IMPORTANT CLAUSES IN FINANCIAL INSTRUMENTS

A. ACCELLERATION CLAUSE:
Means exactly what it says; speed up! If a bor­rower does not do some­thing the loan requires, or alien­ates him or her­self from a prop­erty (sells it and no longer has any inter­est in the prop­erty, he or she is now alien to the title) the lender can force full pay­ment of the loan at that time. It doesn’t mat­ter if the loan has 25 years left, the bor­rower broke the terms of the loan and it is now, imme­di­ately due and payable in full. This is referred to as being in default. Most loans require that pay­ments be made on time. If a pay­ment is more than 10 days late, it is con­sid­ered late and a late charge will be assessed. Lenders usu­ally allow for a Grace period to account for U.S. mail prob­lems and accept a pay­ment within this grace period with no penalty or late charge.

B. ALIENATION CLAUSE:

This was dis­cussed above in item #A. Bor­rower no longer has an inter­est in the prop­erty. If a bor­rower alien­ates him or her­self from a prop­erty (sells it and no longer has any inter­est in the prop­erty, he or she is now alien to the title) the lender can force full pay­ment of the loan at that time. It doesn’t mat­ter if the loan has 25 years left, the bor­rower alien­ates him or her­self from a prop­erty it is now, imme­di­ately due and payable in full

C. ASSUMPTION:

If the lender allows a buyer to take over respon­si­bil­ity for a loan and releases the orig­i­nal bor­rower from any lia­bil­ity, this is con­sid­ered a full assump­tion. Lenders have the right to qual­ify a buyer’s finan­cial, credit his­tory, and any­thing the lender would use to approve a buyer for financ­ing. Lenders may also charge fees, charge loan points for this assump­tion. If a seller wishes to be released from all lia­bil­ity for a loan, the seller must make sure a Nova­tion Agree­ment is pre­pared by the lender releas­ing the orig­i­nal bor­rower (seller) from lia­bil­ity. If there is no Nova­tion agree­ment, the seller will still be sec­on­dar­ily liable for the loan. This means that if the lender can not get money from the new buyer the lender can sue the seller. A Nova­tion is very, very impor­tant for a seller. Licensees must be sure that sell­ers under­stand this sit­u­a­tion. SUBJECT TO means a buyer makes the pay­ments on a seller’s loan. The seller is still respon­si­ble for pay­ment. It is gen­er­ally not allowed in Cal­i­for­nia. Most indi­vid­u­als when pur­chas­ing prop­erty do not assume or take loans sub­ject to. They obtain new financing.

D. SUBORDINATION CLAUSE: This is a clause nor­mally used when some­one pur­chases a vacant par­cel of land. The orig­i­nal seller car­ries back financ­ing until the buyer is ready to build on the prop­erty. At this point the buyer obtains a “con­struc­tion loan” to pay for the con­struc­tion. Lenders do not like to be placed in a sec­ondary posi­tion (2nd trust deed) and require that the first loan be paid off in order for the lender to become the first trust deed. Buy­ers usu­ally don’t want to invest the money needed to pay off exist­ing loans. The buy­ers arrange with the seller that upon obtain­ing the new con­struc­tion loan, the seller will allow his loan to become sub­or­di­nate, or sec­ond, to the new con­struc­tion, or other type of loan. This is agreed upon dur­ing the orig­i­nal nego­ti­a­tions of the pur­chase and a “sub­or­di­na­tion agree­ment, or clause,” is included as part of the orig­i­nal agree­ment. Then, when the con­struc­tion loan is obtained it is an easy mat­ter to change the order of the loans. The sub­or­di­na­tion clause allows for sub­or­di­na­tion of the exist­ing financ­ing and the new loan takes pri­or­ity in the future.

E. PREPAYMENT PENALTIES: A pre­pay­ment penalty is a charge for pay­ing a loan off early. Lenders gen­er­ally charge six (6) months, but it can be longer, inter­est to pay the loan off early. Penal­ties are cov­ered in detail in the text. They were very pop­u­lar from 1950 to 1980 where com­pe­ti­tion forced the lenders to stop charg­ing them or lose cus­tomers. They are mak­ing a come­back and are becom­ing pop­u­lar with Adjustable Rate loans and start­ing to creep into Fixed Rate loans as well.

F. IMPOUND ACCOUNTS: An impound account is a forced sav­ings account for prop­erty taxes and insur­ance. Bor­row­ers with less than twenty (20) per­cent down are required to make a monthly pay­ment of 1/12 of annual prop­erty taxes and insur­ance charges to a spe­cial account to insure that the taxes and insur­ance will be paid. This is added to the nor­mal prin­ci­pal and inter­est pay­ment. We refer to it as: P.I.T.I (prin­ci­pal, inter­est, taxes and insur­ance) pay­ment. Lenders call these “escrow accounts.” They are col­lect­ing and hold­ing funds to pay some­thing at a later date. They are in escrow, a neu­tral account as far as the bank is con­cerned. They can pay up to two per­cent (2%) inter­est on an escrow/impound, but not all lenders do.

G. ASSIGNMENT OF RENTS: When a bor­row defaults on a loan, the lender is not receiv­ing any money. Within a trust deed is a para­graph stat­ing that a lender may con­tact ten­ants and col­lect the rents from them and apply the income to the pay­ment due until a fore­close takes place. This clause is strictly for the ben­e­fit of a lender.

SPECIAL PURPOSE TYPES OF LOANS:
1. Grad­u­ated Pay­ment Mort­gage. A GPM loan is a type of loan where the ini­tial inter­est rate is fixed (doesn’t change) at a cer­tain amount but the begin­ning pay­ments lev­els are set at a lower inter­est rate. For exam­ple; the true rate for a loan is eight per­cent and the pay­ment starts at a three per­cent amount for the first year, four per­cent for the sec­ond year, and five per­cent for the third year. The pay­ment rate increases by one per­cent until the true rate is achieved. The pay­ments “grad­u­ate” until the full pay­ment cov­ers all inter­est due. Dur­ing the period of time when the pay­ments are lower and increase yearly the loan is a “neg­a­tive” amor­tized loan. The dif­fer­ence between the pay­ment and the inter­est due is added to the prin­ci­pal bal­ance. Usu­ally, after five years the bor­rower owes approx­i­mately five per­cent more than at the start of the loan. This is a good loan for first time bor­row­ers who know their income will be increas­ing and it allows them to obtain hous­ing now and when the loan reaches the full inter­est the bor­row­ers will be able to han­dle the full pay­ment amount.
2. Biweekly Mort­gage. Instead of mak­ing one pay­ment a month, a bor­rower will pay one half of the pay­ment every two weeks. The bor­rower will make twenty six pay­ments instead of twelve. This is a loan designed for those who receive pay­checks every two weeks and allows them to bud­get for their loan oblig­a­tion. As a side ben­e­fit, the loan actu­ally pays off sooner because a teeny, tiny extra amount of prin­ci­pal is paid over the course of twenty six pay­ments.
3. Fif­teen (15) year Fixed and Adjustable Rate Loans. Instead of amor­tiz­ing the pay­ments over a thirty year period (360 pay­ments), a fif­teen year loan is amor­tized over fif­teen years (180 pay­ments). The fif­teen year pay­ments are higher but not twice as much and the loan is com­pleted much more quickly.
4. Reverse Annu­ity Loans. These have been cre­ated for those  sixty two years of age and over. It is exactly what it says; the bank makes the pay­ments to the bor­rower monthly instead of in one large amount. These act like an income source for the senior who receives a monthly check. The amount of money paid to the senior is all due and payable when the senior moves, dies or some­how vacates the prop­erty. Most lenders use a spe­cial FHA pro­gram for this pur­pose although a few lenders are cre­at­ing their own reverse annu­ity pro­grams for seniors.