Week 1

This week will focus largely on real estate lending, and terminology related to lending transactions.

Real Estate mortgages Reading – Business Law in Canada (BLIC) 12 th edition pages 451-452; or 11th
edition pages 477-479 gives a very brief overview of mortgages.

Understanding a bit of the history helps to understand the area today.

1. The term “mortgage” means dead hand, as if the mortgagee (lender) holds the property with a
dead hand.
2. In the original system before the land titles system of land registry developed, the fee simple
(real ownership) of the land was transferred by the mortgagor (borrower) to the mortgagee.
The mortgagee had legal ownership of the land.
3. The mortgagor had an “equity of redemption” which is the right to have the land transferred
back if the mortgagor paid the mortgage payments as required. The equity of redemption was a
concept developed by the equity courts, not the common law courts.
4. If the mortgagor failed to repay the loan, the mortgagee could “foreclose” which meant that the
equity of redemption was closed out - the mortgagor had no right to get the property back once
the foreclosure was approved. The land belongs to the mortgagee as the sole owner, and
whatever the mortgagor had paid on account of the mortgage debt was lost.
5. Because of this heavy onus on the mortgagor, the courts developed a concept of a judicial sale
of the property. If the mortgagor requests, the court can order that, in lieu of a foreclosure, the
property would be sold by a court supervised sale. On the sale:
 If the sale price exceeds what is owed by the mortgagor, then the mortgagee retains the
amount required to pay off the mortgage and the excess goes to the mortgagor.
 If the sale price is less than what is owed, the mortgagor is liable to the mortgagee for
the shortfall.
 This is so because the mortgagor has signed a personal covenant to pay the mortgage
debt to the mortgagee, and thus is liable for the mortgage debt.
 If the land is foreclosed, so that the title is actually transferred to the mortgagee, then
the mortgagor is not liable on the covenant to pay, since the land has been substituted
for the mortgage debt.

This system of mortgages in UK developed prior to the development of a concept of a land registry office
where deeds, mortgages and other documents related to real estate ownership were registered and
public notice. Instead, the holder of the land actually held the title deed and all previous deeds to the
property in their own possession. When a buyer purchased the land, the seller would give him all the
previous documents for inspection prior to closing. This was a somewhat chaotic situation.

This situation was improved when the system of land registry offices developed in UK. This was a
system where all deeds, mortgages, and other documents related to real estate were registered in an
office that was open to the public. At that point, a buyer or mortgagee could see all of the documents
that were registered in the office without having to require the owner to provide these documents. The
system was that all documents registered were considered public knowledge, and any document not
registered was not public knowledge.

This registry system gave way to a land titles system in many jurisdictions such as BC. Under that
system, the actual ownership is shown on the register, as well as all encumbrances and this is
guaranteed by the Land Title Registrar, backed up by an insurance fund.

As a result, the buyer does not do an in depth search of all of the documents registered on title, going
back 40 years as was the case under the Land Registry System, but just looks at who is shown as the
owner etc today.

Under the land titles system as we have in BC, the title to the property is not transferred to the
mortgagee when a mortgage/charge is registered as was the case under the old registry system; rather
the mortgagee has a charge on the property. However, the above discussion is applicable in the same
way between the parties. The mortgagor is now called the chargor and the mortgagee is the chargee.

This week, we will look at various types of lenders, and lending terminology.

You can look at the terminology that you are not clear about at the following sites:

https://www.tdcanadatrust.com/products-services/banking/mortgages/mortgage-glossary.jsp

https://www.hsbc.ca/1/2/personal/borrowing/mortgages/knowledge-centre/glossary

A comprehensive list can be seen at:

http://www.mortgage101.com/article/mortgage-terminology

Types of lenders – in some cases, the same lender will fall into a number of categories, such as banks
that provide secured and unsecured loans as well various types of secured loans as set out below.

Unsecured lenders – personal loans, credit card loans, store credit. Higher risk since no security for the
loan. If the borrower does not pay, the lender must sue the borrower, obtain a court judgement and
attempt to obtain assets of the borrower through the court enforcement systems. Because of these
risks, the rate is usually higher than a secured loan.

Secured lenders
Asset based lenders – lenders that lend money, taking assets as security for the loan. These types of
lenders only look at the value of the asset being pledged – they are less concerned with the ability of the
borrower to repay the loan, as they see the asset as being sufficient security. Often, they are happy if
the borrower defaults and they can take the asset.
Equity Lenders – they are similar to asset- based lenders, looking to what equity the borrower has in the
asset. If the borrower has sufficient equity in the asset, they feel safe that if the borrower does not
repay, they can take the asset and there will be enough value in it to sell it, and recoup the loan and
interest from the security. They do not concern themselves too much with whether the borrower will be
able to repay – less emphasis on credit checks, proof of income. Some of the smaller trust companies
and other private mortgage lenders are equity lenders.

Covenant based lenders – these lenders usually lend only if they are satisfied that the borrower can
repay the loan, and then take security for the loan to protect themselves. They will check the credit of
the borrower, ensure that the borrower has income (employment) to pay the loan. Banks are typical
examples of this type of lender.

Insured Lenders – many banks lend on the basis of insurance from CMHC or other insurers – the largest
of which is Genworth. http://genworth.ca/en/index.aspx. Both real estate loans and commercial loans
(non-real estate) can be insured. CMHC and Genworth insure real estate mortgage loans only.

If the borrower does not repay the loan, the lender can obtain payment from the insurer. This is the
least risky of loans since the bank has insurance against default.

Many lenders will provide loans on more than one basis. For example, banks will usually provide
mortgage loans on the basis of the covenant of the borrower, but if the borrower has 50% equity in a
property, the bank may lend without concern for the credit rating or income of the borrower –they will
thus provide an equity lender type loan. .

Cash flow lenders – these lenders will lend on the basis of the cash flow that is derived from the assets
being mortgaged as security. For example, if the borrower owns a commercial property that is leased
out to tenants, the lender may be looking primarily to the income from the property to ensure that the
loan is repaid. Large insurance companies often lend on commercial properties based upon the
expected cash flow from the tenants of the property.

Recourse vs non recourse lenders

Recourse lenders are those who are relying on the borrower to repay the loan – if the borrower
defaults, the lender will sue the borrower to obtain payment.

Non-recourse lenders are lenders who look only to the security in the event of default by the borrower.
The borrower cannot be sued. This is sometimes referred to as project based lender, as the lender will
only look to the project for repayment, not to the borrower directly.

Terminology for loans – this is for both mortgage loans and commercial loans:

You should become familiar with each of these terms through the various sites referred to above, or
by searching for the terms.

Principal

Interest rate –fixed or floating, adjustable rates

Blended payments – each payment is partially principal and partially interest

Interest only loans - each payment consists only of interest, not principal so at the end of the term, the
principal is the same as at the beginning because all payments have been on account of interest only.

Calculation period for interest - daily, monthly, quarterly, annually

Compounding period for interest for mortgages, usually semi-annually.

Effective Rate of Interest - expressing the rate as an annual rate.

Term of loan - length of the loan – not the same as amortization period.

Balloon payment = principal outstanding on the loan at the end of the term.

Amortization period - period over which the loan will be repaid in full, together with all interest

Payment dates – monthly, quarterly, annually

Open or closed loans – this is a major issue that borrowers often overlook. A closed mortgage is one in
which the borrower cannot pay off the mortgage prior to the expiry of the term of the mortgage. An
open mortgage is one in which the borrower has the right to pay all or part of the mortgage off prior to
the expiry date. If a mortgage is silent on the issue of closed or open, then it is closed.

Prepayment penalties or bonuses

If a mortgage is closed, and the purchaser needs to pay it off early (often because the house is being sold
and the purchaser is not going to take over the property with that mortgage – the purchaser wants
clean title) the lender will usually negotiate with the borrower as to how much penalty has to be paid for
the early repayment. The normal penalty is 3 months interest on the principal, plus an interest
differential. An interest differential is the difference that between the rate on the mortgage and the
rate that the lender would get if it lent the same money out on the mortgage today. If the rate today is
higher than on the mortgage, then the lender may be better off to allow the borrower to pay off the
loan at the mortgage rate and find a new borrower at a higher rate, in which case there would be no
interest differential penalty. If the rates have gone down, so the lender would get less interest on that
principal if lent out today to a new borrower, then there will be an interest differential that the lender
will usually charge.

Late payment penalties Often the loan will charge a penalty to the borrower if the payment is made
late.

Lender fees –fees charged by the lender to the borrower in order to lend the money. These fees are in
addition to the interest that the lender is charging on the mortgage.

Arranging fees – usually these are fees charged by mortgage brokers to arrange the mortgage.

Prepayment of interest to secure the lender – in some cases the lender will want the borrower to prepay
some of the interest at the beginning of the loan, so that the lender has the interest payments in a bank
account to use in case the borrower cannot make the interest payments when due. This is often the
case on a development mortgage, where the borrower will have no cash flow from the project for a
couple of years while the project is being developed – houses built.
Loan to value – the amount of loan relative to the value of the security. If the property is worth $100,
and the loan is for $50 to be secured by a first mortgage on the property, then the loan to value is 50%.
The higher the LTV, the higher the risk to the lender and thus, the higher the interest rate usually.

Appraisals - valuation of the property done by a licenced expert. However, there are various types of
appraisals that can be done for lenders – eg development potential appraisal where the appraiser looks
at the land and the plans that the developer has for the lands, determines what the property will be
worth at the end of the construction process. This is highly subjective type of appraisal, and is not
generally acceptable for loans.

Vendor take back mortgages –where the purchaser gives back a mortgage to the vendor on closing.

Collateral mortgage vs conventional mortgage - this is an important concept so please look it up.

Equity v Debt

Hybrid financing - very common with merchant banks, mezzanine finance, or venture capitalist
companies (VC’s)

Loan with security and equity participation -the lender obtains an equity stake in the company such as
common shares in addition to the security on the assets against which the loan is being made

Loan with security and profit participation - the lender obtains the right to obtain part of the profits of
the venture, in addition to return of the loan principal plus interest. Similar to equity, but the lender gets
participation in profits, not equity.

Priority Issues

Priority of registration usually governs priorities of the mortgage – the first one registered is the first
mortgage, with first priority.

Postponement of priorities - lenders can agree to change their priorities. Thus, the first mortgagee may
agree to post its mortgage to the second mortgagee so. Usually the postponement agreement is
registered on title to real estate.

Bridge loans - a loan to “bridge” a time problem. Eg. The purchaser of a house must close the purchase
before the sale of his/her existing home is completed so needs a loan to complete the purchase and will
repay the loan when the house is sold. The lender “bridges” by providing a loan to the purchaser which
is repayable out of the sale proceeds.

Syndicated loans – a group of lenders form a syndicate to make the loan. This is becoming very popular
in attracting small investors into large, risky loans for which funds are generally not available from
knowledgable investors. See http://www.macleans.ca/economy/angry-investors-seek-class-action-
against-high-profile-seller-of-risky-syndicated-mortgages/

Partial discharges - often a large piece of land is mortgaged to the bank to obtain financing to construct
houses on the property. The mortgage should provide for partial discharges, to allow the borrower to
sell the houses individually to purchasers and have the mortgage discharged from the lot being sold to
the purchaser. Usually there will be an amount specified in the mortgage regarding how much of the
proceeds of the sale must be paid to the lender in order for the lender to discharge the mortgage from
that individual lot.

Remedies terminology

Foreclosure – where the court transfer the property to the lender because the borrower has defaulted
on the loan.

Judicial Sale – court sells the property and gives the lender what is owed on the debt and the balance, if
any, goes to the borrower.

Power of Sale (private power of sale) -some provinces, such as Ontario, allow a mortgagee to sell the
property if the mortgagor defaults, and this is not supervised by the courts. This is the most common
form of remedy used by mortgage lenders in Ontario, as it is quick, cheap and easy.

Scenarios to make this concrete:

Scenario 1 Joan has agreed to purchase a house, at a price of $500,000. She can afford to put down
$50,000 cash on closing and needs to borrow $450,000 by way of mortgage loan.

The bank offers her financing on the following basis. What do they mean?

1. Principal to be lesser of $450,000 or 90% of appraised value.

2. Mortgage to be a first mortgage. No subsequent mortgage shall be registered against the
property.
3. The interest rate is 4% per annum, compounded semiannually, payable monthly blended
payments.
4. The term is 5 years, the amortization is 25 years. What happens at the end of the term?
5. The mortgage loan is open on any anniversary date for repayment of up to 10% of the
principal outstanding. What happens if Joan wants to pay the whole mortgage off in full in
2 years, because she will be selling the house then?
6. The bank says they will charge her a lender’s fee of 1% and an appraisal fee of $300.
7. Bank wants the mortgage to be CMHC insured.

Remedies issues:

1 In scenario 1 above, Joan is unable to make the mortgage payments. What are the rights of the bank if
she defaults on the loan?
What are Joan’s rights if she defaults in payment?
Scenario 2 More advanced

John has purchased a piece of land for $4 million, on which he will build 6 houses. He has paid $1
million cash for the property and has a first mortgage to the vendor for $3 million. This mortgage back
to the vendor is called a vendor take back mortgage, or VTB.

He needs the following financing:

1. $2 million to pay for the “soft costs” of the project, such as rezoning the property to allow 4
houses on the property, marketing of the houses, drawings for the houses, building permits etc.

2. $ 4 million to build the 6 houses on the property

For the first funding of $2 million he must find a lender who will lend on a development project like this.
The risk is very high to that lender because if he lends $2 million and the borrower defaults, the property
at that point only has a value of $4 million, but the VTB is $3 million, so the borrower’s equity is only $1
million. The VTB has priority over the development loan. If John defaults on that VTB, that
vendor/lender has first priority on the property. If the development lender wants to take the property,
he will have to pay the VTB lender the $3 million (plus any arrears and fees) in order to be in a position
to take over the property on a foreclosure.

Assuming that he is able to obtain the development loan, he will then need to find a construction
financier who will agree to provide $4 million to fund the construction of the houses. The construction
lender will usually want to ensure that all 6 houses have been presold by John, with reasonable deposits
paid by those purchasers to ensure that the purchasers are serious about closing.

When John completes the houses and wants to complete the sale of the house to the purchaser he will
need to be in position to give good title to the purchasers, which means he will have to get the
mortgages off the property that the purchaser is buing on closing. In order to do this, he will need the
privilege of obtaining a partial discharge of the mortgages on payment of a certain fixed amount of
money to the lenders in order for them to discharge their mortgages from the particular unit being sold.
After all, he will not complete the sale of all of the hous the same time. Thus, he will have to negotiate
with the lenders as to how much he will have to pay for each partial discharge.

He will also want to pay off the amounts to obtain the discharges without paying any interest penalties
or bonuses, if possible, but lenders may demand bonuses partial discharges.