Chapter 2 Notes and Mortgages

Real Estate Financing:
Notes and Mortgages

Notes
• A promissory note is a document which serves
as evidence that debt exists between a borrower
and a lender and usually contains the terms
under which the loan must be repaid and the
rights and responsibilities of both parties.
• Unless stated otherwise, the borrower is
personally liable for payment of all amounts
due under the terms of the note. While many
loan provisions may be included, notes usually
contain at least the following:
A. The amount borrowed—this is generally the
face amount of the note, which is usually advanced
in total when the loan agreement is executed.
However, in cases involving construction loans,
amounts could be advanced as a construction
progresses, not to exceed a maximum amount.
B. The rate of interest—this could be a fixed rate

of interest or an adjustable rate. If it is the latter,
exactly how the rate may be adjusted (changed)
will be specified.
C. The dollar amount, due dates, and number of payments to be made by the
borrower— (e.g.: $500 per month due on the 1st of each month following the
closing date for 300 consecutive months).
D. The maturity date, at which time all remaining amounts due under the
terms of the loan are to be repaid.
E. Reference to the real estate serving as security for the loan as evidenced by
a mortgage document (to be discussed).
F. Application of payments, which are usually made first to cover any late
charges/ fees/penalties, then to interest, and then to principal reduction.
G. Default—occurs when a borrower fails to perform one or more duties

under the terms of the note. Default usually occurs because of nonpayment of
amounts due.
H. Penalties for late payment and forbearance
provisions
I. Provisions, if any, for unscheduled (early)
payments or the full or partial prepayment of
outstanding balances
J. Notification of default and the acceleration clause
K. Nonrecourse clause—as quoted above, when a
borrower executes a note, he is personally liable, or
the loan is made “with recourse.”
• Loan assumability—this clause indicates under
what conditions, if any, a borrower will be
allowed to substitute another party in his place,
who will then assume responsibility for
remaining loan payments.
• The assignment clause—clause giving the
lender the right to sell the note to another party
without approval of the borrower.
N. Future advances—provision under which the
borrower may request additional funds up to some
maximum amount or maximum percentage of the
current property value under the same terms
contained in the original loan agreement.
O. Release of lien by lender—lender agrees to

release or extinguish its lien on the property when
the loan is fully repaid.
The Mortgage Instrument
• Definition of a Mortgage
• In its most general sense, the mortgage
document is created in a transaction whereby
one party pledges real property to another
party as security for an obligation owed to that
party. A promissory note (discussed
previously) is normally executed
contemporaneously with the mortgage.
Default
• Default is a failure to fulfill a contract,
agreement, or duty, especially a financial
obligation such as a note. It follows that a
mortgage default can also result from any
breach of the mortgage contract. The most
common default is the failure to meet an
installment payment of the interest and
principal on the note.
Alternatives to Foreclosure: Workouts
• Foreclosure involves the sale of property by

the courts to satisfy the unpaid debt. The
details of this process are discussed later.
Because of the time involved and the various
costs associated with foreclosure (and possibly
repair of any damage to the property), lenders
often prefer to seek an alternative to actual
foreclosure.
• The term workout is often used to describe the various
activities undertaken to deal with a mortgagor who is in
financial trouble. Many times the parties make a workout
agreement that sets forth the rules by which, during a specified
period of time, they will conduct themselves and their
discussions. The lender agrees to refrain from exercising legal
remedies. In exchange the borrower acknowledges his or her
financial difficulty and agrees to certain conditions such as
supplying current detailed financial and other information to
the lender and establishing a cash account in which any rental
receipts from the property are deposited and any withdrawals
are subject to lender approval
• Six alternatives can be considered in a workout:
• 1. Restructuring the mortgage loan.
• 2. Transfer of the mortgage to a new owner.
• 3. Voluntary conveyancy of the title to the
mortgagee (lender).
• 4. A “friendly foreclosure.”
• 5. A prepackaged bankruptcy.
• 6. A “short sale” with the lender agreeing to a sale
price less than the loan balance.
Restructuring the Mortgage Loan
• Loans can be restructured in many ways. Such

restructuring could involve lower interest
rates, accruals of interest, or extended maturity
dates
Recasting of Mortgages
• Once a mortgage is executed and placed on
record, its form may change substantially
before it is redeemed. It may be recast for any
one of several reasons. A mortgage can be
renegotiated at any time, but most frequently
it is recast by changing the terms of the
mortgage (either temporarily or permanently)
to avoid or cure a default.
Extension Agreements
• Extension Agreements Occasionally, a

mortgagor in financial difficulty may seek
permission from the mortgagee to extend the
mortgage terms for a period of time. This is
known as a mortgage extension agreement. A
mortgagor may request a longer amortization
period for the remaining principal balance or a
temporary grace period for the payment of
principal or interest payments or both.
• In responding to such a request, the mortgagee needs to consider the
following issues:
• 1. What is the condition of the security? Has it been reasonably well

maintained or does it show the effects of waste and neglect?
• 2. Have there been any intervening liens? These are liens recorded or
attached after the recordation of the mortgage but before any
modifications to it. If so, what is their effect upon an extension
agreement? If such liens exist, it is possible that the extension of an
existing mortgage may amount to a cancellation of the mortgage and the
making of a new one. If so, this could advance the priority of
intervening liens.
• What is the surety status of any grantees who
have assumed the mortgage? Will an extension
of time for the payment of the debt secured by
the mortgage terminate the liability of such
sureties? The best way for mortgagees to
protect themselves against the possibilities
implied in these questions is to secure the
consent of the extension agreement from all
sureties to the extension.
Transfer of Mortgage to a New Owner
• Mortgagors who are unable or unwilling to meet

their mortgage obligations may be able to find
someone who is willing to purchase the property
and either assume the mortgage liability or take the
property “subject to” the existing mortgage. The
new purchaser may be willing to accept the transfer
of mortgage if he or she thinks the value of the
property exceeds the balance due on the mortgage.
In either case, the seller retains personal liability for
the debt.
Voluntary Conveyance
• Borrowers (mortgagors) who can no longer
meet the mortgage obligation may attempt to
“sell” their equity to the mortgagees. For
example, suppose that the mortgagors are
unable to meet their obligations and face
foreclosure of their equity. To save the time,
trouble, and expense associated with
foreclosure, the mortgagees may make or accept
a proposal to take title from the mortgagors.
Friendly Foreclosure
• Foreclosure can be time-consuming and expensive,

and there can be damage to the property during this
time period. A “friendly foreclosure” is a
foreclosure action in which the borrower submits to
the jurisdiction of the court, waives any right to
assert defenses and claims and to appeal or
collaterally attack any judgment, and otherwise
agrees to cooperate with the lender in the litigation.
This can shorten the time required to effect a
foreclosure
Prepackaged Bankruptcy
• In a prepackaged bankruptcy, before filing
the bankruptcy petition, borrowers agree with
all their creditors to the terms on which they
will turn their assets over to their creditors in
exchange for a discharge of liabilities. This
can save a considerable amount of time and
expense compared with the case where the
terms are not agreed upon in advance.
Short Sale
• A short sale is a sale of real estate in which
the proceeds from the sale fall short of the
balance owed on a loan secured by the
property sold. In a short sale, the mortgage
lender agrees to discount the mortgage loan
balance because of an economic or financial
hardship on the part of the mortgagor.
Foreclosure
• Judicial Foreclosure
• Redemption

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Real Estate Financing:

Notes and Mortgages

B. The rate of interest—this could be a fixed rate

G. Default—occurs when a borrower fails to perform one or more duties

O. Release of lien by lender—lender agrees to

• Foreclosure involves the sale of property by

• Loans can be restructured in many ways. Such

• Extension Agreements Occasionally, a

• 1. What is the condition of the security? Has it been reasonably well

• Mortgagors who are unable or unwilling to meet

• Foreclosure can be time-consuming and expensive,

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