Real Estate Transaction Terms
21 February 2009
Did you realize that you probably don’t have a mortgage? Although the term “mortgage” is commonly used for any real estate loan, the actual definition of the word mortgage is a contract saying that a lender can take your property if you default on a loan. These days though, most lenders in most states will secure the loan using a Trust Deed instead of a mortgage. I bring this up because there are many important documents involved in a real estate transaction, and considering the amounts of money involved it is important to understand them and to know what you are signing. This is just one of the reasons that you want to be represented by a real estate professional when buy or selling a property.
As I noted above the strict definition a mortgage is essentially a contract between you and the lender that says that they can foreclose on your property if you default on the terms of the Promissory Note. A mortgage is a judicial remedy and that means that the lender needs to take you to court to enforce the mortgage if you default. You’ve probably heard of property being sold on the courthouse steps. This happens if you don’t pay your taxes for four years (Utah) or your lender holding an actual mortgage wins in court. A mortgage always implies a Sheriff’s Sale. That is, the lender can’t just repossess your property; the court orders the sheriff to sell it. Once the property is sold at a sheriff’s sale you do not loose the property immediately. In Utah you keep the property for 6 months and if you can pay off the note in full along with fees and expenses, then you keep the property. Because the lender already has the defaulting borrower in court, they will also often get a judgment for the balance of the loan if they believe that the house will not pay the note in full at the sheriff’s sale. Because of this long process and because of the expense of taking people to court, most lenders now prefer that you secure the note with a Trust Deed.
Trust Deed or Deed of Trust
Like a mortgage, a Trust Deed is a contract between you and the lender that says that if you default on the loan, then the lender can foreclose on your property. It should be noted that the terms “Trust Deed” and “Deed of Trust” are two terms for the same thing. The main difference between a mortgage and a Trust Deed is that the lender does not need to take you to court to foreclose on at Trust Deed. The lender hires a third party called the Trustee to take over the property and sell it, turning over the money that they get in the sale to the lender, less the Trustee’s fees. In this process you only have about three months to bring the note current or loose the property. Because the lender would need to go to court to get a judgment for any amounts that the sale of the property did not cover, they will often not seek this remedy. Also some states have laws that say that if the lender forecloses on a Trust Deed, then the lender must accept the proceeds from the sale as payment if full and are not allowed to obtain a court judgment.
The promissory note that you will sign at settlement is the contract between you and the lender where you promise to repay the loan. The promissory note is often just called the “Note”. This is the document that states the terms of the loan including the interest rate, loan term (i.e. 15 or 30 year), monthly payment amount, and late fees. It will also state additional terms such as any pre-payment penalty and the amount of that penalty. Most notes today have an “alienation” clause that says that if you sell the property you must pay off the loan in full at that time. There was a time that many loans could be assumed by the buyer, but those days are long gone except for certain types of loans. Make sure that you keep your Promissory Note and all other documents that you sign at closing. I once refinanced a house and the lender who held the note that I was refinancing billed me for early repayment. I got out my original contract and there was no prepayment penalty in there. So I called, and in my most wounded sounding voice, asked them how they could even think of charging me this fee when it was not in the contract. It was a hassle, but they finally relented and sent me my money back.
When it comes to real estate, “title” is a concept and not a physical document. Yes, this is different than owning an automobile where the state sends you a document called a title. A deed is the physical document that shows ownership of real estate. In real estate title means ownership. You can say that you hold title to a piece of real estate and that means that you own it and that you have a set of rights that come along with that ownership.
This is the physical document that you get that you can use to prove that you own the property. Some of the items that the deed must include are the name of the seller (Grantor), the name of the purchaser (Grantee) and that something was given in payment for the property. This “something” is commonly called “consideration”. Since Utah is a state where you are not required to tell any level of government how much you paid for the property your deed will often say that you paid “… the sum of Ten Dollars and other good and valuable consideration…”. One of the most important parts of the deed is the legal description of the property, so that you can show which property that you own. There is additional information that should be on your deed to ensure that it is valid. Because there are several requirements to make a good deed and mistakes on the deed may allow some rascal to take your property you always want to have the deed prepared by a reputable title company.
The deed that you get is usually called a “Warranty Deed” or a “Special Warranty Deed”. In this case warranty means that someone will ensure that get all of your property rights except those explicitly excluded in the deed for as long as you own the property. Generally this means that you are protected against someone coming forward who really owns the property who can kick you off or make some claim to the property. Generally the seller will purchase a title insurance policy for the seller and the title company will then defend lawsuits claiming an interest in the land, and pay you the purchase price of the property if they lose and your property is taken in court. Although it may sound as if a “Special Warranty Deed” is more special than a “Warranty Deed” it is not. It is always better to get a Warranty Deed because it offers more protection.
Title insurance is insurance that protects your ownership of the property. When you purchase property the settlement is typically done at the office of a title company. Usually the seller will pay the one-time insurance premium to be able to provide a Warranty Deed without having to be responsible to guarantee the ownership of the property themselves. Once the title insurance policy is issued the title insurance company is then responsible for defending any lawsuits that may arise where someone else claims to own the property. If they loose they will pay you an amount equal to the purchase price of the property. To reduce their risk the title company will search the records at the county to see who may have claims to the property. In this search they will generally find any easements recorded against the property. It is a good idea to ask the title company for the title report so that you can see what they found. When you are getting a loan to purchase the property the lender will usually also require that you purchase a second title insurance policy for the amount of the note so that they will also get paid in the event that you lose the property to someone with a legitimate claim.
Settlement and Closing
Like me, I’ll bet that you thought that you owned the property that you bought as soon as you left the settlement table and signed your name, seemingly hundreds of times. Well think again. The deal does not close until the lender actually sends the money to the title company and the title company sends the money to everyone who is supposed to get it. This is called the closing and it usually happens the day after settlement.
HUD-1 Settlement Statement
This document goes by several names depending on who is using it. It can be called the “HUD-1” or the “Settlement Statement” or the “HUD-1 Settlement Statement”. This document lists all of the costs that are part of the deal and who is paying them and who is receiving them. These costs include the purchase price, earnest money deposit, pro rata property taxes, loan amounts, title insurance fees, pro rata rents, document prep fees, and many other numbers along with who is paying and receiving them. They contain a lot of data. By law you can demand to have a copy of the settlement statement one day prior to settlement. ALWAYS make sure that you request this. This document contains a lot of important money amounts and it is important that you understand them all so that someone else’s mistake does not cost you money! It is a good idea to call your lender and prod them to provide their information to the title company with enough time to allow the title company to complete the statement a day early. Lenders are notorious for waiting until the last minute to give the title company their information.
Good Faith Estimate
When you are shopping for a loan, you should always ask lenders to provide a “Good Faith Estimate”. This document the interest rate, the APR, and discloses the lender’s many fees. Always ask for this document so that you can compare the fees that you would be charged if you were to sign up with a particular lender.
Real Estate Purchase Contract
When you make an offer to purchase a property and you are using a realtor, he will almost always use the state approved from called the “Real Estate Purchase Contract or “REPC”. Before signing the REPC go over it in detail with your real estate agent and make sure that you understand everything in it. If the seller accepts the offer, then this is a binding contract between the two of you and you are obligated to do certain things by certain dates, or you give up certain rights. For example, there is a financing deadline that you specify when making an offer. If your lender denies the loan and you do not notify the seller or seller’s real estate agent in writing by that date that you did not get financing, the seller can keep your earnest money or even give it back and sue you for damages. There are many important clauses and you should know exactly what each means before writing an offer. This is just one area where having a real estate agent represent you is a great benefit.
There are many other terms and documents that you may not be familiar that are commonly part of a real estate transaction. Considering the amounts of money involved and the liability that you can incur by not understanding them it is important to have someone who understands this helping you with your transaction. I sincerely hope that you will pick me to be that someone.