Problem.Illustrative transaction

     This problem is intended to expand and explore your understanding of basic concepts and vocabulary involved in a typical real estate secured transaction.

     A.  Purchase of a residence

     A buyer and seller agree to the purchase and sale of a residence for $300,000. Our sample standard form Real Estate Purchase Contract and Receipt for Deposit illustrates the lengthy written document that the parties may execute. The buyer can afford to make a 10% down payment ($30,000). The buyer has obtained the commitment of a lender to loan $270,000 for the balance of the purchase price, to be secured by a first deed of trust on the real property that she is going to purchase.

          1.  Who receives the $30,000 down payment and who receives the proceeds from the $270,000 loan? Who signs the promissory note and who is responsible for repaying the $270,000 loan? 

          2.  Why will a lender generally insist on a down payment (sometimes referred to as a margin of security) rather than lending the entire $300,000? 

          3.  Assume that at the time of sale the seller's residential real property is subject both to a deed of trust in favor of the lender that financed the seller's purchase of the residence and to a judgment lien. Upon what will the buyer and the new lender insist as a condition to disbursement of funds deposited in escrow? How much may the seller expect to receive?

          4.  If the buyer cannot find a large enough loan from an institutional lender (e.g. a savings and loan) at a reasonable interest rate but the seller wants to sell to this buyer, the seller may be willing to defer collection of some of the purchase price, typically for a period ranging from three to seven years, taking a promissory note for the amount deferred and securing the note with a deed of trust. This process is often referred to as a "seller carry-back." Other than a desire to sell, what might motivate the seller to structure the transaction in this way? Why might the note to the seller provide for a balloon payment rather than  fully amortizing the debt?  How might the buyer expect to make the balloon payment? What would be the relationship between the deed of trust executed in favor of the institutional lender and the deed of trust executed in favor of the seller? 

          5.  Assume that the buyer only has $20,000 of the $30,000 she needs for the down payment, but she wants to purchase now.  She qualifies for a $170,000 loan and the seller has agreed to carry back $100,000. What are the possible sources for obtaining the additional $10,000 she needs? Would those sources require security for this money? How is the institutional lender likely to feel about such an arrangement? If the seller and institutional lender were willing for buyer to borrow $10,000 of the down payment and secure this $10,000 with a deed of trust on the residence, what would be the most likely priority of such a deed of trust?

     B.  Default and foreclosure (no seller carry-back)

     Assume our buyer above, who purchased for $300,000, paying $30,000 down and borrowing $270,000 from an institutional lender secured by a first deed of trust on the residence. Several years later the buyer lost her job and was unable to continue making mortgage payments. The lender commenced a non-judicial foreclosure. At the time of the foreclosure sale, the amount owing on the note, including accrued but unpaid interest and collection costs, including the costs of the foreclosure, is $250,000, and the residence might command a price of about $310,000 if it were being offered for sale without distress on the residential real estate market.

          1.  What is the maximum amount that the foreclosing lienor will be entitled to credit bid?

          2.  If a third party bidder is present at the sale, what is the maximum amount he or she will bid? Why?

          3.  How will the money bid by a successful third party bidder be distributed?

          4.  Who owns the property after the sale? What happens if the debtor refuses to vacate the premises?

     C.  Default and foreclosure (with seller carry-back)

     Assume that our buyer paid $30,000 down, borrowed $170,000 from the institutional lender secured by a first deed of trust, and the seller carried back $100,000 of the purchase price, payable interest only for five years with a $100,000 balloon payment at the end of five years, secured by a second deed of trust. Buyer defaults on payments to both the institutional lender and the seller shortly after the purchase.  The debt to the institutional lender is still virtually $170,000 and the debt to the seller is, if anything, slightly greater than $100,000 because of interest accruals following default.   Non-judicial foreclosure ensues.

           1.  If seller has initiated the non-judicial foreclosure sale, what is the maximum amount that it will be entitled to credit bid? If seller is the successful bidder and thereafter seller resells the property for $310,000, how will the proceeds of that sale be distributed and what will the seller's net economic gain or loss be taking together the original sale, the foreclosure sale, and the sale subsequent to the foreclosure sale?

           2.  Why might the institutional lender permit the seller to foreclosure first? 

           3.  If the institutional lender has initiated the non-judicial foreclosure sale, what would be its maximum credit bid? How much more might a third party bid?  How would the money from a successful third party bid be distributed? What happens to the second deed of trust and the amount of money owed to the seller?