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10 Things to Know About Mortgages

In Law, Legal Education & Pedagogy, Property on September 4, 2013 at 7:45 am

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1. A mortgagee obtains a security interest (a note) from the mortgagor who mortgages the asset (the house) to secure the loan for the mortgagee.

2. The note is a security that, under the Uniform Commercial Code (UCC), is a negotiable instrument that may be bought and sold.

3. The mortgage is recorded in the land records, thus allowing the mortgagee, in the event of the default of the mortgagor, to enforce the security on the note by foreclosing the rights of the mortgagor to the mortgaged property.

4. In most cases, a defaulting mortgagor will have the opportunity to redeem the property after the foreclosure of its rights, although a cloud will remain on the title to the property. A foreclosure is the elimination of the equitable right of redemption to take both legal and equitable title to the property in fee simple. When a mortgagor defaults by, say, failing to make payments, the mortgagee (or its assigns) files a lien on the property and can eventually eliminate the aforementioned rights and exercise a power of sale. The power of sale is also known as a non-judicial foreclosure and is authorized and provided for by the mortgage itself or the deed of trust. In a “power of sale” foreclosure, if the debtor does not cure his or her default or file bankruptcy to stop the sale, the mortgagee will conduct a public auction much like a sheriff’s auction, and the mortgagee can itself bid on the property; unlike other bidders, the mortgagee can bid on credit.

5. Usually a mortgagee transfers the note to a special purpose vehicle (SPV) that pools the note with other such notes, all of which are sold/assigned (in the form of a “security”) on what’s called the “secondary mortgage market.” Proceeds generated by the assigned security are paid back to the original mortgagee to “compensate” the mortgagee for selling a “security” in the first place.

6. The mortgagee collects payments from the mortgagor (i.e., the monthly mortgage payments) and passes them along to the investors who have an assigned interest (i.e., a “security”) in the note.

7. In theory, the buying and selling of notes on the secondary mortgage market lowers the interest rates of all mortgagors and gives investors a low-risk “security” to invest in so that all parties are better off. The investors hold only an assignment of the note (i.e., a “security”), not the actual mortgage recorded in the land records. Therefore, they have an interest in the mortgage by way of the assigned note, but as assignees, they are protected from certain liabilities that could befall the originating mortgagee and are free from requirements such as recording their interests in the land records. Mortgagees like investors (who, again, enter into the process by way of SPVs) because they essentially pay off the risks associated with being the originating interest and then take on that interest with little risk involved.

8. The process of pooling notes and issuing securities to investors (thereby lowering interest rates over time) is called “securitization.” The investors, through SPVs, pay off the original mortgagees and thereby relieve the mortgagees of their burden of risk in being the lender to the mortgagor. In return, the investors gain an interest in the mortgage and, as assignees, do not have the risk that the mortgagee would have had in its relationship with the mortgagor. Therefore, the mortgagee and the investors have entered into a mutually beneficial relationship whereby each offsets the risks of the other. All of this happens without any effect on the mortgagor and his/her mortgage payments, except possibly to the extent that the mortgagor may, if anything, benefit from lower interest rates. However, mortgagors may not understand that SPVs and investors have been assigned the rights enjoyed by the mortgagee (namely, the right to foreclose), although the mortgagees should have apprised mortgagors that the security in the note has passed along to other parties.

9. The investors become what are called “trustees” that hold the securities (i.e., the assignments of the rights to the note). The rights and obligations of the mortgagees, SPVs, and trustees/investors are spelled out in a “Pooling and Servicing Agreement,” which includes provisions about allowing the SPVs or trustees/investors to foreclose on the mortgagor’s rights by virtue of the chain of interest that extended from the mortgagee’s original transfer to the SPV to the investors (i.e., the “trustees”).

10. This whole process has created difficulties with recording, which, although not required of assignees, often had to take place in order to have a record tracking the passing of interest from the SPV to the investor/trustees and potentially to other investor/trustees, etc. Accordingly, companies came into being that handled the transfer process and maintained electronic databases for investors and the mortgage industry generally to track the passing of interests in notes/securities. These companies are called “nominees.” When drafting their original note, the mortgagor and mortgagee designate a company to serve as a “nominee” for the mortgagee’s successor and assigns. The nominee does not own or fund the mortgage loan, but instead tracks the transfer of interest in the loan and becomes the mortgagee of record. A nominee makes its money by collecting on membership fees that are required of anyone wanting access to the database. There is an overlap between nominees and mortgagees because nominees serve the function and do the work of the mortgagee. In fact, banks and mortgage companies hire and certify people who can work with and for nominees.

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