This chapter

was first
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21

Financing

THERESE L. OBRIEN
OBrien Law Group, P.C.
Orland Park

COPYRIGHT 2011 BY IICLE.

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I. [21.1] Introduction
II. [21.2] Financing Devices
A. Alternative Financing Devices
1. [21.3] Installment Contracts
2. [21.4] Purchase-Money Mortgage
3. [21.5] Assignments of Beneficial Interest in Land Trust
4. [21.6] Absolute Deed
B. [21.7] Mortgages
1. [21.8] Theories of Mortgage Law: Title, Lien, and Intermediate
2. [21.9] Types of Mortgage Loans
a. [21.10] Conforming Loans
b. [21.11] Nonconforming Loans
(1) [21.12] Jumbo loans
(2) [21.13] Subprime loans
c. [21.14] Conventional Mortgage Loans
d. [21.15] Adjustable-Rate Mortgage Loans
e. [21.16] Balloon Loans
f. [21.17] Bridge Loans
g. [21.18] Construction Loans
C. Government Loans
1. [21.19] FHA Loans
2. [21.20] VA Loans
3. [21.21] HUD 203(k) Loans
4. [21.22] FmHA Farm Loans
5. [21.23] Government Loans in General
D. [21.24] Junior Mortgage Loans
1. [21.25] Home Equity Loans
2. [21.26] Wraparound Mortgage Loans
E. [21.27] Reverse Mortgages
III. [21.28] Mortgage Insurance/Private Mortgage Insurance
IV. [21.29] Sources of Financing
A. [21.30] Primary and Secondary Sources
B. [21.31] Contract Issues Affecting Financing

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V. The Loan Process

A. Preliminary Considerations
1. [21.32] Type of Loan
2. [21.33] Residential Mortgage Licensee
3. [21.34] Preapproval
4. [21.35] Predatory Lending
5. [21.36] Anti-Predatory Lending Database Program
B. Formal Requirements
1. [21.37] Application
2. [21.38] Good-Faith Estimate
3. [21.39] Processing
4. [21.40] Underwriting
5. [21.41] Appraisal
6. [21.42] Commitment and Conditions
7. [21.43] Closing the Loan
8. [21.44] Loan Package
9. [21.45] Fees
C. Post-Loan Closing Considerations
1. [21.46] Prepayments
2. [21.47] Escrows and Impounds
3. [21.48] Termination of Private Mortgage Insurance
4. [21.49] Payoff and Release
VI. [21.50] State and Federal Regulation of the Mortgage Industry
A. [21.51] Federal Regulation
1. [21.52] Truth in Lending Act
2. [21.53] Fair Credit Reporting Act
3. [21.54] Equal Credit Opportunity Act
4. [21.55] Real Estate Settlement Procedures Act
5. [21.56] Home Mortgage Disclosure Act
6. [21.57] Housing and Economic Recovery Act
B. [21.58] State Regulation
VII. [21.59] Distressed Real Estate Sellers
A. [21.60] Loan Modification
B. [21.61] Short Sale
C. [21.62] Deed in Lieu of Foreclosure

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D. [21.63] Income Tax Consequence

E. [21.64] Impact on Credit Scores
VIII. Appendix Forms
A. [21.65] Sample Note
B. [21.66] Sample Security Instrument (Mortgage)

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21.1

I. [21.1] INTRODUCTION
This chapter is intended as a primer on the principles and procedures commonly encountered
in conjunction with financing the purchase of residential real estate. It is a foundation from which
persons unfamiliar with residential real estate transactions can develop an understanding of the
role financing plays in a typical residential transaction. This chapter explores sources of
financing, types of loans available, the mortgage loan process, closing the mortgage loan, and
regulation of the mortgage industry. It is not intended as a discussion of the mortgage industry,
the mortgage markets, or the recent financial crisis as it relates to the mortgage markets. It is a
practical resource addressing one critical aspect of the residential real estate transaction. But for
the requisite financing, the transaction will not close.
In the purchase and sale of residential real estate, a cash deal is always preferred.
Unfortunately, it is the exception, not the rule. Most often, a purchaser will need to obtain
financing in order to consummate the transaction. Although alternative financing devices exist,
the device most often utilized is a mortgage loan. Historically, mortgages were obtained from
neighborhood banks at fixed interest rates paid over 30 years. In recent years, the financial
services industry witnessed the expansion of residential mortgage lending, resulting in a dramatic
increase in the types of mortgage loans offered and their being obtained through, most rarely, the
neighborhood bank. Mortgage loans were readily available as underwriting standards were
minimal at best. This overzealous lending environment led to an abundance of subprime, interestonly, and adjustable-rate loans being made to persons unable to repay the debt. A high default
percentage of these loans contributed to the financial crisis of 2008. In response, creditors have
tightened underwriting standards, and funds available to finance the purchase of residential real
estate are available to only the most creditworthy borrowers.
Todays borrowers are faced not only with a limited choice of lenders but also with less funds
available to borrow, fewer loan products to choose from, and stringent underwriting guidelines. In
addition, they are faced with financial obstacles stemming from the abundance of distressed and
real estate owned (REO) properties (bank-owned properties) available. As a result of the financial
loss associated with these properties, these sellers typically shift customary seller contractual
obligations and closing costs to the purchaser, thereby further burdening the purchaser.
The financial crisis impacted not only the nature of the transaction and the responsibilities of
the parties but also the regulatory aspect of financing the transaction. The most notable changes
include those made to the Truth in Lending Act (TILA), 15 U.S.C. 1601, et seq., and the Real
Estate Settlement Procedures Act of 1974 (RESPA), 12 U.S.C. 2601, et seq., and the creation of
the Housing and Economic Recovery Act of 2008 (HERA), Pub.L. No. 110-289, 122 Stat. 2654.
Under TILA and RESPA, the U.S. Department of Housing and Urban Development (HUD) has
implemented simplified disclosure requirements in a new, easy to understand Good Faith
Estimate form and a new HUD-1 and HUD-1A Settlement Statement, which are available at
www.hud.gov/offices/hsg/rmra/res/gfestimate.pdf and http://portal.hud.gov/hudportal/HUD?src=/
program_offices/administration/hudclips/forms (case sensitive), respectively. In addition, HERA
authorized the creation of a conservatorship for Fannie Mae and Freddie Mac, the two
government-sponsored entities that play a crucial role in mortgage financing. See 21.30 below.

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The financial crisis and the resulting regulatory changes have created a challenging credit
environment for borrowers. Unless the purchaser has cash in hand, prepare for a time-consuming
and tedious undertaking.

II. [21.2] FINANCING DEVICES

In a typical residential transaction, a purchaser will secure a mortgage loan from a third-party
lender. However, alternatives do exist. These include installment contracts, purchase-money
mortgages, assignments of beneficial interests, and absolute deeds. Throughout history,
alternative financing devices have been utilized by creditors for reasons that include
circumventing the judicial mortgage foreclosure proceeding and the debtors equity of
redemption. Currently, however, the use of alternative financing devices occurs most often when
a purchaser is unable to obtain a mortgage loan and looks to the seller to finance a portion of the
purchase price.
A. Alternative Financing Devices
1. [21.3] Installment Contracts
The installment contract (also referred to as the contract for deed) is a form of seller
financing. It is a transaction in which the parties agree that (a) the buyer will take immediate
possession of the property, (b) the buyer will pay the purchase price over time (in installments),
and (c) the seller will retain title to the property until the buyer completes its purchase obligation.
The buyer typically assumes responsibility for property taxes and maintenance, and the contract
typically provides that, upon default, the buyer will forfeit all money paid and the seller will
regain possession. The installment contract is an executory contract a contract that is yet to be
fully completed or performed. It is a contract on which performance remains due to some extent
on both sides. In re Liquidation of Inter-American Insurance Company of Illinois, 329 Ill.App.3d
606, 768 N.E.2d 182, 263 Ill.Dec. 422 (1st Dist. 2002). In general, an installment contract vests
equitable title in the buyer, while the seller maintains legal title until such time as the contract is
paid in full. Shay v. Penrose, 25 Ill.2d 447, 185 N.E.2d 218 (1962). The contract may specifically
provide that there is no transfer of even equitable title. Eade v. Brownlee, 29 Ill.2d 214, 193
N.E.2d 786, 788 (1963). However, even when the contract provides that no equitable title will
pass, courts still find that the buyer has a recognizable beneficial interest in the property. Ruva v.
Mente, 143 Ill.2d 257, 572 N.E.2d 888, 157 Ill.Dec. 424 (1991). For information on the
termination of installment contracts, see REAL ESTATE LITIGATION (IICLE, 2008, Supp.
2010).
2. [21.4] Purchase-Money Mortgage
Similar to the land installment contract, a purchase-money mortgage (PMM) is a form of
seller financing wherein the mortgage secures the indebtedness from the buyer to the seller of real
estate. With a PMM, the seller conveys legal title of the property to the purchaser, who is
obligated to pay all of the property-related expenses and obtains risk of loss in the event of a
casualty. The purchaser usually pays a significant down payment to the seller at closing and then

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21.7

makes interest and principal payments on the purchase-money financing over a period of time
that usually lasts one to five years. If there is a default by the purchaser in making the payments
or otherwise performing under the loan agreement, the seller may reacquire the property and
retain the down payment and portion of the purchase-money financing paid to date. The benefit of
a land installment contract and a PMM is that they allow the purchaser to obtain property with a
relatively small amount of cash and may present an opportunity for a purchaser with questionable
credit to acquire property while preparing to secure permanent financing.
3. [21.5] Assignments of Beneficial Interest in Land Trust
An assignment of beneficial interest (ABI) in an Illinois land trust can be pledged as
collateral security for the payment of a debt. The documentation executed to effect an ABI
includes an assignment, an acceptance, and a consent of the beneficial interest in the land trust. A
note and security agreement that pledge the beneficial interest as collateral will accompany the
ABI. Once the assignment and acceptance are acknowledged by the trustee, the lenders interest
is perfected without any other filing or recording requirements.
4. [21.6] Absolute Deed
The absolute deed as a financing device contemplates a deed given to the lender as security
on a loan with an agreement between the parties that the lender (creditor) will reconvey the
property to the borrower (debtor) only if the debtor pays the debt. A question may arise as to
whether a deed was intended as a conveyance or merely as a security device. Every deed
conveying real estate, which shall appear to have been intended only as a security in the nature of
a mortgage, though it be an absolute conveyance in terms, shall be considered as a mortgage.
765 ILCS 905/5. Under the doctrine of equitable mortgage, in order for a court to convert a deed
that is absolute on its face into a mortgage, it is essential for a mortgage that there be a debt
relationship. Nave v. Heinzmann, 344 Ill.App.3d 815, 801 N.E.2d 121, 279 Ill.Dec. 829 (5th Dist.
2003). The factors to consider in determining whether a deed that is absolute in form was
intended to be a mortgage include the relationship of the parties, the circumstances surrounding
the transaction, the adequacy of the consideration, and the situation of the parties after the
transaction. 801 N.E.2d at 126. Agreements to reconvey property are an indication that the parties
intended the transaction to be a mortgage under the Mortgage Act, 765 ILCS 905/0.01, et seq.,
and not a conveyance. 801 N.E.2d at 127.
B. [21.7] Mortgages
A mortgage is an interest in land created by written instrument providing security in real
estate to secure the payment of a debt. Aames Capital Corp. v. Interstate Bank of Oak Forest, 315
Ill.App.3d 700, 734 N.E.2d 493, 248 Ill.Dec. 565 (2d Dist. 2000). The debt is the principal
obligation, and if there is no valid existing debt, there can be no mortgage. Thus, a debt
relationship is essential to a mortgage. McGill v. Biggs, 105 Ill.App.3d 706, 434 N.E.2d 772, 61
Ill.Dec. 417 (3d Dist. 1982). See also Evans v. Berko, 408 Ill. 438, 97 N.E.2d 316 (1951). The
obligation to repay the amount financed is evidenced by a promissory note requiring repayment
of the funds borrowed, plus interest, in regular monthly installment payments referred to as
amortization. The promissory note is secured by a mortgage held as security for the

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performance of repayment of the loan. The mortgage is recorded in the office of the recorder in
the county where the property is located, creating a lien on the property in favor of the lender
(mortgagee). If the borrower (mortgagor) defaults on the loan, the mortgagee can foreclose its
lien, have the property sold, and apply the proceeds toward the repayment of the debt. Lenders
are secure in knowing that if the borrower does not repay the debt, the lender can obtain title to
the property. Conversely, the borrower knows that when the debt is paid in full, the mortgage lien
will be released and the borrower will hold an unencumbered title to the property.
Because a mortgage involves a transfer of an interest in real estate, it is subject to the statute
of frauds. The court in Enos v. Hunter, 9 Ill. (4 Gilm.) 211, 219 (1847), stated, As a general rule,
the policy of the law requires that everything which may affect the title to real estate, shall be in
writing; that nothing shall be left to the frailty of human memory. In Corbridge v. Westminster
Presbyterian Church & Society, 18 Ill.App.2d 245, 151 N.E.2d 822, 831 (2d Dist. 1958), the
court, quoting Wiley v. Dunn, 358 Ill. 97, 192 N.E. 661, 663 (1934), stated, [E]verything which
affects the title to real estate shall be in writing. Similarly, mortgages are the subject of state law.
Because mortgages are concerned with transactions relating to real property and are governed by
the same general principles as conveyances of real property, in general the validity of a mortgage
on realty is determined by the law of the state where the land is located. 16 AM.JUR.2d Conflict
of Laws 45 (1998).
1. [21.8] Theories of Mortgage Law: Title, Lien, and Intermediate
American courts have traditionally recognized one of three theories of mortgage law title,
lien, and intermediate. Under the title theory, legal title to the mortgaged real estate remains in
the mortgagee until the mortgage is satisfied or foreclosed. In lien theory jurisdictions, the
mortgagee is regarded as owning a security interest only, and both legal and equitable title remain
in the mortgagor until foreclosure. Under the intermediate theory, legal and equitable title
remains in the mortgagor until a default, at which time legal title passes to the mortgagee. These
three mortgage law theories are the product of several centuries of English and American legal
history. RESTATEMENT (THIRD) OF PROPERTY: MORTGAGES 4.1 (1997). The
substantial majority of American jurisdictions follow the lien theory. Under this theory, the
mortgagee acquires only a lien on the mortgaged real estate, and the mortgagor retains both
legal and equitable title and the right to possession until foreclosure or a deed in lieu of
foreclosure. Id.
The general view is that Illinois adopted the lien theory in 1984. See Harms v. Sprague, 105
Ill.2d 215, 473 N.E.2d 930, 85 Ill.Dec. 331 (1984); Kelley/Lehr & Associates, Inc. v. OBrien,
194 Ill.App.3d 380, 551 N.E.2d 419, 141 Ill.Dec. 426 (2d Dist. 1990) (referring to Illinois as lien
theory state). However, under legislation enacted in 1987, as to residential real estate, the
mortgagor shall be entitled to possession of the real estate. 735 ILCS 5/15-1701(b)(1). However,
if the mortgage so authorizes and the court is satisfied that there is a reasonable probability that
the mortgagee will prevail on a final hearing [in foreclosure and the mortgagee shows good cause
for being placed in possession], the court shall upon request place the mortgagee in possession.
Id.

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21.13

2. [21.9] Types of Mortgage Loans

There are a number of mortgage products available to a purchaser of residential real estate.
The options vary depending on the circumstances of the transaction. Circumstances may include
the type of property purchased, the purpose of the loan (owner occupied or investment), the loanto-value ratio (amount of funds borrowed as compared to the value of the property), the desired
term of the loan, the creditworthiness of the borrower, and the desire for a fixed versus variable
rate. Notwithstanding the foregoing, due to the recent collapse of the subprime mortgage market,
certain types of mortgages may no longer be available as investor skepticism has lessened the
availability of credit in the mortgage market. At a minimum, all mortgage loans are considered
either conforming or nonconforming.
a. [21.10] Conforming Loans
A conforming loan is a mortgage loan that conforms to the guidelines of a governmentsponsored enterprise (GSE). GSEs are a group of financial services corporations created by the
U.S. Congress whose function is to enhance the flow of credit to targeted sectors of the economy
and to make those segments of the capital market more efficient. The desired effect of the GSE is
to enhance the availability and reduce the cost of credit to the targeted borrowing sectors,
including residential home finance. The residential home finance segment is by far the largest of
the borrowing segments in which the GSEs operate. The GSEs of this residential home finance
segment are Fannie Mae and Freddie Mac.
b. [21.11] Nonconforming Loans
A nonconforming loan is any loan that does not meet the underwriting guidelines of Fannie
Mae or Freddie Mac and is typically categorized as either a jumbo loan or a subprime loan.
(1)

[21.12] Jumbo loans

A jumbo mortgage loan is a loan in which the amount borrowed exceeds the industrystandard definition of conventional conforming loan limits as set annually by the two largest
secondary market lenders, Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac, as the
largest government-sponsored agencies that purchase the bulk of residential mortgages in the
U.S., set limits on the maximum dollar value of any mortgage they will purchase. Thus, jumbo
mortgages apply when Fannie Mae and Freddie Mac limits do not cover the full loan amount.
Jumbo loans are commonly provided by large investors, including insurance companies and
banks. The average interest rate on a jumbo is typically greater than is normal for conforming
mortgages due to the higher risk to the lender. The spread depends on the current market price of
risk. Typically, the spread fluctuates between 0.25 percent and 0.5 percent; however, at times of
high investor anxiety, it can exceed a full percentage point.
(2)

[21.13] Subprime loans

A loan that does not meet the underwriting standards of either Fannie Mae or Freddie Mac for
reasons other than the loan amount is called subprime. Subprime loans have a higher credit risk

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that may be the result of a borrowers prior bankruptcy, high debt, slow or bad payment history,
or any other factors that result in a low credit score. Although subprime loans serve a legitimate
purpose, counsel should be aware that this market is also seen by some lenders as an opportunity
for predatory lending that can include an unreasonable markup in the interest rate or lender fees
passed on to the borrower.
Subprime mortgages emerged on the financial landscape more than two decades ago but did
not gain popularity until mid-1990. This expansion was fueled by several factors including the
development of credit scoring (means by which a lender assesses price and risk), as well as the
ongoing growth in the secondary mortgage market that increased the ability of lenders to sell
mortgages to various intermediaries instead of carrying the loans on their books. The
intermediaries or securitizers pooled large numbers of mortgages and sold the rights to the cash
flow to investors. This originate to distribute process allowed lenders to share the risk more
broadly and increased the supply of mortgage credit. Many lenders will not deal with borrowers
who apply for nonconforming loans, while other lenders specialize in this market. Private,
nongovernment-chartered enterprises buy nonconforming loans, securitize them in pools, and
issue mortgage-backed securities, which are sold on the open market. The abundance of subprime
mortgages resulting in default have been identified as one of the major factors contributing to the
financial crisis of 2008 and are virtually nonexistent today.
c. [21.14] Conventional Mortgage Loans
A conventional mortgage loan is any mortgage loan that is not guaranteed or insured by the
federal government. The mortgage is conventional in that the lender looks only to the credit of the
borrower and the security of the property and not to the additional backing of another.
d. [21.15] Adjustable-Rate Mortgage Loans
An adjustable-rate mortgage (ARM) is a mortgage loan in which the interest rate is not fixed
but is tied to a commercially acceptable standard referred to as an index. The rate is
periodically adjusted as the index moves up or down. The borrowers monthly payment is then
adjusted at predetermined intervals to reflect the rate of adjustment. The index rate is used as the
starting point to which the adjustment margin (the number of points that the loan interest rate can
be increased or decreased on the adjustment date) is added to set the interest rate of the ARM.
The ARM may contain a cap on either the amount the rate can change at each adjustment interval
or a cap on the change of the rate over the lifetime of the loan or both. Many ARMs carry an
introductory rate (teaser rate), which is a low interest rate for an initial period of time. At a
predetermined date, the interest rate adjusts to the market rate.
Examples of the types of ARMs available include fixed-period adjustable-rate and interestonly loans. The fixed-period adjustable-rate mortgage has an initial fixed-rate period, after which
the rate may adjust either upward or downward annually based on the cap structure and the index
chosen. The interest-only feature allows borrowers to make lower payments on an ARM by
offering an interest-only period during the early years of the loan, followed by a fully amortizing
period. Generally speaking, mortgages with the interest-only feature are intended for financially
informed borrowers who are prepared for the increased mortgage payment when the loan
converts to a fully amortizing payment.

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21.19

e. [21.16] Balloon Loans

A balloon-payment mortgage is a mortgage that does not fully amortize over the term of the
note, thereby leaving a balance due at maturity larger than the previous monthly installments. The
interest rate may be fixed or variable, and the final payment is called a balloon payment
because of its large size. Since a borrower may not have the resources to make the balloon
payment at the end of the loan term, a two-step mortgage plan may be utilized. Under a two-step
plan, also known as a reset option, the mortgage note resets using current market rates and a
fully amortized payment schedule. This option is not automatic and may be available only if the
borrower is still the owner/occupant of the property, has no 30-day late payments in the preceding
12 months, and has no other liens against the property. A balloon differs from an adjustable-rate
mortgage in that a balloon will require payoff or refinance (absent a reset option), while an ARM
most often will adjust automatically at the end of the applicable period with no refinancing
needed.
f.

[21.17] Bridge Loans

A bridge loan is a form of interim financing commonly used when a borrower purchases a
new home prior to selling his or her existing home. It is a short-term balloon loan, usually for a
number of months, that carries a higher interest rate than permanent financing and requires
interest-only payments until the end of the short term, at which time the balance is due. A buyers
mortgage commitment may require that a borrower sell an existing home before permanent
financing will be funded.
g. [21.18] Construction Loans
Construction loans provide funds to a developer during the period of construction of
improvements on the real estate and are usually secured by a first mortgage on the real estate. A
construction loan agreement sets forth the conditions precedent to funding the loan and
establishes procedures for periodic payments. Lenders typically utilize a construction escrow,
either in-house or through a title company, that requires a general contractor and subcontractors
to submit lien waivers to support the periodic draws. Upon completion of the improvements, the
construction loan is converted to permanent financing.
C. Government Loans
1. [21.19] FHA Loans
Federal Housing Administration (FHA) loans are government-insured loans made through
FHA-approved lenders. The FHA is a unit of the Department of Housing and Urban
Development, which administers various programs of mortgage insurance under the National
Housing Act, 12 U.S.C. 1701, et seq. 42 U.S.C. 3533. There are several FHA loan programs
that make loans available to first-time home buyers of one- to four-family dwellings, mobile
home buyers, condominium unit buyers, low- and moderate-income families, and co-op units.
The lender must apply for FHA insurance on each loan, showing that the loan meets the criteria
for one of the available insurance programs. Although FHA-insured loans are commonly

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available, they are not available from all financial institutions. Only those institutions approved
by the FHA that are willing to provide relatively small loan amounts, tolerate the FHAs authority
to mandate repairs to the property as a condition of a loan, and endure the extended time it takes
to close an FHA loan can offer an FHA-insured loan.
2. [21.20] VA Loans
The U.S. Department of Veterans Affairs (VA) provides assistance in obtaining mortgage
loans to qualified military veterans for the acquisition, construction, improvement, or refinance of
a primary residence. See 38 U.S.C. 3701, et seq. These benefits are intended to enable veterans
to obtain housing on more favorable terms and to protect the veteran and the lender against loss
on foreclosure. United States v. Shimer, 367 U.S. 374, 6 L.Ed.2d 908, 81 S.Ct. 1554 (1961). The
benefits include the possibility of no down payment, competitive interest rates, and the ability to
prepay a loan without penalty. In addition, the VA requires a VA appraisal and compliance
inspections to ensure the reasonable value of the property.
3. [21.21] HUD 203(k) Loans
The Department of Housing and Urban Developments Federal Housing Administration
makes available loans through FHA-approved lending institutions for the rehabilitation and repair
of single-family homes. These loans, known as 203(k) loans, which are intended to enable HUD
to promote and facilitate the restoration and preservation of the nations existing housing stock,
are authorized under 12 U.S.C. 1709(k), as amended by 101(c) of the Housing and Community
Development Amendments of 1978, Pub.L. No. 95-557, 92 Stat. 2080. See also 24 C.F.R.
203.50,
203.440

203.494.
As
explained
on
HUDs
website
at
www.hud.gov/offices/hsg/sfh/203k/203kabou.cfm:
Most mortgage financing plans provide only permanent financing. That is, the
lender will not usually close the loan and release the mortgage proceeds unless the
condition and value of the property provide adequate loan security. When
rehabilitation is involved, this means that a lender typically requires the
improvements to be finished before a long-term mortgage is made.
When a homebuyer wants to purchase a house in need of repair or modernization,
the homebuyer usually has to obtain financing first to purchase the dwelling;
additional financing to do the rehabilitation construction; and a permanent
mortgage when the work is completed to pay off the interim loans with a permanent
mortgage. Often the interim financing (the acquisition and construction loans)
involves relatively high interest rates and short amortization periods. The Section
203(k) program was designed to address this situation. The borrower can get just
one mortgage loan, at a long-term fixed (or adjustable) rate, to finance both the
acquisition and the rehabilitation of the property. To provide funds for the
rehabilitation, the mortgage amount is based on the projected value of the property
with the work completed, taking into account the cost of the work. To minimize the
risk to the mortgage lender, the mortgage loan (the maximum allowable amount) is

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eligible for endorsement by HUD as soon as the mortgage proceeds are disbursed
and a rehabilitation escrow account is established. At this point the lender has a
fully-insured mortgage loan.
Additional information about 203(k) loans may be found on the FHAs website and in HUD
HANDBOOK 4240.4, www.hud.gov/offices/adm/hudclips/handbooks/hsgh/4240.4/index.cfm.
4. [21.22] FmHA Farm Loans
The Farmers Home Administration (FmHA) is an agency of the U.S. Department of
Agriculture that provides credit to rural residents who are unable to obtain financing for housing
at reasonable rates and terms from other sources under Title V of the Housing Act of 1949, 42
U.S.C. 1471, et seq. The FmHA also provides loans to acquire and operate small farms. 7 U.S.C.
1921, et seq. Under both programs, the direct or insured loans may include loans that provide for
low initial installment payments and larger subsequent installment payments when the borrower
otherwise would not qualify for a loan in a sufficient amount but has the potential to increase his
or her income in the future. 7 U.S.C. 1934; 42 U.S.C. 1473. For further discussion on this
topic, see 6 ILLINOIS REAL PROPERTY SERVICE 37.29 (1989).
5. [21.23] Government Loans in General

PRACTICE POINTER

The time it takes a borrower to secure an unconditional loan commitment for a

government-insured loan typically is longer than for a conventional loan. Whereas a
conventional loan can be processed, underwritten, and cleared close in an average of 30
calendar days, a government-insured loan can take upwards of 45 to 60 calendar days.
Thus, counsel should be mindful of the time allotted in the financing contingency of the
real estate contract for the buyer to secure an unconditional loan commitment.

D. [21.24] Junior Mortgage Loans

Junior mortgage loans, or second mortgages, enable a borrower to access the equity in the
property without having to refinance a first mortgage. A junior mortgage, recorded subsequent to
the recording of a first or senior mortgage, results in a lower priority. A junior mortgage is
usually for a lesser amount than a first mortgage, is for a relatively short term, and typically has a
higher interest rate than the first mortgage because it poses an increased risk to the mortgagee. A
default by a borrower followed by a foreclosure of the senior mortgage would eliminate the junior
mortgage as a lien on the property. Although there is typically no limit to the number of junior
mortgages that may be placed against a property, the terms of a senior mortgage may consider the
recording of a junior mortgage against the property a default.
1. [21.25] Home Equity Loans
A home equity loan (HEL) is a consumer credit plan that provides for any extension of credit
that is secured by the borrowers principal dwelling. 15 U.S.C. 1637a(a). An HEL is a closed-

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end loan in which the borrower receives funds in a lump sum at the time of closing and cannot
borrow further. An HEL may also take the form of a line of credit referred to as a home equity
line of credit (HELOC). A HELOC is a revolving credit loan in which the borrower can choose
when and how often to borrow against the equity in the property, with the lender setting an initial
limit to the credit line based on criteria similar to those used for closed-end loans. HELs usually
bear a slightly higher interest rate than the first or senior mortgage.
2. [21.26] Wraparound Mortgage Loans
A wraparound mortgage is a second mortgage that wraps around or exists in addition to a first
or other mortgages. In a wraparound mortgage, the lender assumes the first mortgage obligation
and also loans additional funds, taking back from the mortgagee a junior mortgage in the
combined amount at an intermediate interest rate.
E. [21.27] Reverse Mortgages
A reverse mortgage is a loan used to convert a portion of a homeowners equity in the
property into cash. It is the reverse of a traditional mortgage, as here the lender pays the borrower,
and the homeowners obligation to repay the loan is deferred until the owner dies, the home is
sold, or the owner no longer uses the property as a primary residence (e.g., moves into aged care).
Under the Illinois Banking Act, 205 ILCS 5/1, et seq., a reverse mortgage loan shall be a loan
extended on the basis of existing equity in homestead property. 205 ILCS 5/5a. A bank, in
making a reverse mortgage loan, may add deferred interest to principal or otherwise provide for
the charging of interest or premium on the deferred interest. Id. Before borrowing, applicants may
seek free financial counseling from a source that is approved by the Department of Housing and
Urban Development. The counseling is a safeguard for the borrower and his or her family to
make sure the borrower completely understands what a reverse mortgage is and how one is
obtained.

III. [21.28] MORTGAGE INSURANCE/PRIVATE MORTGAGE INSURANCE

Section 10 of the Mortgage Insurance Limitation and Notification Act, 765 ILCS 930/1, et
seq., defines mortgage insurance as including any mortgage guaranty insurance, against the
nonpayment of, or default on, a mortgage or loan involved in a residential mortgage transaction,
the premiums of which are paid by the mortgagor. 765 ILCS 930/10. Private mortgage
insurance (PMI) means mortgage insurance other than mortgage insurance made available under
the National Housing Act, Title 38 of the U.S. Code (veterans benefits), or Title V of the
Housing Act of 1949. It is insurance against loss to the mortgagee in the event of default by the
mortgagor and a failure of the mortgaged property to satisfy the balance owing plus costs of
foreclosure. PMI premiums are paid monthly and are included in the monthly mortgage payment.
When a borrower enters into a transaction for a mortgage and PMI may be required, the lender is
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a. whether PMI will be required;

b. the period during which the insurance shall be in effect; and
c. the conditions under which the mortgagor may cancel the insurance. 765 ILCS 930/15.
Likewise, the lender must notify the mortgagee no less than once a year whether the
insurance may be terminated, the conditions and procedure for termination, and a contact person.
Id. The borrower has the right to request termination of PMI payments when the loan reaches 80
percent of the original value of the property, and the mortgagee will automatically terminate PMI
when the loan reaches 78 percent of the original property value.

PRACTICE POINTER

Historically, a borrower could avoid the PMI requirement by structuring the financing as
a piggyback loan, i.e., an 80/20 loan, 80/10/10 loan, or 80/15/5 loan. In each of these
scenarios, a borrower takes out an 80-percent first mortgage and a second mortgage
(home equity loan) for the balance (less the down payment), thereby eliminating PMI
payments on a loan exceeding conventional limits. These options are rarely available
today.

IV. [21.29] SOURCES OF FINANCING

Depending on the type of financing device utilized, the source of funds will vary. When an
alternative option is used, the source of funds comes from a private party most often, the
seller. When a mortgage from a third-party lender is obtained, the funds come from two general
sources commonly referred to as primary and secondary sources.
A. [21.30] Primary and Secondary Sources
Primary, or institutional, sources of first mortgage loans include commercial banks, savings
and loan associations, credit unions, savings banks, life insurance companies, and pension funds.
Primary sources originate mortgages and provide the initial funding to the borrower. After the
loan is closed, a primary source may retain the loan in its portfolio or may sell the loan to a
secondary source in the secondary mortgage market.
Secondary sources include three federally chartered institutions: the Federal National
Mortgage Association (Fannie Mae), 12 U.S.C. 1717; the Federal Home Loan Mortgage
Corporation (Freddie Mac), 12 U.S.C. 1452; and the Government National Mortgage
Association (Ginnie Mae), 12 U.S.C. 1717. Secondary sources are part of the secondary
mortgage market and are the most active buyers of residential loans originated by primary
sources. The secondary market for mortgage loans comes into play after the mortgage loan has
been originated and funded by a primary source. These three institutions have standard
underwriting guidelines, and any loan that meets these guidelines is considered a conforming

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loan. Once a primary source has originated and funded a loan, it may keep the note and mortgage
in-house in its own portfolio, assign the note and mortgage to another institution (i.e., sell the
loan), or place the loan in a pool with other mortgages having similar characteristics and
securitize the loans. These securitized loans, which meet the standard underwriting guidelines of
Fannie Mae, Freddie Mac, or Ginnie Mae, are salable on the secondary market.
Fannie Mae, www.fanniemae.com, is a government-sponsored enterprise authorized to make
loans and loan guarantees. Fannie Mae plays a central role in mortgage financing. Originally
founded in 1938 as a government agency, its purpose was to create liquidity in the mortgage
market. In 1968, Fannie Mae was converted to a private corporation and ceased to be the
guarantor of government-sponsored loans. That responsibility was transferred to Ginnie Mae.
Fannie Mae makes money by charging a guarantee fee on loans it has pooled and securitized into
mortgage-backed securities (MBSs) that are purchased by investors. Fannie Mae guarantees the
investor repayment of the underlying principal and interest even if the borrower on the underlying
debt defaults. The investors who purchase MBSs pay the guarantee fee in lieu of accepting the
underlying risk on the debt. Fannie Mae is not backed or funded by the United States
Government, nor does it benefit from any government protection or guarantee. However, there is
a perception by investors that the government would prevent Fannie Mae from defaulting on their
debt.
Freddie Mac, www.freddiemac.com, is a GSE that is publicly owned and authorized to make
loans and loan guarantees. Freddie Mac, like Fannie Mae, plays a central role in mortgage
financing. Freddie Mac was created in 1970 for the purpose of expanding the secondary mortgage
market. Freddie Mac buys mortgages on the secondary market, pools them, and sells them to
investors in the open market. Like Fannie Mae, Freddie Mac is not backed or funded by the
United States Government, nor does it benefit from any government protection or guarantee.
Ginnie Mae, www.ginniemae.gov, guarantees investors the timely payment of principal and
interest on MBSs backed by federally insured or guaranteed loans, mainly, those loans insured by
the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Other
guarantors or issuers of loans eligible as collateral for Ginnie Mae MBSs include the Department
of Agricultures Rural Housing Service (RHS) and the Department of Housing and Urban
Developments Office of Public and Indian Housing (PIH). Ginnie Mae is the only MBS that
enjoys the full faith and credit of the United States government.
On September 7, 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae and
Freddie Mac in conservatorship. As conservator, the FHFA has full powers to control the assets
and operations of the firms. Dividends to common and preferred shareholders are suspended but
the U.S. Treasury has put in place a set of financing agreements to ensure that the GSEs continue
to meet their obligations to holders of bonds that they have issued or guaranteed. This means that
the U.S. taxpayer now stands behind trillions of GSE debt. This step was taken because a default
by either of the two firms, which have been battered by the downturn in housing and credit
markets, could have caused severe disruptions in global financial markets, made home mortgages
more difficult and expensive to obtain and had negative repercussions throughout the economy.
See Baird Webel and Edward V. Murphy, Congressional Research Service, The Emergency
Economic Stabilization Act and Current Financial Turmoil: Issues and Analysis (CRS Report for
Congress Order Code RS 22950), www.fas.org/sgp/crs/misc/RL34730.pdf (case sensitive).

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B. [21.31] Contract Issues Affecting Financing

The mortgage contingency provision of a contract is critical. It governs the terms and
conditions of the loan to be obtained by a purchaser. As such, the terms of the mortgage
contingency must be realistic, ascertainable by the borrower (given the borrowers economic
status), and available within current market conditions. The following excerpt from the MultiBoard Residential Real Estate Contract 5.0 exemplifies the extent of terms and conditions to be
considered:
This Contract is contingent upon Buyer obtaining a firm written mortgage
commitment (except for matters of title and survey or matters totally within Buyers
control) on or before_______________, 20____ for a [check one] fixed
adjustable; [check one] conventional FHA/VA (if FHA/VA is chosen, complete
Paragraph 35) other __________________ loan of _____% of Purchase Price,
plus private mortgage insurance (PMI), if required. The interest rate (initial rate, if
applicable) shall not exceed _____% per annum, amortized over not less than _____
years. Buyer shall pay loan origination fee and/or discount points not to exceed
_____% of the loan amount. Buyer shall pay the cost of application, usual and
customary processing fees and closing costs charged by lender. (Complete
Paragraph 33 if closing cost credits apply.) Buyer shall make written loan
application within five (5) Business Days after the Date of Acceptance. Failure to do
so shall constitute an act of Default under this Contract. If Buyer, having applied for
the loan specified above, is unable to obtain such loan commitment and serves Notice
to Seller within the time specified, this Contract shall be null and void. If Notice of
inability to obtain such loan commitment is not served within the time specified, Buyer
shall be deemed to have waived this contingency and this Contract shall remain in full
force and effect. Unless otherwise provided in Paragraph 31, this Contract shall not be
contingent upon the sale and/or closing of Buyers existing real estate. Buyer shall be
deemed to have satisfied the financing conditions of this paragraph if Buyer obtains
a loan commitment in accordance with the terms of this paragraph even though the
loan is conditioned on the sale and/or closing of Buyers existing real estate. If Seller
at Sellers option and expense, within thirty (30) days after Buyers Notice, procures
for Buyer such commitment or notifies Buyer that Seller will accept a purchase
money mortgage upon the same terms, this Contract shall remain in full force and
effect. In such event, Seller shall notify Buyer within five (5) Business Days after
Buyers Notice of Sellers election to provide or obtain such financing, and Buyer
shall furnish to Seller or lender all requested information and shall sign all papers
necessary to obtain the mortgage commitment and to close the loan. [Emphasis in
original.]
The website of the Illinois Real Estate Lawyers Association (IRELA) is the repository of the
Multi-Board Residential Real Estate Contract 5.0. A fillable sample of the contract is available at
www.irela.org/developments_contract_alert.asp. The form is also reprinted in Chapters 2 and 13
of this handbook.

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PRACTICE POINTER

Consult with the borrower-client to ensure that the terms stated in the financing
contingency are ascertainable given the borrowers current economic status and mortgage
market conditions. In the event the terms are unrealistic, seek modification of the same
during the attorney approval period.

It is common for the seller to agree to provide a closing cost credit to the purchaser. Pursuant
to the disclosure requirements of the Real Estate Settlement Procedures Act, such credits must be
disclosed on the HUD-1 Settlement Statement, which is available HUDs website at
http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case
sensitive).

PRACTICE POINTER

Despite the fact that the contract calls for the seller to provide a specific credit (either in
the form of a percentage of the purchase price or a sum certain), it is ultimately the end
lender who dictates the type and amount of the credits allowable on the HUD-1 at
closing. A buyer may expect the disallowed portion to be paid outside of closing;
however, payments made outside closing are prohibited by RESPA and should be
avoided.

V. THE LOAN PROCESS

A. Preliminary Considerations
1. [21.32] Type of Loan
The initial decision confronting a borrower is the type and amount of loan to apply for.
Factors influencing the type of loan include the purpose (owner-occupied versus investment
property), the loan-to-value ratio (amount borrowed as compared to the value of property), the
borrowers credit history, the borrowers current economic condition, how long the borrower
intends to remain in the property, the current interest rate market, and the overall availability of
credit. Factors influencing the amount of the loan include the purchase price of the property, the
amount of the borrowers down payment, amounts needed to improve or repair the property, sums
for payment of any debts the lender requires the borrower to pay, and payment of any loan fees
and closing costs. The second decision confronting a borrower is from whom to get the loan.
2. [21.33] Residential Mortgage Licensee
In Illinois, a mortgage license is required when in the business of brokering, funding,
originating, servicing, or purchasing residential mortgage loans, unless otherwise excepted out.
The Residential Mortgage License Act of 1987, 205 ILCS 635/1-1, et seq., is designed to protect

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Illinois consumers seeking residential mortgage loans and to ensure that the residential mortgage
lending industry is operating fairly, honestly, efficiently, and free from deceptive and
anticompetitive practices; to regulate residential mortgage lending to benefit the citizens of
Illinois by ensuring the availability of residential mortgage funding; to benefit responsible
providers of residential mortgage loans and services; and to avoid requirements inconsistent with
legitimate and responsible business practices in the residential mortgage lending industry. 205
ILCS 635/1-2(b). It specifically provides the following:
No person, partnership, association, corporation or other entity shall engage in the
business of brokering, funding, originating, servicing or purchasing of residential
mortgage loans without first obtaining a license from the Commissioner in
accordance with the licensing procedure provided in this Article I and such
regulations as may be promulgated by the Commissioner. 205 ILCS 635/1-3(a).
The Act applies to all entities doing business in Illinois as residential mortgage bankers,
existing residential mortgage lenders, or residential mortgage brokers, whether or not previously
licensed. 205 ILCS 635/1-3(h). The Act applies to real property located in Illinois upon which is
constructed or intended to be constructed a dwelling. 205 ILCS 635/1-4(a).
A mortgage broker is an intermediary who sources mortgage loans on behalf of individual
borrowers. A mortgage broker neither originates nor funds the loan but negotiates a mortgage
loan with lenders (also referred to as investors or end lenders). Brokers are compensated by
commissions, paid by the lender but earned as a result of selling a higher interest rate to a
borrower, referred to as a yield spread premium. A yield spread premium is a payment from the
lender to the broker for delivering a loan with an interest rate above a preset par rate. The
amount of the premium is determined from a rate sheet provided by the lender. The higher the
interest rate is above the par (or market rate), the higher the yield spread premium that the broker
receives. Watson v. CBSK Financial Group, Inc., No. 01 C 4043, 2002 WL 598521 (N.D.Ill. Apr.
18, 2002). See Johnson v. Matrix Financial Services Corp., 354 Ill.App.3d 684, 820 N.E.2d 1094,
290 Ill.Dec. 27 (1st Dist. 2004). A mortgage banker commonly uses its own source of capital to
originate mortgage loans that are then sold to institutional lenders. Banks, via their loan officer
employees, originate mortgage loans that are then either held in the banks portfolio or sold on
the secondary mortgage market.
A mortgage broker shall be considered to have created an agency relationship with the
borrower in all cases. 205 ILCS 635/5-7(a). A mortgage broker shall act in a borrowers best
interests and deal with the borrower in good faith. 205 ILCS 635/5-7(a)(1). A mortgage broker
must disclose all material facts to a borrower and must use reasonable care in carrying out his or
her duties. 205 ILCS 635/5-7(a)(3), 635/5-7(a)(4).
3. [21.34] Preapproval
Although not a universal practice, it is common for a buyer to obtain a prequalification or
preapproval letter. Preapproval means that the buyer has made an attempt to ensure that the buyer
can afford the property and will qualify for a mortgage before an offer is made. It is an opinion by
a residential mortgage licensee that is based on the information furnished by the buyer that the

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buyer will qualify for a mortgage of a stated amount if the collateral value is sufficient. A
preapproval is limited to a buyers qualification, based on the buyers representations, and is not
limited to a particular parcel of property. It is not a commitment by a lender to make a mortgage
and should not be relied on by buyers counsel as fulfillment of a buyers obligation under a
contractual financing contingency.

PRACTICE POINTER

A preapproval letter has no legal significance.

4. [21.35] Predatory Lending

The term predatory lending is not defined by Illinois law but most closely refers to a
number of restricted practices for state licensed or chartered residential mortgage brokers and
lenders under the High Risk Home Loan Act, 815 ILCS 137/1, et seq., which is commonly
referred to as the Illinois predatory lending law. This Act, which took effect January 1, 2004,
protects borrowers who enter into high-risk home loans from abuses that occur in the credit
marketplace. Its express purpose is
to protect borrowers who enter into high risk home loans from abuse that occurs in
the credit marketplace when creditors and brokers are not sufficiently regulated in
Illinois. This Act is to be construed as a borrower protection statute for all purposes.
This Act shall be liberally construed to effectuate its purpose. 815 ILCS 137/5.
It contains a number of consumer-oriented protections designed to prohibit high-cost loans that
borrowers cannot afford to pay back. P.A. 93-561, which adopted the High Risk Home Loan Act,
also amended 2Z of the Consumer Fraud and Deceptive Business Practices Act (Consumer
Fraud Act), 815 ILCS 505/2Z, so that any person who knowingly violates the High Risk Home
Loan Act also commits an unlawful practice under the Consumer Fraud Act. Further, P.A. 93-561
amended the Illinois Fairness in Lending Act, 815 ILCS 120/1, et seq., authorizing the Illinois
Attorney General to file an action to enjoin any person from violating the Fairness in Lending
Act.
5. [21.36] Anti-Predatory Lending Database Program
Started as a pilot program, the Anti-Predatory Lending Database Program has been
established under 70, et seq., of the Residential Real Property Disclosure Act. 765 ILCS 77/70,
et seq. The purpose of the Program, which is administered by the Illinois Department of Financial
and Professional Regulation, is to reduce predatory lending practices by assisting the borrower in
understanding the terms and conditions of the loan for which he or she has applied. Based on
information submitted by the mortgage broker or loan originator, the Department may require the
borrower to attend HUD-certified mortgage counseling. 765 ILCS 77/70(c). The broker or
originator and the borrower may not take any legally binding action concerning the loan
transaction until the later of (a) the Department issuing a determination not to recommend HUD-

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certified counseling for the borrower or (b) the Department issuing a determination that HUDcertified credit counseling is recommended for the borrower and the credit counselor submits all
required information for the database in accordance with 765 ILCS 77/70(d). 765 ILCS 77/70(e).
The Program began July 1, 2008, in Cook County and July 1, 2010, in Kane, Peoria, and Will
Counties. 765 ILCS 77/70(a-5). A completion certificate or a certificate of exemption must be
recorded with the mortgage. 765 ILCS 770/70(g).
All owner-occupied, one- to four-unit residential property is subject to the Residential Real
Property Disclosure Act. 765 ILCS 77/5. Exempt property (not subject to the Act) includes nonowner-occupied property, commercial property, residential property of more than four units, and
government property. In addition, reverse mortgages are exempt. 765 ILCS 77/78.
Any entity not required to be licensed under the Residential Mortgage License Act, such as
banks and other depository financial institutions, as well as certain limited private lenders (such
as an individual making a loan to a family member), are exempt from the Program. 765 ILCS
77/70(a). Exempt entities are not required to enter information into the database but must obtain a
certificate of exemption from the closing agent to record their mortgages. Loans by these entities
may go directly to closing upon approval. If an exempt entity, such as a bank, chooses to close its
own loans, it must register as a closer. See the Anti-Predatory Lending Database Program website
at www.ilapld.com/overview.aspx.
B. Formal Requirements
1. [21.37] Application
The first step in obtaining financing is the application process. After selecting a residential
mortgage licensee, the borrower completes a mortgage application, e.g., Fannie Mae Form
1003/Freddie
Mac
Form
65,
Uniform
Residential
Loan
Application,
www.efanniemae.com/sf/formsdocs/forms/1003.jsp. The loan application requires information
from which the lender can make a preliminary credit analysis. However, before a licensee may
accept an application or application fee, the licensee must give the borrower a borrower
information document. This document operates to inform the borrower of the specific
information the licensee is required to provide and what information must be available upon
borrowers request. The document states:
This document is being provided to you pursuant to the Residential Mortgage
License Act of 1987 and Rules promulgated thereunder (38 Ill. Adm. Code 1050).
The purpose of this document is to set forth those exhibits and materials you should
receive or be receiving in connection with your residential mortgage loan
application with (name of licensee), holder of License (license number) and
regulated by the State of Illinois, Division of Banking, under the aforesaid Act. 38
Ill.Admin. Code 1050.1110(a).
The documents included are the federal settlement cost booklet required under the Real Estate
Settlement Procedures Act (see 21.38 below), the good-faith estimate of costs required under 12

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C.F.R. pt. 226 (see id.), a copy of the Mortgage Escrow Account Act, 765 ILCS 910/1, et seq. (if
applicable), and the Federal Reserve Boards Consumer Handbook on Adjustable-Rate
Mortgages
as
required
under
12
C.F.R.
535.33
(if
applicable)
(see
www.federalreserve.gov/pubs/arms/armsbrochure.pdf). 38 Ill.Admin. Code. 1050.1110(c)
1050.1110(g). In addition, the following documents must be made available to the borrower upon
request: a sample of the form of note and mortgage that will be executed if the loan applied for is
approved; a sample copy of the commitment letter; and a general description of the underwriting
standards that will be considered in evaluation of the application. 38 Ill.Admin. Code
1050.1110(h).
The application entails the submission of a borrowers financial information in anticipation of
a credit decision relating to a mortgage loan. The application itself includes the borrowers name,
the borrowers monthly income, the borrowers social security number (for obtaining a credit
report), the property address, an estimate of the value of the property, the mortgage loan amount
sought, and any other information deemed necessary by the loan originator. The balance of the
application package typically consists of a number of documents to be completed by the
borrower, which are then submitted to the licensee along with an application fee. The purpose of
the application fee is to ensure a borrower is serious about wanting a loan and acts as
compensation to the lender in the event the loan is rejected or the borrower walks. Some lenders
credit this fee back to the borrower at closing on the HUD-1 Settlement Statement, available at
http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case
sensitive). Although paid prior to settlement, it is required to be disclosed by the lender on the
HUD-1 and labeled POC (paid outside closing). If the application fee is used to pay other fees,
such as the cost of the appraisal or credit report, those separate costs should also be disclosed, but
a footnote should be used to show that those charges were paid from the application fee. These
items likewise should be marked POC.
The application does not constitute a contract to make a mortgage loan and does not create a
fiduciary relationship between the lender and borrower. However, the lender may be liable in a
fraud action for misrepresentations as to its actions on, or the status of, the application and may
be liable in negligence if the lender fails to process the loan application with due care. High v.
McLean Financial Corp., 659 F.Supp. 1561 (D.D.C. 1987). In addition, the borrower may be held
criminally liable if the borrower knowingly provides false information in order to influence a
lender that has accounts insured by Federal Deposit Insurance Corporation, the Federal Home
Loan Bank System, the Farm Credit System Insurance Corporation, or the National Credit Union
Administration Board. 18 U.S.C. 1014. The borrower may also be convicted of obtaining money
from a bank under false pretenses. 18 U.S.C. 2113(b); United States v. Bradley, 812 F.2d 774
(2d Cir. 1987).
2. [21.38] Good-Faith Estimate
In certain residential transactions, a creditor must make a good-faith estimate (GFE) of the
costs of the settlement services. The GFE required by the Real Estate Settlement Procedures Act
is intended to give borrowers sufficient information to allow them to make informed choices as to
providers of settlement services and to avoid surprises at settlement (i.e., closing). The obligation
to provide the GFE falls on the lender or the mortgage broker and is to be given to all applicants

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for the loan. The GFE must be provided no later than 3 business days after a mortgage broker or
lender receives an application or information sufficient to complete an application. 24 C.F.R.
3500.7(a)(1). The lender cannot charge any fee for an appraisal, inspection, or other settlement
service as a condition for providing the GFE; however, the lender may collect a fee equal to the
cost of obtaining a credit report. 24 C.F.R. 3500.7(a)(4). The actual charges at settlement may
not exceed the amounts included on the GFE. 24 C.F.R. 3500.7(e). Certain tolerances for
specific costs are allowed (id.), but if changed circumstances affecting the settlement costs exceed
the allowable tolerances, then the loan originator must provide a revised GFE within 3 business
days of receiving the information. 24 C.F.R. 3500.7(f)(1). If the changed circumstances affect a
borrowers eligibility for a specific loan, the originator likewise must provide a revised GFE
within 3 business days of receiving the information. 24 C.F.R. 3500.7(f)(2). If settlement is
expected to occur more than 60 calendar days from the time the GFE is provided, the originator
may provide an updated GFE to the borrower at any time provided the original GFE contained a
clear and conspicuous disclosure statement. If not, a revised GFE may be made only as otherwise
provided in 24 C.F.R. 3500.7(f). 24 C.F.R. 3500.7(f)(6). The Department of Housing and
Urban Developments revised Good Faith Estimate form is available at
www.hud.gov/offices/hsg/rmra/res/gfestimate.pdf.

PRACTICE POINTER

A revised version of Shopping for Your Home Loan: HUDs Settlement Cost Booklet
(rev. Jan. 6, 2010) is available at www.hud.gov/offices/hsg/ramh/res/settlement-costbooklet01062010.cfm. This booklet includes a simple, step-by-step, line-by-line
explanation of the GFE form that can be used as a valuable learning tool for a practitioner
who is unfamiliar with the GFE. Additionally, since the figures disclosed on the GFE
transfer to the identical line on the HUD-1 Settlement Statement,
http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/form
s (case sensitive), the practitioner can use this same simple tool to further his or her
understanding of the HUD-1.

3. [21.39] Processing
Loan processing is the period of time during which the lender evaluates the borrowers loan
application and credit history. The lender will obtain the borrowers credit report and
corresponding credit score. A credit score, developed by FICO (formerly known as Fair Isaac
Corporation), is a numerical expression based on a statistical analysis of a persons credit files,
which represents the creditworthiness of that person and the likelihood that the person will pay
his or her debts in a timely manner. Credit reporting agencies collect information about
consumers and consumers credit history from public records, creditors, and other reliable
sources. These agencies make consumer credit history available to current and prospective
creditors and employers as allowed by law. Credit reporting agencies do not grant or deny credit;
they merely supply information. Credit reporting agencies are governed by the Fair Credit
Reporting Act (FCRA), 15 U.S.C. 1681, et seq. The FCRA protects consumers from the
circulation of inaccurate or obsolete information and ensures that credit reporting agencies

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exercise their responsibility fairly and equitably and respect consumers right to privacy and
confidentiality. 15 U.S.C. 1681. The three main credit reporting agencies are Equifax, Experian,
and TransUnion. For an in-depth discussion of the FCRA, see CREDITORS RIGHTS IN
ILLINOIS, Ch. 7 (IICLE, 2009).
4. [21.40] Underwriting
Underwriting is the process during which the lender evaluates the borrowers financial
condition and credit history to determine whether credit will be extended. The lender must
ascertain the borrowers ability to repay the loan and considers factors such as the borrowers
income, reliability of the sources of income, record of making payments on other debts, ratio of
income to payments on the loan, payments on other long-term obligations, and payments for
property taxes, insurance, and assessments, as well as the borrowers ability to obtain cash for a
down payment and closing costs. In addition, the lender must ascertain a borrowers willingness
to repay the loan and considers such factors as the borrowers credit history, loan references with
other creditors, and history of prior residency and mortgage and/or rental payments. Also
considered are information and circumstances or events that could materially and adversely affect
either the borrowers ability or willingness to repay the loan or the value, ownership, or
marketability of the security property. In addition to evaluating a borrowers loan application, the
lender evaluates whether the property is sufficient to secure the loan. This is accomplished
through a duly licensed appraiser.
5. [21.41] Appraisal
An appraisal is a valuation or an estimation of value of property by disinterested persons of
suitable qualifications. It is the process of ascertaining a value of an asset or liability that involves
expert opinion rather than explicit market transactions. The Real Estate Appraiser Licensing Act
of 2002, 225 ILCS 458/1-1, et seq., governs persons engaged in the appraisal of real estate in
connection with a federally related transaction, which is defined as any real-estate related
financial transaction in which a federal financial institutions regulatory agency, the Department
of Housing and Urban Development, Fannie Mae, Freddie Mac, or the National Credit Union
Administration engages in, contracts for, or regulates and requires the services of an appraiser.
225 ILCS 458/1-10. The cost of the appraisal is borne by the borrower and must be disclosed at
closing
on
the
HUD-1
Settlement
Statement,
which
is
available
at
http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case
sensitive). The borrower is entitled to a copy of the appraisal, which is delivered prior to or at
closing or may be requested by the borrower, in writing, within 90 days post-closing. See Fannie
Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report,
www.efanniemae.com/sf/formsdocs/forms/1004.jsp.
6. [21.42] Commitment and Conditions
Once the lender has determined that a borrower is an acceptable credit risk, the lender will
issue a conditional loan commitment. The purpose of a conditional commitment is to provide
assurance to the borrower that if the conditions of the commitment are satisfied and the lender
obtains a valid security interest in the property, the loan will be funded. Borrower and counsel
alike should utilize the conditional commitment as a guide to prepare for the closing.

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7. [21.43] Closing the Loan

Closing the loan consists of executing the loan documents and disbursing the loan proceeds.
This typically occurs at the title company but may occur at either the lender or the sellers
attorneys office. It is the borrowers responsibility to understand what he or she is signing. The
lender generally owes no duty to a person signing the mortgage documents to explain their
contents or the effect of the persons signature. State Bank of Geneva v. Sorenson, 167 Ill.App.3d
674, 521 N.E.2d 587, 118 Ill.Dec. 305 (2d Dist. 1988). If the borrower executes the note, the
mortgage, or any other loan documents without reading them, the borrower is bound by the
provisions of the documents, including those that vary from the terms of the commitment or
disclosure documents. American Savings Assn v. Conrath, 123 Ill.App.3d 140, 462 N.E.2d 849,
78 Ill.Dec. 730 (5th Dist. 1984). The lender may fill in blanks in the note according to the loan
commitment if the borrower fails to do so. 810 ILCS 5/3-407; West Chicago State Bank v.
Rogers, 162 Ill.App.3d 838, 515 N.E.2d 1261, 113 Ill.Dec. 954 (2d Dist. 1987), appeal denied,
119 Ill.2d 576 (1988).
8. [21.44] Loan Package
The bulk of the documents included in a typical loan package consist of standardized forms;
however, the terms and conditions will vary according to the specific terms of the loan. At a
minimum, every loan package will contain a note, mortgage, and a truth-in-lending disclosure. In
addition, a first payment letter and disclosures pertaining to impounds and escrows may be
included.
Note. The note evidences the indebtedness of the borrower to the lender and is a promise to
repay the amount borrowed. It is a binding contract signed by the borrower. The provisions of the
note include the borrowers promise to pay in return for the loan received, the interest rate to be
charged on the principal, the time, place, and amount of payments to be made under the note, a
statement of the borrowers right to prepay (and corresponding prepayment penalty, if any), a
statement that the charges on the loan shall comply with state law, a statement defining late
charges and default in the event of the borrowers failure to timely pay, a notice provision, a
statement of joint and several liability if more than one person executes the note, a waiver of
presentment and dishonor, and a statement that the note gives the note holder rights under the
note and under the security instrument (i.e., mortgage) executed simultaneously with the note.
See Multistate Fixed Rate Note Single Family Fannie Mae/Freddie Mac Uniform
Instrument Form 3200, www.freddiemac.com/uniform/doc/3200-MultistateFRNote.doc (case
sensitive).
Mortgage. The mortgage is an interest in land created by written instrument providing
security in real estate to secure the payment of a debt. Aames Capital Corp. v. Interstate Bank of
Oak Forest, 315 Ill.App.3d 700, 734 N.E.2d 493, 248 Ill.Dec. 565 (2d Dist. 2000). It is recorded
in the county where the property is located, creating a lien on the property. The mortgage is the
security instrument that governs how and under what conditions the borrower may be required to
make immediate payment. The mortgage must specify the events that constitute a default by the
borrower since only those events justify acceleration of the mortgage debt and enforcement of the
mortgage. Federal National Mortgage Assn v. Bryant, 62 Ill.App.3d 25, 378 N.E.2d 333, 18

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Ill.Dec. 869 (5th Dist. 1978). Acceleration is permissible if the mortgage and note give the lender
the option to declare the entire principal balance of the mortgage loan (plus accrued, unpaid
interest) due before the maturity date of the mortgage debt for the borrowers default.
Acceleration clauses are legal and enforceable. Damen Savings & Loan Assn v. Heritage
Standard Bank & Trust Co., 103 Ill.App.3d 301, 431 N.E.2d 34, 59 Ill.Dec. 15 (2d Dist. 1982);
Zalesk v. Wolanski, 281 Ill.App. 54 (1st Dist. 1935). Common events of default include the
borrowers failure to pay the note, property taxes, or assessments; transfer of the property or
restoration of the property after it has been damaged or destroyed; and maintaining of insurance
policies, among others. See Illinois Single Family Fannie Mae/Freddie Mac Uniform
Instrument Form 3014, www.freddiemac.com/uniform/doc/3014-IllinoisMortgage.doc (case
sensitive).
Federal truth-in-lending disclosure statement. The truth-in-lending statement discloses the
actual cost of the consumer credit (the finance charge) in terms of dollars and as a percentage
(i.e., annual percentage rate).
Notice of assignment, sale, or transfer of servicing rights. Pursuant to 24 C.F.R.
3500.21(d), a lender must notify a borrower that the right to collect payments has been assigned.
Impounds and escrows. The Mortgage Escrow Account Act, 765 ILCS 910/1, et seq.,
governs the terms and conditions of the accumulation of funds for payment of property taxes and
insurance via an escrow account. A lender may require a borrower to establish an escrow account
for payment of property taxes and insurance as a condition of the mortgage loan. 765 ILCS 910/2.
Notice of the requirements of the Mortgage Escrow Account Act shall be furnished in writing to
the borrower at the date of closing. 765 ILCS 910/11. A mortgage lender must give notice at least
annually to the borrower of tax payments made from an escrow account. 765 ILCS 910/15.
Mortgage payment letter. Timely payment is the responsibility of the borrower. A typical
loan package will include a first payment letter that delineates the components of the payment,
consisting of principal, interest, taxes, and insurance, commonly referred to as PITI.
Notwithstanding the foregoing, a payment may be interest only, may not include tax and/or
insurance escrows, and may include mortgage insurance (MI) or private mortgage insurance
(PMI), as well.
Loan documents will vary among lenders. However, a typical loan package may include
a. general and specific closing instructions;
b. the loan commitment;
c. the note and riders;
d. the mortgage;
e. the federal truth-in-lending disclosure statement and itemization of amount financed;

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21.45

the first payment letter and address certification;

g. a notice of assignment and sale or transfer of servicing rights;

h. notice of the Mortgage Escrow Account Act requirements and initial escrow account
disclosure statement;
i.

a collateral protection insurance notice, hazard insurance requirements, and tax record
information sheet;

j.

flood certification;

k. the borrowers certification and authorization;

l.

IRS Forms W-9, Request for Taxpayer Identification Number and Certification, and
4506-T, Request for Transcript of Tax Return (both of which are available at
www.irs.gov), and a request for a copy of the tax return;

m. Fannie Mae Form 1003/Freddie Mac Form 65, Uniform Residential Loan Application,
www.efanniemae.com/sf/formsdocs/forms/1003.jsp;
n. the federal Equal Credit Opportunity Act notice;
o. the borrowers certification: false statement/employment/occupancy form;
p. name, occupancy, and financial status affidavits;
q. the compliance agreement (errors and omissions);
r.

the customer identification verification and name affidavit; and

s.

a consumer credit score disclosure and a notice concerning the furnishing of negative
information to consumer reporting agencies.

9. [21.45] Fees
Sections 8 10 and 12 of the Real Estate Settlement Procedures Act, 12 U.S.C. 2607
2610, regulate the charges that may be charged on loans subject to the Act. Fees included in the
application and origination of the loan may include an application fee, origination fee and/or
discount points, appraisal fee, credit reporting fees, flood certification fees, tax service fees,
underwriting fees, processing fees, document preparation fees, hazard insurance and property tax
impounds and escrows, prepaid interest, recording fees, and title insurance fees. The above fees
are paid prior to or at closing and are usually deducted from the loan proceeds before distribution
to the borrower. Lender charges are delineated on the HUD-1 Settlement Statement,
http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case
sensitive), at closing in the 800 series titled Items Payable in Connection with Loan. Charges

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required by the lender to be paid in advance (interest, mortgage insurance premium, hazard
insurance premium, or VA funding fee) are delineated in the 900 series, and the reserves to be
deposited with the lender (escrows for property taxes and insurance) are delineated in the 1000
series.
C. Post-Loan Closing Considerations
1. [21.46] Prepayments
Long-term real estate mortgages frequently contain stipulations that payment of the principal
debt may be made prior to its due date but that in order to entitle the mortgagor to make such
prepayment, he or she must pay the mortgagee an additional sum, which additional payment is
termed a prepayment penalty. When a borrower desires to prepay the loan, there is no absolute
right to do so. As stated in LaSalle National Bank v. Illinois Housing Development Authority, 148
Ill.App.3d 158, 498 N.E.2d 697, 101 Ill.Dec. 373 (1st Dist. 1986), the borrower has no absolute
right to prepay a mortgage loan, i.e., to pay all or a portion of the balance of the loan before the
date it is due. The right to prepay must be stated in the mortgage to be enforceable. Brenner v.
Neu, 28 Ill.App.2d 219, 170 N.E.2d 897 (4th Dist. 1960). The amount and timing of the
prepayment may be limited in those instruments. The mortgage should specify whether partial
prepayments alter the due date or amount of future installments. Smith v. Renz, 122 Cal.App.2d
535, 265 P.2d 160 (1954).
In Illinois, the Notice of Prepayment of Federally Subsidized Mortgage Act, 765 ILCS 925/1,
et seq., protects the mortgagor:
It is the purpose of this Act to preserve and retain to the maximum extent
practicable, as housing affordable to low and moderate income families or persons,
those privately owned dwelling units that were provided for such purposes with
federal assistance, to minimize the involuntary displacement of tenants currently
residing in such housing, to ensure that the appropriate governmental authorities
are given adequate notice to respond to the potential problems created by
conversions of subsidized rental units to nonsubsidized rental units and to ensure
that the subsidized rental unit occupants are provided with information and
assistance, in the event of conversions. 765 ILCS 925/2.
2. [21.47] Escrows and Impounds
A borrower is entitled to terminate escrows and assume liability for payment of property
taxes and insurance when the loan reaches 65 percent of its original value, as follows:
When the mortgage is reduced to 65% of its original amount by payments of the
borrower, timely made according to the provisions of the loan agreement secured by
the mortgage, and the borrower is otherwise not in default on the loan agreement,
the mortgage lender must notify the borrower that he may terminate such escrow
account or that he may elect to continue it until he requests a termination thereof, or
until the mortgage is paid in full, whichever occurs first. 765 ILCS 910/5.

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3. [21.48] Termination of Private Mortgage Insurance

A borrower may request the termination of private mortgage insurance when the loan reaches
80 percent of the value of the property. A lender shall automatically terminate private mortgage
insurance when the loan reaches 78 percent of the value of the property. A lender must notify the
mortgagee no less than once a year of whether the insurance may be terminated, the conditions
and procedure for termination, and a contact person for the mortgagee to determine whether the
insurance may be terminated and the conditions and procedures for termination. 765 ILCS
930/15.
4. [21.49] Payoff and Release
A borrower who desires to pay a mortgage loan in full must first obtain a payoff statement as
governed by the Mortgage Certificate of Release Act, 765 ILCS 935/1, et seq. A payoff
statement is a statement for the amount of (a) the unpaid balance of a loan secured by a
mortgage, including principal, interest, and any other charges due under or secured by the
mortgage; and (b) interest on a per-day basis for the unpaid balance. 765 ILCS 935/5. A borrower
who is selling his or her property for less than the payoff amount may consider a short sale. A
short sale occurs when the lender agrees to write off the portion of a mortgage that is higher
than the fair market value of the home, provided there is a willing purchaser. A short sale is the
result of a property sale with a value less than the amount owed to the lender. Finally, upon
receipt of payment in full, the mortgage shall be released.
Every mortgagee of real property . . . having received full satisfaction and payment
of all such sum or sums of money as are really due to him from the mortgagor . . .
shall . . . make, execute and deliver to the mortgagor . . . an instrument in writing
executed in conformity with the provisions of this section releasing such mortgage
. . . which release shall be entitled to be recorded or registered. 765 ILCS 905/2.
The lien release shall be issued within one month after payment in full, or the lender may be
liable for damages. 765 ILCS 905/4. Likewise, [r]eceipt of payment pursuant to the lenders
written payoff statement shall constitute authority to record a certificate of release. A certificate
of release shall be delivered for recording to the recorder of each county in which the mortgage is
recorded . . . by the title insurance company or its duly appointed agent. 765 ILCS 935/10.

VI. [21.50] STATE AND FEDERAL REGULATION OF THE MORTGAGE

INDUSTRY
Local real estate law, a blend of state and federal statutory law, and common law regulate real
estate lending. The law represents a balance of rights between borrower and lender that has taken
centuries to evolve.

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A. [21.51] Federal Regulation

The Consumer Credit Protection Act, 15 U.S.C. 1601, et seq., is the controlling piece of
federal legislation regulating the manner in which lenders approve or disapprove residential
mortgage loans. The regulation covers not only access to credit and control of the dissemination
of credit information but also the information required to be disclosed to the borrower and the
manner of this disclosure. The Consumer Credit Protection Act includes, among others, the Truth
in Lending Act (Title I), the Fair Credit Reporting Act (Title III), and the Equal Credit
Opportunity Act (Title VIII). See 21.52 21.54 below. Other federal legislation regulating
residential mortgage loans includes the Real Estate Settlement Procedures Act, the Home
Mortgage Disclosure Act, and the Housing and Economic Recovery Act of 2008. See 21.55
21.57 below.
1. [21.52] Truth in Lending Act
Title I of the Consumer Credit Protection Act is commonly known as the Truth in Lending
Act, 15 U.S.C. 1601, et seq. TILA, implemented through Regulation Z, 12 C.F.R. pt. 226, issued
by the Federal Reserve Board, is a disclosure statute that requires that creditors provide specific
information to consumers in a uniform, accurate, and meaningful manner so as to ensure that
consumers can make informed choices.
TILA covers any consumer credit transaction in which (a) credit is extended to a natural
person, not a corporation, partnership, government, or other entity; (b) credit is extended by one
who regularly extends consumer credit; (c) the extension of credit is primarily for personal,
family, or household purposes; (d) the extension of credit is subject to a finance charge or
repayable in more than four installments; and (e) the extension of credit is for $25,000 or less,
unless it is secured by real estate or personal property used as the consumers principal dwelling,
in which case no limit applies. 15 U.S.C. 1602; 12 C.F.R. 226.1(c), 226.3(b).
There is a specific requirement for timing of disclosures in residential mortgage transactions
that apply when a mortgage or other consensual security interest is created or retained in the
consumers principal dwelling. 12 C.F.R. 226.19. TILA requires two types of disclosure: (a)
disclosures of certain basic information in all credit transactions and (b) disclosures that in form
and content are dependent on the type of transaction. The former disclosures are encompassed in
a general requirement to set forth the finance charge and annual percentage rate of that charge.
The disclosures of the finance charge and the APR are the essence of TILA because they
represent the actual cost of consumer credit the finance charge as the dollar amount and the
APR as a yearly percentage rate.
15 U.S.C. 1605 and 1606 control what shall be included in the finance charge and how the
annual percentage rate shall be computed. When the creditor is required to disclose the finance
charge and the annual percentage rate with a corresponding amount or percentage, they must
appear more conspicuously than any other disclosures except the creditors identification. 15
U.S.C. 1632; 12 C.F.R. 226.17(a)(2). TILA defines finance charge as the sum of all
charges, payable directly or indirectly by the person to whom the credit is extended, and imposed
directly or indirectly by the creditor as an incident to the extension of credit. 15 U.S.C. 1605(a).

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See 12 C.F.R. 226.4. The finance charge is the cost of credit to the consumer and must be
measured in those terms. TILA specifies those charges that shall be included in the calculation of
the finance charge as well as those charges that are excluded. 15 U.S.C. 1605(a); 12 C.F.R.
226.4(b), 226.4(c). Likewise, the APR must be disclosed. The APR is the measure of the cost
of credit that relates the amount of credit, the finance charge, and the timing and amounts of
payments to be made by the consumer. For an in-depth discussion of TILA, see CREDITORS
RIGHTS IN ILLINOIS, Ch. 7 (IICLE, 2009).
2. [21.53] Fair Credit Reporting Act
The Fair Credit Reporting Act, 15 U.S.C. 1681, et seq., applies to consumer reporting
agencies that issue consumer reports to users. See 15 U.S.C. 1681 (addressing applicant privacy
during the transaction, placing substantial limitations on access to applicant information, and
requiring notice to the applicant when additional information is to be obtained). Its purpose is to
protect consumers from the circulation of inaccurate or obsolete information and to ensure that
the consumer reporting agencies exercise their responsibilities in a manner that is fair and
equitable to consumers and that respects their right to privacy and confidentiality. Id. It extends
only to consumers eligibility for personal credit and not to the consumers business transactions.
Matthews v. Worthen Bank & Trust Co., 741 F.2d 217 (8th Cir. 1984).
3. [21.54] Equal Credit Opportunity Act
The Equal Credit Opportunity Act (ECOA), 15 U.S.C. 1691, et seq., mandates that lenders
must evaluate applicants based on creditworthiness only and not on factors that do not affect their
ability to repay the debt. The ECOA expressly prohibits a lender from rejecting applicants based
on a number of protected bases (race, color, religion, national origin, age, sex, and marital status)
and is intended to ensure that illegal discrimination does not otherwise prevent creditworthy
applicants from applying. The ECOA applies to both the application process and the evaluation
process and further prohibits lenders from requesting certain information during the application
process on the theory that if a lender does not obtain prohibited information, it cannot be used to
discriminate when the credit decision is made. The ECOA and the regulations issued thereunder
require lenders to notify prospective borrowers within 30 days after the creditors receipt of a
completed application of any adverse action and the reasons therefore. Adverse action is
defined as a denial or revocation of credit, a change in the terms of an existing credit
arrangement, or a refusal to grant credit in substantially the amount or on substantially the terms
requested. 15 U.S.C. 1691(d)(6).
4. [21.55] Real Estate Settlement Procedures Act
The Real Estate Settlement Procedures Act of 1974, 12 U.S.C. 2601, et seq., was enacted to
enable consumers to better understand, through disclosure, the home purchase and settlement
process and the costs associated with settlement. Its requirements are implemented through
Regulation X, 24 C.F.R. pt. 3500, issued by the Department of Housing and Urban Development.
RESPA applies to all federally related mortgage loans unless otherwise excepted. 24 C.F.R.
3500.5(a). RESPA requires disclosures in the form of the special information booklet at the time
of application for a loan, the good-faith estimate of settlement services given within three days of

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receipt of the loan application, the one-day advance inspection of the HUD-1 Settlement
Statement (at the borrowers option), and the Settlement Statement itself,
http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case
sensitive), which is delivered at or before settlement. RESPA also contains additional regulatory
provisions such as a prohibition against referral fees or unearned fees, a prohibition against
requiring use of a specific title company, and limitations on payments to escrow accounts.
RESPA applies when there is an application for a federally related mortgage loan, which
encompasses a loan (a) secured by a first or subordinate lien, (b) on residential property
containing a one- to four-family structure, when (c) the lender is a federally related lender or a
creditor under the Consumer Credit Protection Act or the loan is federally related.
Since RESPA is aimed at protecting consumers, its reach extends only to residential property
designed for occupancy by one to four families. The term federally related lender is broad in its
coverage. It encompasses a lender whose accounts are insured by any federal agency or that is
regulated in any way by the federal government. The term creditor under the Consumer Credit
Protection Act is similarly broad. It means a creditor who regularly extends consumer credit
payable in more than four installments or for which a finance charge is paid. 15 U.S.C. 1602(f).
Finally, the term federally related mortgage loan includes loans made, insured, guaranteed, or
assisted in any way by the federal government or those intended to be sold to Fannie Mae, Ginnie
Mae, or Freddie Mac. 12 U.S.C. 2602(1).
RESPA, originally passed in 1974, is a derivative legislative result of the Emergency Home
Finance Act of 1970, Pub.L. No. 91-351, 84 Stat. 450, which required the Secretary of HUD and
the Administrator of Veterans Affairs to prescribe standards for settlement costs that may be
incurred in connection with Federal Housing Authority and VA-insured loans. Standards were
proposed to Congress that led to additional consideration and debate and failed legislation for
purposes of regulating settlement costs. RESPA, when initially passed, was intended to enable
consumers to understand better the home purchase and settlement process and, when possible, to
bring about a reduction in settlement costs. As time progressed, new complaints led to new
legislation, resulting in a host of amendments to the original legislation. It is the filing of an
application for a federally related mortgage loan that triggers RESPA disclosure requirements.
5. [21.56] Home Mortgage Disclosure Act
The Home Mortgage Disclosure Act of 1975 (HMDA), 12 U.S.C. 2801, et seq., requires
public disclosure of loans originated to ensure lending institutions are not guilty of disinvestments
toward certain communities. The Act is implemented through Regulation C, 12 C.F.R. pt. 203,
issued by the Federal Reserve Board. HMDA requires compilation and annual reporting of
lending activity regarding home purchase and home improvement loans. The lending institution is
required to maintain a register of all loans for which application is made and final action on such
applications, as well as all loans purchased. The register is submitted to the applicable regulatory
agencies. It is also available for inspection by the public. The institution is also required to make
its loan data disclosure statement, prepared by the Federal Financial Institutions Examination
Council, available to the public.

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HMDAs obligations are imposed on depository institutions. However, the definition of

this term is broad. It includes any bank or savings association and any other person engaged for
profit in the business of mortgage lending. 12 U.S.C. 2802(4). Regulation C does, however,
exempt certain institutions based on size. The Act requires compilation and disclosure of
information on mortgage loans to purchase or improve residential real property. Regulation C
uses the terms home purchase loans and home improvement loans to describe the covered
transactions. It defines home purchase loan as any loan secured by or made for the purpose of
purchasing a dwelling. 12 C.F.R. 203.2(h). It also defines home improvement loan as one
for repairing, rehabilitating, remodeling, or improving a dwelling or the real property on which
it is located. 12 C.F.R. 203.2(g). The term dwelling, in turn, is defined as a residential
structure. 12 C.F.R. 203.2(d). The definition goes on to state explicitly that individual
condominium units and individual cooperative units are included within the term dwelling. Id.
Obviously, commercial units, e.g., medical offices, do not fall within the term. It is not clear if
residential units purchased but leased to third parties for their residential occupancy fall within
the term. However, staff commentary to Regulation C states that such rental property does fall
within the term dwelling. 12 C.F.R. pt. 203, supp. I, Section 203.2, 2(d) Dwelling. Time-share
interests are also difficult to classify, since the term dwelling and the phrase residential
structure do not usually connote short-term occupancy for leisure purposes. However, the staff
commentary to Regulation C states that the term dwelling is not limited to the principal or other
residence of the loan applicant or borrower and that vacation or second homes fall within the
term. Only recreational vehicles such as boats or campers are expressly excluded. Id.
6. [21.57] Housing and Economic Recovery Act
The Housing and Economic Recovery Act of 2008, Pub.L. No. 110-289, 122 Stat. 2654, was
enacted July 30, 2008, and provides the authority for the governments takeover of the
government-sponsored enterprises. HERA created a new GSE regulator, the Federal Housing
Finance Agency (FHFA), with authority to take control of either GSE to restore it to a sound
financial condition. According to the FHFA website, www.fhfa.gov, the FHFA was created when
President George W. Bush signed into law the Housing and Economic Recovery Act of 2008:
The Act created a world-class, empowered regulator with all of the authorities
necessary to oversee vital components of our countrys secondary mortgage markets
Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. In addition, this
law combined the staffs of the Office of Federal Housing Enterprise Oversight
(OFHEO), the Federal Housing Finance Board (FHFB), and the GSE mission office
at the Department of Housing and Urban Development (HUD). With a very
turbulent market facing our nation, the strengthening of the regulatory and
supervisory oversight of the 14 housing-related GSEs is imperative. The
establishment of FHFA will promote a stronger, safer U.S. housing finance system.
As of June 2008, the combined debt and obligations of these GSEs totaled $6.6
trillion, exceeding the total publicly held debt of the USA by $1.3 trillion. The GSEs
also purchased or guaranteed 84% of new mortgages. Considering the impact of
these GSEs on the U.S. economy and mortgage market, it is critical that we intensify
our focus on oversight of Fannie Mae, Freddie Mac, and the Federal Home Loan
Banks. See About FHFA, www.fhfa.gov/Default.aspx?page=4 (case sensitive).

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B. [21.58] State Regulation

The following acts regulate real estate lending in Illinois and are discussed in this chapter.
For the Residential Mortgage License Act of 1987, see 21.33 above. For the Notice of
Prepayment of Federally Subsidized Mortgage Act, see 21.46 above. For the Mortgage
Insurance Limitation and Notification Act, see 21.28 above. For the Mortgage Certificate of
Release Act, see 21.49 above. For the Illinois Fairness in Lending Act, the High Risk Home
Loan Act, and the Consumer Fraud and Deceptive Business Practices Act, see 21.35 above.
Other acts that regulate real estate lending in Illinois but that are not discussed in this chapter
are briefly outlined below.
The Mortgage Act, 765 ILCS 905/0.01, et seq., provides that
[e]very mortgagee of real property . . . having received full satisfaction and payment
of all such sum or sums of money as are really due to him from the mortgagor . . .
shall, at the request of the mortgagor . . . make, execute and deliver to the
mortgagor . . . a deed of trust in the nature of a mortgage . . . an instrument in
writing . . . releasing such mortgage . . . which release shall be entitled to be
recorded or registered and the recorder or registrar upon receipt of such a release
and the payment of the recording fee therefor shall record or register the same. 765
ILCS 905/2.
The Mortgage Escrow Account Act, 765 ILCS 910/1, et seq., regulate[s] certain practices of
mortgage lenders in the administration of escrow accounts. P.A. 79-625. The Mortgage Payment
Statement Act, 765 ILCS 920/0.01, et seq., relates to periodic payments with respect to real
estate mortgages, trust deeds, and contracts for deed. P.A. 86-1324.
Effective January 1, 2010, 26 of the Title Insurance Act provides that a title insurance
company, title insurance agent, or independent escrowee shall not make disbursements in
connection with any escrows, settlements, or closings out of a fiduciary trust account or accounts
unless the funds in the aggregate amount of $50,000 or greater received from any single party to
the transaction are good funds as defined by the statute and are unconditionally held by and
credited to the fiduciary trust account of the title insurance company, title insurance agent, or
independent escrowee. 215 ILCS 155/26. This is commonly referred to as the Good Funds
Law.
Under the statute, the following funds are considered good funds as defined under 215
ILCS 155/26(c):
(1) lawful money of the United States;
(2) wired funds unconditionally held by and credited to the fiduciary trust account
...;

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(3) cashiers checks, certified checks, bank money orders, official bank checks, or
tellers checks drawn on or issued by a financial institution chartered under the
laws of any state or the United States . . . ;
(4) a personal check or checks in an aggregate amount not exceeding $5,000 per
closing, provided that the . . . escrowee has reasonable grounds to believe that
sufficient funds are available for withdrawal in the account upon which the check is
drawn at the time of disbursement;
(5) a check drawn on the trust account of any lawyer or real estate broker licensed
under the laws of any state, provided that the . . . escrowee has reasonable grounds
to believe that sufficient funds are available for withdrawal in the account upon
which the check is drawn at the time of disbursement;
(6) a check issued by [the State of Illinois], the United States, or a political
subdivision of this State or the United States; or
(7) a check drawn on the fiduciary trust account of a title insurance company or title
insurance agent, provided that the . . . escrowee has reasonable grounds to believe
that sufficient funds are available for withdrawal in the account upon which the
check is drawn at the time of disbursement.
If good funds are not provided as set out above, then the funds must be collected funds as
defined in 215 ILCS 155/26(d). Collected funds means funds deposited, finally settled, and
credited to the title insurance company, title insurance agent, or independent escrowees fiduciary
trust account. Id. These good funds guidelines are a minimum of what is required by law for
funding in the State of Illinois. Requiring funds to be tendered electronically reduces the risk but
does not completely eliminate the risk that the funds are uncollectible.

VII.

[21.59] DISTRESSED REAL ESTATE SELLERS

The 2008 recession has impacted real property owners from all walks of life. Not only has the
subprime mortgage market led to an abundance of foreclosures, but unemployment and the
decline in residential real property values have left many responsible homeowners either upside
down (loan exceeds value of property) and/or otherwise unable to meet their monthly mortgage
debt. The result is an increase in mortgage defaults on all types of homes in all areas of the
country. Although much can be written on this topic, this paragraph is intended to inform the
reader that resources for rescue exist. Before a distressed seller concedes to the inevitable judicial
foreclosure, counsel should explore alternatives that may allow the client to remain in his or her
property. In the alternative, if the client cannot remain in his or her property, options exist that
may result in a lesser impact on the clients credit score. These options, and other issues related to
distressed sellers, are discussed in 21.60 21.64 below.

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A. [21.60] Loan Modification

A loan or mortgage modification is a process whereby the mortgagee (lender) agrees to
permanently change one or more of the terms of a mortgage loan (interest rate, term, principal)
resulting in a payment the mortgagor (borrower) can afford. This allows the borrower to remain
in his or her property provided continual, timely payments are made. A borrower should consult
with his or her mortgagee to obtain a modification. Notwithstanding the foregoing, the
government also plays a role. The Home Affordable Modification Program (HAMP) is the result
of a $75 billion dollar federal program established in February 2009 to help responsible
homeowners avoid foreclosure by providing affordable and sustainable loans. For details on
HAMP, visit www.makinghomeaffordable.gov.
B. [21.61] Short Sale
A short sale occurs when a property is sold for less than the seller (borrower) owes on his or
her outstanding mortgage. This is also referred to as a short payoff. The difference between the
outstanding mortgage debt and the short payoff is called the deficiency. The borrower remains
liable for the deficiency unless negotiated otherwise. A lender may forgive the deficiency, settle
for a reduced one-time lump sum payment, or require that the borrower execute a new note for
the deficiency to be paid over a period of time.
In order to initiate a short sale, the borrower, individually or through his or her attorney, must
contact the mortgagees loss mitigation department and obtain the specific procedures for
submission and negotiation. Procedures differ by lender both in documents required and means of
submission (some require fax submissions, while others, such as the Bank of America, require
submissions via Equator, a Internet-based short-sale system). However, all require one complete
short-sale package be submitted in lieu of sending documents piecemeal. At a minimum, the
short-sale submission must include the following: (1) a written offer to purchase or a contract
with a short-sale addendum; (2) a listing agreement; (3) the borrowers recent pay stubs; (4) the
borrowers recent bank statements; (5) a financial affidavit disclosing the borrowers income and
liabilities; (5) a hardship letter from the borrower; (6) the borrowers prior year tax return; and (7)
a preliminary HUD-1 Settlement Statement, showing all closing costs and net proceeds to be sent
to the mortgagee. (The Settlement Statement is available at HUDs website,
http://portal.hud.gov/hudportal/HUD?src=/program_offices/administration/hudclips/forms (case
sensitive).) If the borrower is having a third party negotiate the short sale, the borrower must
execute an authorization for the negotiator to talk to the third party. Once the complete short-sale
package is submitted, the mortgagee will assign a negotiator. The negotiator will review the
package for completeness, request additional documentation if needed, order a broker price
opinion (BPO), and evaluate the short-sale request, which may include eliminating or reducing
certain closing costs. That is, the mortgagee may agree to the short-sale request but not agree to
pay for unnecessary expenses, including but not limited to a termite inspection, survey, municipal
transfer taxes, delinquent association dues, excessive broker commission, and/or attorneys fees,
and challenge the real estate tax proration credits. It is critical that the borrower discuss the
deficiency with the negotiator. Specifically, will the mortgagee require the borrower to execute an
unsecured note at closing for the deficiency amount? Will the mortgagee forgive the deficiency,
potentially resulting in a taxable event to the borrower? Or will the mortgagee agree to settle the

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deficiency for a lump-sum payment of a lesser amount at closing? Counsel should explore the
potential deficiency issues with the client. If the client is unwilling to execute a promissory note,
counsel should modify the contract, allowing the seller a right to terminate if the mortgagee
requires the seller to sign a promissory note. Once the short sale has been agreed to, the
mortgagee will issue a payoff letter. The letter will mandate that the final figures on the
preliminary HUD-1 Settlement Statement cannot change and that the closing and payoff occur by
a certain date. If the closing does not timely occur, the payoff letter will expire. Finally, when a
seller has multiple mortgage liens, all lienholders must consent to the short sale and agree to
release their liens. Usually, the junior lienholder is paid a nominal amount to release its lien.

PRACTICE POINTER

When representing a seller in a short-sale transaction, counsel should confirm that the
contract includes a short-sale provision making the sellers performance contingent upon
approval from the sellers mortgage holder. This provision is included in some form
contracts, but not all. Thus, counsel must modify the contract via the attorney
modification provision to adequately protect his or her client.

C. [21.62] Deed in Lieu of Foreclosure

The mortgagor and mortgagee may agree on a termination of the mortgagors interest in the
mortgaged real estate after a default by a mortgagor. Any mortgagee or mortgagees nominee
may accept a deed from the mortgagor in lieu of foreclosure subject to any other claims or liens
affecting the real estate. Acceptance of a deed in lieu of foreclosure shall relieve from personal
liability all persons who may owe payment or the performance of other obligations secured by the
mortgage, including guarantors of such indebtedness or obligations, except to the extent a person
agrees not to be relieved in an instrument executed contemporaneously. A deed in lieu of
foreclosure, whether to the mortgagee or mortgagees nominee, shall not effect a merger of the
mortgagees interest as mortgagee and the mortgagees interest derived from the deed in lieu of
foreclosure. The mere tender of an executed deed by the mortgagor or the recording of a deed by
the mortgagor to the mortgagee shall not constitute acceptance by the mortgagee of a deed in lieu
of foreclosure. 735 ILCS 5/15-1401.
D. [21.63] Income Tax Consequence
Generally, if a consumer borrows money from a commercial lender and the lender later
cancels or forgives the debt, the consumer may have to include the cancelled amount in income
for tax purposes, depending on the circumstances. An obligation that is subsequently forgiven is
reportable as income because the consumer no longer has an obligation to repay the lender. The
lender is usually required to report the amount of the canceled debt to the IRS on Form 1099-C,
Cancellation of Debt. See www.irs.gov for a sample Form 1099-C. However, cancellation of debt
is not always taxable.
The Mortgage Forgiveness Debt Relief Act of 2007, Pub.L. No. 110-142, 121 Stat. 1803,
generally allows taxpayers to exclude income from the discharge of debt on their principal

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residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in
connection with a foreclosure, qualifies for this relief. This provision applies to debt forgiven in
calendar years 2007 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1
million if married filing separately). The exclusion does not apply if the discharge is due to
services performed for the lender or any other reason not directly related to a decline in the
homes value or the taxpayers financial condition. The amount excluded reduces the taxpayers
cost basis in the home. Further information, including detailed examples, can be found in IRS
Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

PRACTICE POINTER

Unless counsel is a CPA, a client should be advised to seek tax advice from his or her
CPA prior to choosing a loan modification, short sale, or deed in lieu of foreclosure.

E. [21.64] Impact on Credit Scores

Foreclosures, short sales, mortgage modifications, and deeds in lieu of foreclosure each have
different effects on credit. Exactly how each affects credit depends on credit history as well as
how the lender reports the situation to the credit bureaus. There is no credit score advantage to a
short sale or deed in lieu over a foreclosure. However, if a borrower is reapplying for a loan,
under Fannie Maes updated underwriting guidelines for new mortgage applications for
individuals with various types of foreclosure history on their credit, short sales have only a twoyear waiting period with no additional requirements. With a foreclosure on a credit record, a
borrower must wait five years in order to get new funding and is subject to additional credit and
down payment requirements for five to seven years. Deeds in lieu warrant a four-year wait, with
additional requirements for four to seven years. See, e.g., Fannie Mae Announcement SEL-201005, Underwriting Borrowers with a Prior Preforeclosure Sale or Deed-in-Lieu of Foreclosure
(Apr. 14, 2010), www.efanniemae.com/sf/guides/ssg/annltrs/pdf/2010/sel1005.pdf. So short sales
and mortgage modifications will enable the borrower to purchase another home within a shorter
period of time than if there is a foreclosure or deed in lieu of foreclosure on the credit report
history or a bankruptcy. A mortgage modification has far less adverse credit implications than a
foreclosure or short sale. It is to a borrowers advantage to choose a mortgage modification to
help save his or her home and credit if in a financial position to make the new, adjusted monthly
payment.

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VII. APPENDIX FORMS

A. [21.65] Sample Note
FORM(S) AVAILABLE BY PURCHASING HANDBOOK OR BY SUBSCRIBING TO
SMARTBOOKS OR SMARTBOOKSPLUS.
B. [21.66] Sample Security Instrument (Mortgage)
FORM(S) AVAILABLE BY PURCHASING HANDBOOK OR BY SUBSCRIBING TO
SMARTBOOKS OR SMARTBOOKSPLUS.

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