A security device goes hand-in-hand with the promissory note when buying real estate. You cannot have one without the other unless you are paying cash. 99% of the time, the purchase is financed through a lender. The security device is a lien on the purchased property. It is the legal document that allows a lender to foreclose on the property if the homeowner does not meet the contractual requirements of the Promissory Note.
Hypothecation is the practice where (usually through a letter of hypothecation) a borrower pledges collateral to secure a debt or a borrower, as a condition precedent to a loan, has a third party (usually an affiliate) pledge collateral for the borrower. The borrower retains ownership of the collateral, but the creditor has the right to seize possession if the borrower defaults. A common example occurs when a consumer enters into a mortgage agreement, in which the consumer's house becomes collateral until the mortgage loan is paid off.
Hypothecation - Buyer offers a note promising to pay on the loan thus places a lien (hypothecates) on the property allowing the lender to foreclose on the house if note payments are not paid as contracted.
Pledge - The buyer offers a note (only) without a lien on the property. This is usually done when the seller owned the house "free and clear" and becomes the lender. The buyer makes monthly agreed upon payments to the seller until the note is paid off. If payments are not paid, the seller can only sue the buyer for not making contracted payments.
Three Major Security Devices: Mortgages, Trust Deeds, Land Sales Contracts
Common characteristics of each of these security devices includes the following:
Mortgage Lien - Provisions/Clauses
The following are usual provisions and clauses that are utilized in a mortgage security device. None of them are mandatory, but most mortgage security devices will use the following.
Compliance Clause - This requires the owner of the financed property to comply with the terms of the promissory note that accompanies this device.
Reserves for PITI Loans - Most security devices require the payment of Principal, Interest , Taxes, and Insurance. This is called a PITI loan. When there is a PITI loan, the monthly payments for taxes and home insurance are placed in a reserve. When payment is due for these areas, the bank will pull money out of the reserve and pay the taxes or insurance premium on the home.
Principal Last - The mortgage payments required under the security device will state that payments will apply first to reserves, then to interest, and any balance will then go towards the principal amount of debt.
Protection - If there are no reserves for property tax or insurance under the security device, it will require the debtor to provide payment for taxes and insurance. If the homeowner does not provide payment for taxes or insurance, the lender has the right to pay and bill the homeowner.
Insurance Premium - The homeowner/debtor will carry homeowner's insurance on their own and purchase protection at least up to the amount of the debt.
Loss Payee - The security device will stipulate that the lender be named in the policy as a loss payee. This means the lender has the right of receiving payment (loss payer) if a loss ensues to the property that they have the lien on.
Priority Liens - Security devices require the owner to promptly pay any charges or liens that have priority over this lien. An example would be a mechanic's lien or a material man lien. The owner/mortgagor would be expected to pay off these liens promptly.
Good Repair - The security device requires the borrower to keep the property in good repair.
The borrower may not remove or demolish any building on the property without the lender's approval.
The borrower must promptly notify the lender of any losses that the property has suffered.
Lender Protection - The security device will usually give the lender the right to protect property from losses if borrower fails to do so.
The lender has the right to pay taxes, buy insurance, order repairs and add any money so spent to the mortgage debt.
Reasonable Inspection - The lender has the right to inspect the property and see if the borrower is doing a proper job. However, they must give the mortgagor reasonable notice of their desire to inspect.
Condemnation - If condemnation occurs, any proceeds must first go to the lender, the balance going to borrower.
Place-of-Contract Clause - This clause states that all legal remedies that are utilized by this security device shall abide by and follow State laws where the property is located.
Assignment of Rents Provision - This is a boiler plating document; it allows use in all States. If the borrower is delinquent on payments, the lender may collect any rental income. The income will offset the delinquent payments on a dollar for dollar basis.
Release/Partial Release Clause
This is found in blanket encumbrances. This is typically a part of subdivision loans that fund projects within the subdivision.
Subordination Clause - This is the clause that allows the changing of positions in rank of priority for security devices. Sub (below) - ordinate (numbers) - the numbers below.
Clause - The clause itself:
Priority - The clause might state that the second device shall gain priority over any first device. In other words the security devices will change priority position. The 1st shall become 2nd and the 2nd shall become the 1 st. As we talked about this earlier, this is usually when the land is purchased first and house is built second. The 2nd on the house becomes 1st and the 1st on the land becomes 2nd.
Obviously this clause would have to appear in the 1st device in order to accomplish this.
The result is the same, owner will be able to secure future financing more readily as any future loan will be first in priority at the time of foreclosure; also the interest rate on a 1st device is typically at a lower rate than a 2nd device.
A husband and wife wish to buy a lot for $25,000. They pay $10.000 cash, and the seller carries back a note and trust deed for the balance. They intend to build a home in 5 years. When they get ready to carry out their construction plans, the absence of which of the following clauses may cause them difficulties?
A) alienation clause
B) acceleration clause
C) release clause
D) subordination clause
The condition of most PITI loan instruments require the borrower to pay all of the monthly and annual costs except:
A) the principal and interest
B) recording fees
C) property taxes
D) insurance premiums
With a PITI loan, which of the following is paid last with each payment?
D) insurance premiums
CLICK HERE FOR REVIEW QUESTIONS AND ANSWERS (42752)
The study of system of rules which a particular country or community recognizes as regulating the actions of its members and which it may enforce by the imposition of penalties.