is less detailed than the summary report. Using either of the two latter types of reports will require the con-sent of the client.

Competitive Market Analysis

Real estate licensees do not generally prepare appraisals, although licensed brokers are permitted to do so pro-vided they follow the uniform standards. Licensees must be careful to state that a Comparative Market Analysis (CMA) is not an appraisal and should not be regarded as such. All CMAs must include a notice to this effect.

The CMA is a tool used by the licensee to enable prospective sellers or buyers to identify a range of value in a given neighborhood. It identifies the properties currently listed, those that have been on the market without success and have expired, and those that have sold.

The client can then choose an asking or offering price that is realistic and within the range. Sellers who estab-lish an asking price above the upper end of the range will make their property invisible to many of the best poten-tial buyers for their properties. Buyers who offer too little, or “low ball,” will often insult the sellers and make it impossible to negotiate with them.



F i n a n c i n g

General Concepts

Mortgages, Deeds of Trust, and Their Provisions

A mortgage is a pledge of property to secure the repayment of a debt. If the debt is not repaid as agreed between the lender and borrower, the lender can force the sale of the pledged property and apply the proceeds to repay-ment of the debt.

Leaving the borrower in possession of the pledged property is known as hypothecation. The borrower con-veys title to the lender but retains the use of the property. This conveyance of title in the mortgage agreement is conditional. The mortgage states that if the debt is repaid on time, title returns to the borrower. This is known as a defeasance clause.

Lenders require that borrowers pledge the real estate as collateral for a mortgage loan. If the borrower defaults on the loan, the lender can terminate the borrower’s interest in a property through a judicial process called fore-closure. Traditionally, because the borrower had possession of the property, this process was the only way for a lender to seek satisfaction in the event of a default. However, a judicial foreclosure requiring court action can be time-consuming and very costly.

Some states provide for an alternative to traditional foreclosure in order to avoid the typical drawbacks of the process. One form of mortgage document is the deed of trust, sometimes called a trust deed. In a deed of trust, a third party is given the power of sale by the borrower. The deed provides for a non-judicial foreclosure when all statutory requirements are followed. The process of non-judicial foreclosure is smoother and less time-consuming than traditional foreclosure, and is therefore appealing to a lender.

The other major document that a borrower signs, besides the deed of trust, is the promissory note. This is a promise to pay the loan off according to a schedule of payments at a certain interest rate over a specified period of time.

The two documents are closely related. The deed of trust stipulates what will happen in the event of a default in the terms of the promissory note. In fact, it is standard practice to record only the deed of trust because it is tied so closely to the promissory note.

Real estate can be pledged as collateral for a loan using any of the following four methods.

1. The standard or regular mortgage is the most common type used today. The borrower conveys title to the lender as security for the debt. The mortgage contains a statement that the mortgage will become void if the debt it secures is paid in full and on time.

2. An equitable mortgage is a written agreement that does not follow the form of a regular mortgage, but is still considered by the courts to be one. An equitable mortgage can arise in a number of ways. For exam-ple, a prospective buyer generally gives the seller a money deposit along with an offer to purchase prop-erty. If the seller refuses the offer and also refuses to return the deposit, the court will hold that the purchaser has an equitable mortgage in the amount of the deposit against the seller’s property.

3. In some cases, the borrower may convey the deed to the pledged property to the lender as a deed as secu-rity for a loan. If the loan is repaid in full and on time, the borrower can force the lender to convey the real property back to him or her. Like the equitable mortgage, a deed used as security is treated according to its intent, not its label.

4. A deed of trust is a three-party agreement including a borrower, a lender, and a neutral third party. The key aspect of this method is that the borrower executes a deed to the trustee rather than to the lender. If the borrower pays the debt in full and on time, the trustee delivers a release of liability to the borrower.

Qualifying the Buyer for Financing

In commercial loans, lenders look only to the income from the property for repayment, so they are not particu-larly concerned about the borrower’s income. However, in residential loans, the borrower’s income is of prime importance because that is what will be used to repay the loan. The borrower’s income is analyzed from the stand-point of its quantity and durability. Also, the borrower’s willingness to pay is of prime importance.

To evaluate the borrower’s quantity of income, the lender calculates the front ratio: the ratio of the requested monthly payment to the borrower’s gross income. The monthly payment is the sum of all housing costs: princi-pal, interest, taxes, and insurance (PITI). Most conventional lenders will not let the front ratio exceed 28%. For example, if a borrower’s monthly income is $5,000, the monthly housing costs could not be more than 28% of

$5,000, or $1,400.

The lender is also concerned about other fixed obligations the borrower may already have. Fixed obliga-tions include any payments that the borrower is required to make on a regular basis, such as car payments, bank loans, credit cards, open charge accounts, and so on. The lender calculates the ratio of housing cost plus other fixed obligations to gross monthly income. Most lenders will not let this ratio exceed 36%. So if the borrower makes

$5,000 a month, the amount of housing costs plus fixed obligations could not exceed 36% of $5,000, or $1,800.

Lenders want to be assured that a borrower will be able to pay back the loan in a timely manner. Depend-ing on the kind of property for which the loan is beDepend-ing sought, lenders make various analyses to determine the creditworthiness of the borrower.

Unimproved land is the most difficult loan to underwrite because it produces little or no income to use to pay back the loan. Also, since the borrower does not occupy the property, there may be little incentive to pay back the loan in the event of financial difficulties.

Income producing properties are analyzed on their ability to generate enough cash flow to pay back the loan.

The property’s net operating income must cover the debt service (the amount of money required to make reg-ular payments on the loan).

The lender typically requires a certain debt coverage ratio, depending on the type of property and the qual-ity of the income. The debt coverage ratio is equal to the net operating income of the property divided by the debt service on the loan. For instance, if a property had a net operating income of $120,000 and the lender required a debt coverage ratio of 1.2, the maximum debt service the lender would allow would be $100,000.

$120,000 ÷ 1.2 = $100,000

To review your math skills, see Chapter 5.

Types of Loans

The most common residential loan is amortized, or paid off, in equal monthly installments that include princi-pal and interest. During a time of reasonable interest rates, the borrower will most often choose a fixed interest rate for the life of the loan.

The most popular time period for fixed rate loans is 15 or 30 years; however, other loan terms are also avail-able. Borrowers who choose a shorter time frame save a sizable amount of money in interest payments.

In some instances a loan will be structured as an amortized loan with a term of 30 years, but the loan will balloon after a certain period. That is, the loan becomes due and payable before the end of the amortization term.

The loan may balloon in five, seven, or ten years, or however long the lender stipulates. A balloon loan usually charges a lower interest rate than a regular fixed rate loan. Since the lenders don’t have to wait 30 years to get their money back, they can afford to charge a lower interest rate because the inflation risk is reduced.

Balloon loans are frequently used in seller financing, since the seller typically does not want to wait for 30 years to be paid in full. Buyers may find a balloon loan attractive if they know that they are going to be selling the property before the loan is due.

During times of high interest rates, a borrower may prefer an adjustable rate loan. The lender will give the borrowers a lower-than-market interest rate for a certain period of time, typically a year. Then the rate is adjusted each year (or whatever time period is agreed upon) to adjust for inflation. The most common type of adjustable rate loan is a one-year adjustable plan.

The rate is adjusted at the specified time based on some predetermined indicator, such as Treasury Bill rates.

For the borrower’s protection, there is usually a cap, or limit, on the amount the rate can be increased in any given year or over the life of the loan.

Sources

The sources of loanable funds and the financing arrangements available to a prospective borrower increase each

Even though the choices grow daily, there are two major types of loans:

1. loans that are insured or guaranteed by an agency of government