Article written based on New Jersey Law
Many clients and readers of News & Views call or e-mail me with recurring questions regarding a real estate acquisition. The purchase of a home, or first venture into multi-family realty, for most individuals requires a substantial investment of time and money. A general understanding of the nature of the transaction can help avoid many costly errors. In this two part article I will attempt to answer, in plain language, the following questions:
-What do real estate agents or brokers do?
-What is a listing broker?
-What efforts will the real estate agent make to sell the property?
-When is the broker’s commission earned?
-What is a binder?
-What is a contract for purchase and sale?
-Can a contract for purchase and sale be contingent (conditional)? -What is a mortgage?
-What types of mortgages are available?
-What portion of a monthly mortgage payment actually goes towards reduction of the loan?
-Where can a purchaser obtain a mortgage?
-How does a buyer obtain a mortgage loan?
-How does a borrower know what a mortgage loan will cost and what the monthly payments will be?
-What happens if the buyer defaults on his mortgage loan and fails to make payments?
Q. What do real estate agents or brokers do?
A. A suitable property for purchase can be found in many different ways. Driving through a desirable neighborhood will often disclose “for sale” signs posted on lawns. Advertisements for property by geographical location are listed in the classified section of almost every newspaper. Primarily, however, people find real estate through the use of a real estate agent or broker. Real estate agents charge a commission based on a percentage of the sales price of property sold. The percentage can vary widely and range from as little as 1% to as much as 6% or more. Often, the commissions are negotiable. As real estate brokers are almost invariably the agent for the seller; they owe a duty to the seller to act with the utmost of good faith. The agent will, therefore, attempt to obtain the highest possible purchase price for his client. A buyer may be able to locate an agent who will work just for him/her; such agents are sometimes called “buyer’s brokers.” A buyer’s broker generally will charge by the hour or on a flat fee basis.
Q. What is a listing broker?
A listing is a contract that gives a broker a right to sell property. The listing agreement details the broker’s commission upon successfully locating a buyer. Listings are ordinarily given for specific periods of time, e.g., 6 months or 1 year. There are three basic types of listing:
Ø 1. Exclusive right to sell – this type of listing assures the agent that regardless of who sells the property, the listing agent will receive at least a portion of the sales commission, even if the owner is the one who finds a buyer.
Ø 2. Exclusive listing – in this type of listing the seller may not list the property for sale with any other broker. Generally, the owner may sell the property independently without incurring liability for commissions.
Ø 3. Open listing – this type of listing allows the owner to list the property with several agents; the first one to sell the property receives the commission.
Q. What efforts will the real estate agent make to sell the property?
A. Real estate agents will often advertise listed properties in newspapers or specialty journals. In New Jersey as well as many other states, they will post the property with a multiple listing service alerting other agents that the property is available for sale. If a real estate agent other than the broker subsequently sells the property, the commission is shared with the listing broker.
Q. When is the broker’s commission earned?
A. This question is often the subject of protracted litigation. A simple answer is that a broker’s commission is earned and payable once a buyer who is ready, willing and able to buy the property is located through the efforts of the broker. If the owner refuses to “close” (conclude) the transaction after a buyer has been found, the owner is obligated to pay the agent’s commission. Likewise, if a buyer defaults (refuses to close) after a purchase contract has been signed, the broker will generally be entitled to all or a portion of the deposit money paid by the buyer, depending on the terms set out in the contract of sale. A broker who introduces parties that consummate a sale even after the listing has expired is generally entitled to a commission.
Q. What is a binder?
A. Occasionally, the purchase of real estate begins with a buyer signing a memorandum indicating a willingness to buy the property under certain conditions. Often, a deposit accompanies the binder. Depending on the language of the binder, it may or may not constitute a binding contract. A purchaser should never sign a binder without the advice of a legal representative.
Q. What is a contract for purchase and sale?
A. Once there has been a meeting of minds between buyer and seller on the terms of purchase of property, a written contract will be prepared and signed by all of the parties. The contract will specify the purchase price, any applicable conditions such as rights of inspection, financing terms and a proposed date and time of closing. A contract for purchase and sale is the final word on the agreement between the parties. Any oral agreements or promises made before the contract is signed are void and unenforceable. The purchase and sale agreement should provide that any earnest money (deposit) will be placed in either the broker’s or an attorney’s escrow (trust) account to ensure that the buyer will get his money back if the purchase is not completed due to no fault of the buyer. There can be no valid or enforceable oral agreement for the purchase or sale of real estate.
Q. Can a contract for purchase and sale be contingent (conditional)?
A. Various contingencies and conditions are often contained in real estate contracts. Contracts usually provide that the buyer will make a good faith effort to obtain a mortgage and that if the buyer fails to qualify for a mortgage, the contract is cancelled and all deposit money will be returned. The contract will also generally be conditioned on the seller being able to convey good and marketable title to the purchaser, i.e., that there are no liens or claims against the property and that it is owned by the seller.
Q. What is a mortgage?
A. Unless a purchaser will be paying all cash to purchase property, they will have to find a lender willing to finance the purchase. Various banks or mortgage lenders can assist in locating lenders and or will actually make the loan. A mortgage is a contract that gives the lender a “secured interest” in real estate. This means that if the borrower fails to make his mortgage payments, the lender can foreclose the mortgage and take the property. Mortgages are accompanied by promissory notes that set out the amount of money owed and how it is to be repaid.
Q. What types of mortgages are available?
A. There are several categories of mortgages and payment plans. The 3 most common include:
Ø 1. Conventional mortgages – a conventional mortgage provides for payoff of the loan (amortization) over a fixed number of years. At the end of the mortgage term, the mortgage will have been paid off and the borrower will receive a “satisfaction” document, indicating that no additional money is due. The interest rate in a conventional mortgage may be fixed (stay the same through the entire loan period) or be variable (subject to annual adjustment up or down). Variable interest rates are generally tied to a national standard interest rate that is published annually.
Ø 2. Balloon Mortgage – a balloon mortgage offers short term financing to a borrower. While payments may be calculated based on a long-term (e.g., 20 year) payout, the mortgage “balloons” or becomes payable in full after a shorter term (e.g., 5 years.) For example, a $100,000 mortgage may be amortized (payments calculated) for a payout over a 20 year period at an interest rate of 8%; the parties agree that at the end of 5 years the entire balance of the mortgage “balloons,” or becomes due. When the mortgage balloons, the buyer will generally have to obtain a new mortgage.
Ø 3. Purchase Money Mortgage – A purchase money mortgage is a conventional or balloon mortgage that the seller gives to the buyer to finance the purchase of the property. These mortgages are often given to buyers who have a poor credit history and would otherwise be unable to obtain financing to complete the purchase.
Q. What portion of a monthly mortgage payment actually goes towards reduction of the loan?
A. The amortization (payoff) of mortgages is scheduled so that in the early years, the largest portion of the monthly payment is allocated to interest and only a small portion to principal. This means that after 5 years of payments on a 20 year mortgage, there will be only a small reduction in the principal amount of the loan. In later years, a larger portion of the payment actually is applied to loan reduction.
Q. Where can a purchaser obtain a mortgage?
A. In addition to banks, mortgages may be available through mortgage companies. A buyer may utilize the services of a mortgage company or broker. Some lenders offer federally guaranteed mortgages that are backed and insured through federal agencies, such as the Federal Housing Administration (FHA) or the Department of Veteran’s Affairs (VA). The FHA or VA may finance up to 100% of the mortgage loan. Conventional lenders will generally only fund 90% or less of the purchase price of a primary residence, and 80% or less for commercial or investment realty, and will require that the non-financed portion be paid directly by the purchaser at or before the closing.
Q. How does a buyer obtain a mortgage loan?
A. The mortgage lender will require the buyer to provide a credit history, tax returns, and other financial information to determine whether the buyer is a good credit risk and has sufficient income to make payments (qualify the borrower). Additionally, the lender will require the property to be inspected for defects and appraised to verify that the purchase price is fair and that there is sufficient equity (value over and above the mortgage) to protect the loan. Different lenders have different financial requirements. Ordinarily, an applicant for a mortgage loan must deposit sufficient funds with the mortgage lender to perform the appraisal and credit check. A buyer may be pre-qualified by a mortgage lender (approved for a loan before a contract to purchase is signed). This will allow a closing to take place more quickly and will assure a seller that he has a buyer who can afford to purchase his property. Pre-approval can be used as a powerful negotiating tool by a buyer who finds a “motivated” seller.
Q. How does a borrower know what a mortgage loan will cost and what the monthly payments will be?
A. Under federal law, the mortgage lender is required to make full disclosure of the true interest rates, the cost of the loan, any commissions paid and the amount of the monthly payment.
Q. What happens if the buyer defaults on the mortgage loan and fails to make payments?
A. The lender will file a legal proceeding called a foreclosure. In a foreclosure action, the lender will be required to show that payments were not made as agreed. After a foreclosure judgment is obtained, the property is auctioned for sale and the proceeds are used to pay off the mortgage loan. The mortgage holder may bid at the auction up to the amount of the mortgage balance. If the proceeds are not sufficient to pay off the loan, there may be a judgment entered against the defaulting borrower for any arrearages (any past money owed). Mortgages almost always provide that the borrower is responsible for all attorney’s fees and court costs incurred in the foreclosure proceeding.
Q. What should a borrower do if served with a complaint for foreclosure?
A. If the borrower is truly in default, the remedies are somewhat limited. The borrower can seek new mortgage financing for a longer term that will allow for reduced payments. The proceeds of the new loan will be utilized to pay off the loan that is in default. Unfortunately, it is very difficult to get a new loan when the borrower is already in foreclosure. The borrower can offer the lender title to his property in lieu of foreclosure. This allows the lender to avoid a lengthy and expensive foreclosure proceeding; the lender becomes the owner of the property without having to proceed with further legal action. In return, the lender agrees not to pursue any arrearage judgment against the homeowner. The homeowner will lose his property, but will not be responsible for any loan balance.
Q. What happens if a buyer cannot qualify for a mortgage loan?
A. If a mortgage contingency clause (i.e., a provision that makes the contract conditional upon the buyer being able to obtain a mortgage) is contained in the contract for purchase and sale, the buyer will receive a refund of any deposit money advanced toward the purchase. The buyer can also attempt to obtain a purchase money mortgage from the seller.
Q. If the seller has an existing mortgage on the property, can the buyer assume (take over) the mortgage so that new financing does not have to be obtained?
A. Mortgages may be assumable or due on sale. The existing mortgage will indicate if it can be assumed by a buyer, or whether it must be paid in full at the time of sale. Mortgages that are assumable may, nevertheless, provide for an increase in interest rates or qualification of the buyer before assumption. Most mortgages are due on sale.
Q. What rights does a buyer have when applying for a mortgage?
A. The federal Equal Credit Opportunity Act as well as other federal regulations prevents lenders from rejecting loan applicants due to race, color, national origin, religion, sex, marital status, age, or handicap. Additionally, a mortgage lender must consider any public assistance funds, alimony, child support or maintenance payments received by the applicant on a regular basis as if such payments were ordinary income.
Q. Do the buyer and seller need to be represented by an attorney in a real estate transaction?
A. It is strongly recommended that a buyer be represented when purchasing real estate property. An attorney will examine the contract, determine whether there are adequate protections for the buyer, make sure that expenses of the sale are properly allocated, and review the documents of conveyance (deed, bill of sale, etc.), the mortgage, and the closing statement (accounting of money paid and received). Attorneys and title companies will also examine title. This means that the buyer’s legal representative will review the history of sales, deeds and mortgages to verify that there are no liens (claims against the property) and that title is good. Generally, an attorney or title company will issue a policy of insurance called a title policy that will reimburse the buyer if it turns out that title was defective due to a forgery or lien that was not picked up during the title search. A seller’s rights must also be protected. Real estate agents are not permitted to practice law or prepare legal documents such as deeds, mortgages or other documents of conveyance.
Q. What happens at the closing?
A. The real estate closing is the final stage in the purchase and sale process. If mortgage financing has been obtained, the closing will generally take place at the offices of the lender. The closing will be attended by the seller and purchaser, their respective attorneys, the real estate broker and the closing agent for the mortgage lender. At the closing, the mortgage and accompanying note are signed by the buyers, the real estate broker remits any escrow money (deposit) to the seller less broker’s commissions, the buyer pays any necessary cash to close above the mortgage and the seller delivers a deed and other documents of conveyance to the buyer, receiving in return the net mortgage proceeds and other cash to close. Any outstanding mortgages or liens are paid off from funds exchanged at the closing. The parties will receive and review detailed accountings of money paid and received (a closing statement) to assure that financial obligations have been met. Deeds and other documents showing a change of ownership, together with any mortgages will be recorded in the county where the property is located to alert future buyers or lenders of the status of title. When existing mortgages are paid off at closing, the buyer will obtain a satisfaction of mortgage that is recorded to reflect that the mortgage lien has been extinguished.
Q. What is a warranty deed?
A. Most real estate contracts require the seller to deliver to the buyer a warranty deed that affirmatively states that the seller has good and marketable title to the property being sold. Occasionally, a buyer will receive and accept a quit claim deed, which merely transfers the seller’s interest in the property to the buyer without promising that title is good and marketable. A quitclaim deed is rarely used in conventional real estate transactions; it is generally used for transfers between family members, gifts of property or in the context of a divorce proceeding when one party is ordered or agrees to convey the marital home to a former spouse.
Q. What are condominiums and cooperatives?
A. Condominium is the term for a form of ownership of real estate where a buyer acquires title to an apartment or unit in a multiple dwelling building and receives a right to use common areas such as recreational areas. Condominiums are purchased in the same way as private homes, that is, they are conveyed by deed and may be financed with a mortgage. A purchaser of a condominium must be pre-approved by a condominium board. Under federal law, a buyer cannot be rejected by reason of race, color, religion or place of national origin. Condominiums have complex rules and regulations that all owners must observe. Monthly maintenance fees are collected by the condominium board to maintain the common areas. Periodic assessments may be levied against unit owners to pay for major expenses. The condominium documents may restrict a unit owner’s right to rent or lease an apartment. In a cooperative, a purchaser acquires shares of stock which allow use of common areas and leases a specific apartment. A governing board that sets policy and rules for the operation of the building controls the cooperative. Cooperatives function like closely held corporations. It is often difficult to obtain financing to purchase shares in a cooperative as the interest that a buyer obtains is not a real estate interest.
Q. How can title to property be held?
A. Purchasers of real property can hold title in different ways. The way that title is held will be reflected on the deed to the property. 1. Joint tenancy – when title is held jointly, the parties named in the deed agree that if one of them dies, the other will acquire exclusive title to the property. A provision in a will giving an interest in jointly held property to a third party will be ineffective – the property can only go to the surviving joint owner. When property is held jointly between a husband and wife, it is referred to as “tenancy by the entireties.” A joint tenant cannot sell his interest in jointly held property without a court proceeding dividing interests and authorizing the sale. 2. Tenancy in common – in this form of ownership, each party named in the deed has absolute title to their share of the property. If there are two tenants in common named in the deed, each owns a interest in the property. The interest may be devised by will or sold.