Mortgage Execution: Recording Requirements, Documentation, and Closing Procedures-Module 2 of 5

Mortgage Execution: Recording Requirements, Documentation, and Closing Procedures-Module 2 of 5


Mortgage Execution: Recording Requirements, Documentation, and Closing Procedures

 

 

Buying a home using a mortgage is complex and time-consuming. Several documents must be executed to effectuate the transfer, ranging from financial documents to consumer protection disclosures and contracts. This module explains how and when real estate finance documents must be recorded, as well as the documentation and closing procedures required to support real estate finance agreements.

 

Mortgage Documentation Required Prior to Closing


When buying a home, the purchaser executes several critical documents at various times in the process. Understanding the intent and legal function of these documents is critical to effectively navigating the mortgage process. The following discussion goes over the standard documents that one can expect to execute when taking out a mortgage loan.

 

The first document is the mortgage application. Most often, the application will be a Uniform Residential Loan Application, also known as a form “1003” mortgage application, which is the industry standard form used by nearly all mortgage lenders in the United States.[1] The 1003 mortgage application form was created by the Federal National Mortgage Association (sometimes called “Fannie Mae” because of its initials “FNMA”) to standardize mortgage applications across the private lending industry. The form requires the disclosure of identification information about the borrower and any co-borrowers, including Social Security numbers, birth dates, marital status and personal contact information.

 

The borrower will also need to provide documentation of income, expenses, assets and liabilities, including any pending legal issues that may impact the borrower financially. The lender reviews the information provided on the mortgage application form along with the prospective borrower’s credit report and credit history to determine the credit risk for the loan. Lenders also typically require information about the property being used to secure the loan with the mortgage application, such as the purchase price, the address, and the year the home was constructed.[2] They use this information to assess the value of the property being used to secure the loan.

 

After submitting the mortgage application, the borrower may receive a pre-approval letter from the lender. This letter spells out the amounts and terms of the loan that the bank is willing to issue, subject to specified conditions. A pre-approval is helpful for budgeting and assessing competing offers and it is often an excellent way to show a potential seller that the purchaser is serious and able to purchase the property, but a preapproval letter is not a binding commitment to issue the mortgage loan.[3]

 

Once the mortgage application is completed, the bank will usually require a credit report, home appraisal, and title search to provide additional certainty regarding the risk it is taking on by issuing the loan. Each of these services comes at a cost, and the bank typically passes this cost on to the borrower.

 

At this stage, assuming the bank is still willing to go forward with the process, the bank will provide a Loan Estimate (formerly called a Good Faith Estimate), which estimates what the borrower can expect to pay for these supplemental requirements and spells out the terms of the loan. This document also outlines the total closing costs that will be borne to the borrower at closing, including the down payment, mortgage origination fee, title insurance, fees for the bank’s attorney and other closing costs.[4]

 

Once the mortgage application is formally approved, the borrower will receive a Commitment Letter spelling out the terms of the mortgage loan. The borrower typically has a limited time to accept the terms in the Commitment Letter, and once the letter is executed, the borrower has all the financial assurances needed to schedule the closing.

 

The Closing Disclosure

 

Closer to the closing, the borrower also receives a Closing Disclosure, which is a five-page form that provides the final details about the mortgage loan.[5] The Closing Disclosure lists all the charges and credits the buyer and seller in a real estate transaction are subject to.[6]  It also lists the total amount of the loan, any financing charges, the payment schedule, the annual percentage rate (or “APR”) of the loan, broker fees, points and any other charges the borrower is required to pay.[7]  Prepayment penalties, balloon payments, mortgage insurance and escrowed amounts must also be included in the disclosure, if applicable. This must be provided to the borrower at least three business days before the closing.[8]

 

The Closing Disclosure replaced the HUD-1 Settlement Statement and Truth-in-Lending disclosure forms that that were used until 2015, and it includes substantially all the information that were in both forms.

 

Some lenders require that they pay the borrower’s property tax and homeowner’s insurance from an escrow account that is funded by the borrower. They do this to ensure that their security interest is preserved in case they need to foreclose. When escrow is required, the lender provides an initial escrow disclosure statement that spells out the amounts that the borrower must put into escrow at closing and on a monthly basis thereafter.[9]

 

Documents at Closing

 

 The mortgage process is finalized at the closing, which requires all the parties to get together to execute the final documents necessary to convey the deed to the buyer and ensure that the seller is paid. The closing usually takes place at a title company or attorney’s office, and the borrower is presented with many documents to sign, including several affidavits and declarations spelling out the terms of the debt the borrower is taking on to purchase the new home, as well as the borrower’s rights as a homeowner.[10]

 

Among the many documents executed at a closing, the Promissory Note may be the most important one for the mortgage. The Promissory Note represents the commitment to repay the loan and it must include many relevant details about the loan, including payment due dates, the term of the loan and the manner in which payments are to be made. The Note will also state whether the loan is for a fixed rate or adjustable. In the case of an ARM, the Promissory Note discloses how or when the rates may change. The Promissory Note will also spell out the events of default that may trigger foreclosure, including what happens if the borrower fails to make payments when due.[11]

 

The Promissory Note is a pivotal legal document in the mortgage process and has become more complicated over time as it’s become more common for mortgages to be bought and sold by investors as securities.[12] As a result, mortgage borrowers commonly retain attorneys to review Promissory Notes or help negotiate more favorable terms.

 

Next, the mortgage document itself conveys the security interest from the borrower to the bank. This document, also called a Security Instrument or Deed of Trust, gives the lender the right to foreclose on the property being used to secure the loan. It includes the same basic information as the Promissory Note, but it provides additional details regarding the lender’s rights in the case of foreclosure and other things that can have a substantial impact on property rights. For example, a Mortgage can include a “due on sale” clause, which prohibits the homeowner from transferring the property without the lender’s consent.[13] This is significant for anyone who plans to sell her home before the end of their mortgage term. It doesn’t mean that the property cannot be sold; it simply means that the lender must be paid back in full at the time of the sale. It should be noted though, that a section of the federal Garn–St. Germain Depository Institutions Act prohibits the enforcement of due on sale causes when the property is transferred to a close relative, such as a spouse or child, and in cases where the property is transferred to any relative because of the death of the borrower or pursuant to many domestic relations orders.[14] Transfers to family trusts for the benefits of these close relatives are also protected by this federal statute.

 

A Mortgage may also have an acceleration clause, which allows the lender to demand payment of the entire loan in full upon an event of default, such as failing to make a payment or failing to maintain homeowners’ insurance.[15] Acceleration clauses allow the initiation of a foreclosure upon a single missed payment, though lenders typically try to collect or negotiate payment arrangements before commencing foreclosure proceedings.

 

The deed to the property is conveyed to the purchaser at closing and the deed itself does not need to reference the mortgage interest at all. The mortgage interest is a separate lien on the property that is evidenced by the Mortgage document. As such, the mortgage document must be recorded alongside the deed to the property to ensure that the mortgagee’s security interest is protected by proper priorities.[16]

 

 

Recording the Documents


Every county has a property records office or “land records” office in which deeds that convey real property interests can be recorded. These are public records and can be accessed by anybody at any time. Many jurisdictions today post their land records online in a way that is searchable by party or by address. These allow parties to research all the deeds relevant to a parcel conveniently and efficiently. Mortgages are interests in property, and so can and should be recorded as soon as possible after the closing.

 

Most states have recording statutes that impose restrictions on when and how a document conveying property rights can be legally created. Recording statutes are important for several purposes. They set forth a framework for legal notice of ownership of interests in property, including encumbrances created by mortgage interests. When mortgage security documents are recorded according to the requirements of the jurisdiction, they are available for inspection in the land records office, and thus provide constructive notice to everyone else about the property interest.[17] This protects mortgage lenders by ensuring that there are no hidden conflicting or superior claims on the property.

 

Recording requirements are particularly relevant in situations where property is mortgaged more than once, or other liens are associated with the property. When there are multiple mortgages on a single property, the priority of these claims is determined by the principle of “first in time, first in right.”[18] Regardless of the recording statute that applies in the jurisdiction, a mortgage already recorded in the land records puts all subsequent lenders on constructive notice of the superior claim. However, when a mortgage is taken out on a piece of property and not properly recorded, it may be subordinated to subsequent interests in the property.


Recording Statutes and Priorities

 

Recording statutes allocate priority among multiple competing transferees of property interests. So, if a homeowner gives multiple mortgage interests or purports to transfer the property to one person and mortgage and to another or grants easements or other liens to additional parties, recording statutes play the critical role of determining priorities. A receiver of a secondary mortgage or other interest in the property will take his interest subject to the rights of the primary holder.

 

States use one of the three types of recording statutes: race, notice and race-notice.

 

Race statutes, by far the rarest of three types, establish priority simply based on which interest was recorded first. When the property interests were transferred, and which parties knew of which transactions are irrelevant. In race recording jurisdictions, constructive notice is irrelevant as adverse claims are resolved by who recorded first regardless of whether the second mortgagee knew about it.[19]

 

Notice statutes, on the other hand, allocate priority to the second recipient of an interest in property if the second recipient is a bona fide, good faith, purchaser of that interest unless the first party’s lien was already recorded at the time of the transfer. The theory is that the first recipient was dilatory in failing to record his mortgage first, thus causing the confusion. Therefore, the policy protects the second innocent purchaser and has the effect of incentivizing parties to record the security interests as soon as possible.[20]

 

Many jurisdictions follow a hybrid “race-notice” approach. This is comparable to the race statute in that whichever party records first wins. However, the second party must have acted in good faith. If the second party knew of the previous transfer to the first party at the time of the second transfer, the second party loses because he did not take the property or security interest in good faith.[21]

 

Let’s look at an example. Imagine that Sarah took out a $150,000 loan from ABC Bank to purchase her new home on April 1, but the mortgage was not recorded until April 30. She discovered that the new home needed costly roof repairs shortly after buying it and so Sarah’s friend, Tim, agreed to lend her an additional $20,000 on April 15, asking for a lien in the home to secure the repayment. Tim recorded his security interest on April 20.

 

In a notice jurisdiction, Tim’s mortgage would have priority over that of ABC Bank as long as he did not know that Sarah had already taken out a mortgage when he made his agreement with Sarah on April 15. In a race-notice jurisdiction, the same result would apply under the same condition because he recorded first. In a race jurisdiction, Tim’s mortgage would have priority even if he did know that Sarah had already taken out a mortgage from ABC Bank because notice is irrelevant in race jurisdictions.

 

Let’s assume instead that Tim did not record his mortgage until May 10. In a notice jurisdiction, Tim’s mortgage would still have priority over that of ABC if he did not know of the original mortgage on April 15 because he was a subsequent bona fide purchaser. In a race-notice or race jurisdiction, on the other hand, ABC’s mortgage would have priority because ABC recorded first.

 

Let’s now assume that Sarah told Tim on April 14 that she had taken a $150,000 mortgage loan from ABC Bank and Tim lent her the $20,000 anyway on April 15. Tim then recorded his mortgage on April 20. In a race jurisdiction, Tim’s would have priority because he recorded first. However, in either of the other types of jurisdictions, ABC’s mortgage would have priority because Tim had notice of the original mortgage.

 

If a mortgage is not recorded, the security interest is usually unenforceable. A few courts have allowed the enforcement of unrecorded mortgage interests under a theory of equitable mortgage when it can be shown that the owner intended to grant a party a mortgage interest, but the document was invalidated for some reason.[22]


Conclusion

 

            As most homeowners know, the paperwork and documentation requirements for mortgages are extensive. Various agreements and disclosures are required at different points in the lending process to ensure that the action is transparent and well-understood by all parties. Much of this paperwork is required to ensure responsible lending and consumer protection. However, in such a complex process even small oversights can have substantial impacts on lenders’ and borrowers’ rights. As a result, it’s critical for everyone involved to take the time to understand the process of finalizing a legally-binding mortgage agreement.

 



[1] Claire Boyte-White, “What is the 1003 Mortgage Application Form?” Investopedia (2018) available at https://www.investopedia.com/ask/answers/041916/what-1003-mortgage-application-form.asp.

[2] Freddie Mac, Understanding Mortgage Documents (Dec. 2011) available at http://myhome.freddiemac.com/docs/pdf/understanding_mortgage_documents.pdf

[3] Id.

[4] Id.

[6] Consumer Financial Protection Bureau, What is a HUD-1 Settlement Statement? (Sept. 12, 2017) available at https://www.consumerfinance.gov/ask-cfpb/what-is-a-hud-1-settlement-statement-en-178/.

[7] Id.

[8] Freddie Mac, Your Step-By-Step Mortgage Guide (June 2016) available at http://www.freddiemac.com/singlefamily/docs/Step_by_Step_Mortgage_Guide_English.pdf.

[9] Consumer Financial Protection Bureau, Guide to Closing Forms, available at http://www.consumerfinance.gov/owning-a-home/.

[11] Consumer Financial Protection Bureau, Guide to Closing Forms, available at http://www.consumerfinance.gov/owning-a-home/.

[13] See e.g. 12 U.S.C. § 1701j-3(a)(1).

[14] See 12 U.S. Code § 1701j-3

[15] Consumer Financial Protection Bureau, Guide to Closing Forms, available at http://www.consumerfinance.gov/owning-a-home/.

[16] Freddie Mac, Understanding Mortgage Documents (Dec. 2011) available at http://myhome.freddiemac.com/docs/pdf/understanding_mortgage_documents.pdf

[17] David Whitman, What You Didn’t Know About Real Estate Recording Acts, American Bar Association (Nov. 2016) available at https://www.americanbar.org/content/dam/aba/publishing/rpte_ereport/2016%20eReport/6-November%202016/What%20You%20Didn_t%20Know%20about%20Recording%20Acts_Whitman%20(2).authcheckdam.pdf

[18] Id.

[20] See e.g. Argent Mortgage Co., LLC v. Wachovia Bank N.A., 52 So.3d 796 (Fla. Dist. Ct. App. 2010).

[21] See Spickler v. Ginn, 40 A.3d 999 (Me. 2012).