D&D School of Real Estate
P.O. Box 4207
Johnson City, TN 37602
800) 282-9375
ddschoolofrealestate.com
Fax (423) 232-2804
D&D School of Real Estate
Fax: 423-232-2804 or 423-232-2976
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Section 1 Quiz
Section 2 Quiz
Section 3 Quiz
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D&D School of Real Estate
P.O. Box 4207
Johnson City, TN 37602
(423) 232-1811 or (800) 282-9375
[email protected]
Fax (423) 232-2804 or (423) 232-2976
Dear Licensee:
As a licensee, you owe it to yourself to keep abreast of the changes in the
industry. Some practices that were common in the past are now illegal.
Others have become outdated and obsolete as changes continue to
come to our industry.
REAL ESTATE UPDATE VOUME III is information updated from our previous
volumes. Just as our earlier Volumes I and II gave you new insight into the
ever-changing industry we are involved in, REAL ESTATE UPDATE VOLUME III
has new and additional information as well. We have added web pages
for your perusal, expanded on sales and technical information and
redesigned our course to better serve the professionals in the real estate
industry such as yourself.
As part of your continuing education requirements, this course has been
approved in your state. Simply follow the instructions enclosed to fulfill the
necessary requirements.
We at D&D School of Real Estate have spent numerous hours
collecting the information and data assembled on these pages. It is our
hope that you find this course informative and helpful in your career. Any
questions or comments will be most appreciated. Thank you for using
D&D School of Real Estate as your provider of continuing education.
Sincerely,
Richard J. Clemmer
President
RENEW YOUR REAL ESTATE LICENSE IN
4 EASY STEPS
STEP ONE
Study the manual at your own pace and complete the progress
quizzes and the end of each chapter.
STEP TWO
After all progress quizzes are completed do the final exam at the
end of the manual.
STEP THREE
Transfer all your answers to the answer sheet at the front of the
manual, complete the additional information on the answer sheet then
mail or fax the answer sheet in for grading.
STEP FOUR
After receiving your notification of successful completion of this
course, send your renewal fee to the state before your deadline.
A licensed instructor will be available during normal business hours if you have any
questions regarding the course material. No assistance on the final exam questions and
answers can be given. For assistance call: 423-232-1811 or email your questions to
[email protected].
Work at your own pace! Complete the
course and send in your answers for
grading. We do the rest. We will notify the
state of your successful completion of the
course. Thank you for using D&D School of
Real Estate.
Table Of Contents
Section One:
Surviving the 21st Century
Key Issues
The Success Profile
Plan For Success
Create A Five Year Business Plan
Make A Budget You Can Live With
Have A Personal Marketing Plan
Research Your Market
The Importance Of Listings
Stay In Touch With Your Prospects And Clients
Maintain High Standards
Personal Discipline
Maintain A Positive Attitude
Who’s Your Client?
Tools For Success
Setting Goals
Annual Earnings Goal Work Sheet
Section One Quiz
Section Two:
Residential Real Estate Financing Review
Key Issues
Financing Residential Real Estate
Conventional Loans
Adjustable Rate Mortgage Loans
Fixed Rate Mortgages
FHA Loans
VA Loans
Assumable Mortgagees
Refinancing Loans
Graduated Payment Mortgage
Growing Equity Mortgage
Reverse Annuity Mortgage
Shared Equity Mortgage
The Secondary Mortgage Market
Fannie Mae
Gennie Mae
Freddie Mac
Additional Concerns For Real Estate Professionals
Truth In Lending Act
Sample Truth In Lending Statement
The Equal Credit Opportunity Act
The Real Estate Settlement Procedures Act
Section Two Quiz
Section Three: Environmental Issues and Property Inspection
Issues
Key Issues
Environmental Issues & Property Inspection Problems
Lead-Based Paint
Asbestos
Radon
Resource Conservation And Recovery Act
Underground Storage Tanks
Comprehensive Environmental Response, Compensation And Liability Act
(CERCLA)
Property Inspection Problems
Section Three Quiz
Section Four:
Agency Relationships In Real Estate
Key Issues
Issues In Agency Law
Agency Relationships
Single Agency
Sub-agency
Dual Agency
No Agency
Duties To Your Client
Loyalty
Obedience
Disclosure
Confidentiality
Reasonable Care And Due Diligence
Accounting
Terminating Agency Relationships
Agency Ethics
End Results Ethics
Rule Or Law Ethics
Social Contract Ethics
Transformational Ethics
Buyer Agency
Duties to Client
Loyalty
Obedience
Full Disclosure
Reasonable Care and Skill
Confidentiality
Accountability
Representation Forms
Buyer Representation in Real Estate
Payment of Fees
Section Four Quiz
Final Exam
USEFUL WEB LINKS FOR REAL ESTATE UPDATE VOLUME III
Tennessee Real Estate Commission
www.stte.tn.us/commerse/boards/trec/index
D&D School of Real Estate
www.ddschoolofdrealestate.com
National Association of Realtors
www.realtor.com
www.fanneimae.com
www.federalsrserve.com
www.ginniemae.com
www.freddiemac.coom
www.hud/gov/fha/fhahoe
www.fema.gov
www.naeba.org
www.reversemortgage.org
www.epa.gov
www.hud.gov/consumer/hhhchild.cfm
www.epa.gov/oppt/asbestos
www.epa.gov/lead
http://es.epa.gov/oeca/ag/aglaws/super.html
www.epa.gov/superfund/action/law/cercla.htm
SECTION ONE
SURVIVING IN THE 21ST CENTURY
Learning Objectives
•
•
•
•
•
•
Keys To Success
Knowing Your Market
Who’s your client
Personal Discipline
Planning your future
Annual goal setting
The 21st century brings new challenges for the real estate
professional. T.L. Wright, contributor to “The Real Estate
Professional”, writes, “Sales agents who want to succeed in real
estate must excel at acquiring knowledge and communicating
information.
Advanced training, education, and earning
professional designations must take top priority.” He notes the
attributes for the real estate sales agent: Persistent, Disciplined,
Creative, Empathetic, and Skilled in Technology, Reliable, and
Honest. Today’s buyers are more sophisticated and demand
excellence from agents. This encourages agents to constantly
upgrade their skills and improve performance.
The largest factor in your success or failure will be whether or
not you have a plan. William Meyersohn, one of the highest
paid agents for The Prudential Real Estate Affiliates notes,
“Looking at the big picture will help you stay motivated even
during the down cycles in our business... I’m constantly
examining the current business climate and then adjusting
myself for shifts in the marketplace. It’s necessary to make
adjustments from time to time, while always staying focused.
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I’ve always been an advocate of long-term planning. I believe
every agent should have at least a five-year strategic plan.”
PLAN FOR SUCCESS
How important is a strategic plan? Jeff Hoffman writes in the
Sacramento Realtor, “Only two out of every ten people
consistently write down their personal and professional goals.
Yet, from experience, a clear written focus is the one practice
shared by almost all top-performers in any field. The ability to
pre-determine goals and then commit to their attainment is the
separating ingredient between the top producer and the
hopeful agent.”
Real Estate Today suggests a simple acronym to keep in
mind while developing a strategic plan: SMART.
Specific - focus your goals precisely.
Measurable - put numbers on your goals. It's not enough
to want to earn "a living”. How much is that? What's the
dollar amount?
Attainable - can you actually accomplish your goal? It
may not be realistic, for instance, to plan to increase your
income tenfold.
Relevant - These must be your goals. You can't expect
your manager's or another salesperson's goals to motivate
you or meet your needs.
Timed - put deadlines on your objectives.
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CREATE A FIVE YEAR BUSINESS PLAN
Write out your goals, not just for the upcoming year, but
also for the next five years. Ask yourself where you want to be
professionally and financially in five years, and then write down
the steps to make that possible. It is well worth the time and
effort to take a weekend to put these goals and steps in writing.
It is also important to review this plan frequently, asking yourself,
if you are taking the appropriate actions.
MAKE A BUDGET YOU CAN LIVE WITH
A problem common to real estate practitioners and many
other small businesspersons for that matter is failing to
adequately estimate their expenses. To operate a successful
business you must plan your expenses as well as your income.
Business planning is the first and probably the most critical plan
in surviving the 21st century market. A good idea is to double
the amount of money you expect to spend each year for your
first few years. You will then have a good idea of your regular
expenses per year. It is essential to plan for the up and down
cycles of the market.
HAVE A PERSONAL MARKETING PLAN
This involves determining your USP, or Unique Selling
Proposition. The Professional Report stresses the importance of
knowing what is unique about you. The Professional Report
says, "You must be able to point out the special benefits of
doing business with you rather than the competition." Look at
your background, previous jobs, interests, etc. Your unique
insights and experiences differentiate you from everyone else.
Bring that knowledge to enhance your service to your clients.
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Create a mission statement that will tell your customers and
clients just why they should do business with you. After you have
created it, insert your competitions name instead of your own
and see if it still applies. If so, then you have work to do to set
yourself apart from the competition and give people a reason
to do business with you rather than anyone else. Having a USP is
important and a must to separate you from the competition.
Now look at what we call your “internal realities” and your
“external perception.” Your internal realities are what actually
happens within the operation of you. How do you respond to
calls, your personal follow-up procedures, etc.? These are the
actual operators of you, the real estate agent. You must be
honest and perhaps somewhat critical of your internal realities.
Some are good; others great, and some definitely need
improvement to better serve your customers and clients.
Once you have the realistic picture of your internal realities
you must look at the external perception. Does the public see
you for what you really are? Your external perception is the
picture the world has of your business. Make sure your personal
marketing plan (your external perception) shows your internal
realities clearly and accurately. If not, then you have work to
do to sell what you really are to your potential customers and
clients.
RESEARCH YOUR MARKET
To use the analogy of a new agent as a small business, the
Business Failure Record notes that 90 percent of all failures are
due to some weakness in the business founder's skills. "Failure to
seek assistance or professional help, whether from a lawyer,
accountant, marketing consultant or engineer is one of the
most common reasons that small businesses (or new agents)
fail." Know just what market you intend to service. If you are
looking to dominate in a particular phase of the market such as
condo sales, then know that market and know it better than
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anyone else. Knowledge is power; it will give you confidence
that shows, when explaining you, in your external perception.
THE IMPORTANCE OF LISTINGS
Larry Frazier writes in his course, How to Get Listings, “Listings
are a Realtor’s inventory. If you want a lot of good buyers you
need only have a lot of listings.”1 He stresses the importance of
accumulating a large number of listings. Sales activity follows
listing activity with a lag somewhere between 4 to 7 weeks. If
you have a large listing inventory, and consistently maintain
that inventory, you can avoid the “feast or famine” financial
syndrome because your listings will regularly sell. Frazier writes,
“You can prevent cycling by maintaining a steady inflow of
new listings every month. If you list the same number of new
single family residential houses every month, your income will
be steady and predictable.”2 Some old cliques such as ‘listers
last’ fit in the 21st century as well as they did in the past.
Remember inventory is the key to success. Can you imagine
Wal-Mart without inventory?
New listings always bring new buyers, so inventories and listings
are essential to success in the real estate business.
STAY IN TOUCH WITH YOUR PROSPECTS AND CLIENTS
If you fail to keep your prospects up to date on your
progress, they will feel they're not getting all the information you
have and they need. Even if you don't have any "new news or
good news," clients like to know you are keeping them
informed. If they feel they are being kept in the dark, the
tendency is to "pull the tree up by its roots." In surveys done over
the years by our industry, lack of communication with the client
is always at the top of the list of complaints against agents.
Don’t let this happen to you.
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MAINTAIN HIGH STANDARDS
Quality service should be your distinctive attribute. Your
attentiveness and excellence will keep customers from hopping
to a new agent. In a service business, one element that can
separate you from the competition is superior customer service.
Here we suggest several questions to ask yourself before you
begin:
What is your purpose? What services do you offer? You
can't be all things to all people, so focus on those areas in
which you have expertise. People buy difference, not
similarity. You must be able to point out the special
benefits of doing business with you rather than the
competition.
Who comprises the market for your services? Identify all
potential prospects, including those you don't currently
serve. This exercise may cause you to consider some
markets you had previously dismissed.
Who are your target markets? A shotgun approach will
defuse your marketing efforts. Determine the kind of
clients you want and don't want. Don't spend time with
prospects that do not meet your criteria.
Focus
geographically,
demographically,
and
psycho
graphically.
The latter may be the most important
because it determines why someone needs you. You
could come up with a list of prospects that meet your
geographic and demographic requirements easily, but if
they are not interested, you are wasting your time.
PERSONAL DISCIPLINE
In the flexible business of real estate, it is essential that real
estate agents learn to balance the many demands placed
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upon them. Jeff Hoffman writes in the Sacramento Realtor that
with daily planning, one can avoid the syndrome of always
“putting out fires.” Instead of reacting to the immediate
situations, he says, “Part of my personal business plan is to
spend the first two hours of my day reviewing current contracts
and handling any immediate concerns. This helps me focus
the rest of my day on marketing, prospecting and meeting with
new clients.”
Real Estate seminar speaker Rick DeLuca
suggests a checklist for agents:
Take 15 minutes to plan each workday.
Set at least one 30-minute appointment with yourself
each day to complete necessary detail work. During this
appointment take no phone calls and allow no
interruptions by other agents.
Schedule some method(s) of prospecting five days per
week.
Contact all sellers every two weeks; (use a seller activity
report).
Send a 30-day subscription of your local newspaper to out
of area buyers.
Mail a flyer of new listings and buyer needs to spheres of
influence monthly.
Summarize income and expense records monthly.
Prepare listing presentation folders in advance.
Schedule three open houses per month (use and open
house checklist).
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Update personal brochure annually and mail to spheres
of influence.
MAINTAIN A POSITIVE ATTITUDE
This is essential in the cyclical business of real estate. There
will be incredibly busy and profitable months balanced by slow
and stagnant months. Your personal budget will allow you to
breathe easier through the slow times, and it is important that
you keep a positive attitude.
Remind yourself that the
downtime is just a part of this business, and don't allow feelings
of defeat keep you from performing to your maximum
potential.
WHO’S YOUR CLIENT?
Knowing your client is critical for success in the 21st century.
With a baby boomer turning 50 every minute from now through
2013 according to Georgia State University’s Center for Mature
Consumer Studies, the profile of the client is changing. Minority
homeownership is also an important factor in the 21st century
market place. According to the 2004 census bureau figures, the
homeownership rate is 49.7% among African Americans and
47.4 percent among Hispanic Americans. 69% of total
American households are in an ownership position.
The second home market is also on the rise. Over 400,000
second home sales in 2003 are a significant number of home
sales in the marketplace. This figure is estimated to grow at
12+% annually making the second home market an attractive
market to participate in. These homes are averaging around
$200,000 in price and can be out on the lake or across the
country. With a trend to downsize the primary home, take
money out of the stock market and low interest rates, people
are in a position to own more than one home. The change in
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capital gains tax has permitted this use of equity for many baby
boomers as well as younger generation X and generation Y
populace. These younger generations are more independent
than the baby boomers and are looking for professionals that fit
their style of doing business.
We can effectively specialize in the market and better serve
the client and customer. Make the decision as to which market
you will serve and then become the expert in that market.
TOOLS FOR SUCCESS
It is essential that today’s real estate agent take advantage
of computer technology. T.L. Wright outlines the benefits of
computers in The Real Estate Professional, “Sales agent 2000
must understand and use all available automation and
technology. There is a direct relationship between computer
skills, effective use of time, and increased earnings. It has been
proven that sales agents who use all available technology can
expect to earn twice as much as agents who don’t.
Consumers will demand accurate information, reliable answers,
and quick response. Unless sales agent 2000 can consistently
provide these services, he/she will be out of business.”
Another tool for success that is rapidly gaining popularity is to
utilize a personal assistant. Real Estate agents have found that
it is worthwhile to pay a personal assistant to handle the
volumes of paperwork so that they can be in the field. Some
offices are providing a pool of personal assistants for agents to
share. Additionally, the team concept is gaining in popularity.
By teaming up agents are able to pool resources and offer the
best service available. Where one member excels at listing
maybe the other handles buyers best and another open
houses. This concept has some drawbacks but a well-planned
approach to the team concept can prove to be very
profitable to all concerned.
108
There are several methods for remaining organized, from
computer programs to a personal assistant. Find a way that
suits you and helps you spend your time most effectively.
William Meyersohn warns, “My philosophy is to stay abreast of
technology without being a slave to it.”
SETTING GOALS
Writing a Business Plan
A business plan is an hourly, weekly, monthly, quarterly
and yearly guide to achieving your goals in the real estate
business. Rather than a nebulous goal (i.e. “I plan to make
$100,000.00 this year!) That will not likely be met. A detailed
business plan allows you to set observable and measurable
tasks for yourself that represent what you have to do each day
to meet your overall yearly goal.
Step One: DETERMINE YOUR REASONABLE EARNING
GOAL FOR THE NEXT 12 MONTHS!
Decide how much income you are willing to make a
commitment to earn in the next 12 months. If you are new to
the real estate field you’ll want to discuss with other more
experienced associates, your sales manager, or your broker
what “reasonable” income expectations are for you. When
you decide on an income figure, be willing to make a
commitment to it! It’s best to share this with another person
who will help you, and support you in attaining this goal.
Step Two: USE THE ANNUAL EARNINGS GOAL WORK
SHEET TO DETERMINE HOW MANY LISTINGS AND SALES
YOU WILL NEED TO OBTAIN DURING THE NEXT 12
MONTHS IN ORDER TO MEET YOUR EARNING GOAL!
109
The annual earnings goal sheet will enable you to see
exactly how many listings and sales you have to achieve in
order to make the amount of income you committed to in step
one.
Step Three: USE THE DAILY BUSINESS PLAN WORK
SHEET TO DETERMINE HOW MANY PROSPECTIVE
SELLERS AND BUYERS YOU NEED TO TALK WITH ON A
DAILY BASIS IN ORDER TO ACHIEVE YOUR OVERALL
EARNINGS GOAL FOR THE YEAR!
The above will allow you to break down exactly how
many contacts you need to make in a days time to achieve
your annual goal.
Step Four: USE THE BUYERS AND SELLERS EXPOSURE
WORK SHEET TO PLAN HOW YOU WILL MEET YOUR
GOALS FOR EACH DAY!
Map out the contacts that you have determined you will
need to make in a workweek and establish from where these
prospects will come. Open Houses, for example, should be
scheduled on weekend days and in locations where they will
generate the highest amount of prospect traffic. On other
days you will need to schedule such activities as mailings, FSBO
contacts, farming, expired contacts, etc. If you are phone
calling an area where most people work during the day, you
will want to schedule your calls for the early evening hours.
It’s important to be specific in scheduling your daily
activities. Don’t just put down that you have to make 10 phone
calls today to prospective sellers.
Note in your daily
appointment log that you will make 5 phone calls between 9
a.m. and 10 a.m. and another 5 calls between 10 a.m. and 11
a.m. Meet with your sales manager to get help in mapping out
your daily and weekly prospecting schedule. Most importantly,
you are making a commitment to these goals. There will be
110
time for plenty of other ‘unforeseen’ activities in your
commitments. Persistence in meeting your commitments and
organizing your time well are the KEYS to achieving your overall
financial goals. It’s best to use an appointment book that has
enough room to schedule your time, list priority tasks, track
what you have accomplished each day and break down your
activities hourly. A two page per day planner is usually best.
There are also many computer programs available for day
planning. PDA’s that can be downloaded to your planning
program are a great help in keeping up with your day-to-day
activities when you are in the field.
The following pages are an annual earnings goal worksheet,
a daily business plan and a weekly goal sheet. Using these
forms together can assist you in planning your activities for the
coming year. Make a copy of the work sheets, determine your
target annual earnings then fill out the work sheets.
111
Annul Earnings Goal Work Sheet
#1. MY INCOME FOR THE NEXT 12 MONTHS WILL BE:
$________________
The next two sections break down your income into two parts; listing
income and sales income. Assume that, on the average, 60% of your
income will come from your listings that sell and 40% of your income will
be generated from sales you make.
#2. LISTINGS SOLD INCOME
A.TOTAL LISTINGS SOLD INCOME (#1 x 60%) = $_______________
B.TOTAL COMMISSION DOLLARS (#2A ÷ 25%) = $_______________
C.GROSS LISTINGS SOLD DOLLARS (#2B ÷ 6%) = $______________
D.TOTAL # OF SOLD LISTINGS NEEDED
(#2C ÷ $120,000.00) = _______________
#3. SALES MADE:
A. TOTAL SALES INCOME
(#1 x 40%) =
$______________
B. TOTAL COMMISSION DOLLARS (#3A ÷ 25%) =$______________
C. GROSS SALES DOLLARS
(#3B ÷ 6%) =
D. TOTAL NUMBER OF SALES NEEDED
(#3C ÷ $120,000.00) =
$______________
_______________
* Assumes an average commission of 6% with 50/50 in office split.
** Assumes average sales price is $120,000.00 (use your markets
average price!)
112
Daily Business Plan Work Sheet
Take the information you computed on your annual earnings goal work
sheet and determine the number of daily contacts you need to make in
order to reach your goal.
#1. LISTINGS
A. Enter line ‘2D’ from your annual earnings goal work sheet
_____________
B. Number of listings you must have in order to sell the
number in ‘1A’ (1A ÷ 60%)
__________________
C. Number of listing presentations you must make to
meet the goal in 1A (1B x 3)
____________________
D. Number of prospective sellers you must talk with
in order to meet the goal in 1C. (1C x 10)
__________________
E. Total number of listing prospects you must speak
with daily (1D ÷ 300)
___________________
#2. SALES
A. Enter line ‘3D’ from your annual earnings goal
work sheet.
__________________
B. Number of active buyers you must work with in order
To make goal in 2A(2A x 3)
____________________
C. Number of active buyers you must talk to in order
to achieve the goal in 2B(2B x 10)
____________________
D. Total number of sales prospects you must speak
with daily (2C ÷ 300)
____________________
113
Weekly Goals
1.
Enter the total number of prospective buyers you must talk
to this week.
2.
Enter the total number of prospective sellers you must talk
to this week.
3.
Enter the number of contacts you will make a
commitment to generate from each of the following
categories:
Number of
Buyers
Open Houses
Mailing with Telephone
Follow up
FSBO
Farm Area Cold Calls
Floor Calls
Other
114
Number of
Sellers
We believe that by following these basic steps you can be
successful in the 21st century in your chosen career. Real estate
is an honorable profession, filled with very successful people.
The common bond between them is a desire to serve to the
best of their ability, to know the market they are dealing in, and
to stick to that market regardless of what may seem to be a
quick trip to the top of the financial ladder. “Be all that you
can be”, if we may borrow a slogan from the U.S. Army, is most
appropriate for real estate sales as well.
Work in your
specialization and the market will reward you.
1
2
Frazier, 1.
ibid., 5.
115
SECTION ONE QUIZ
Transfer our answers to the answer sheet
1. What does the strategic plan acronym SMART stand for?
a. Specific, Measurable, Attitude, Remunerable, Timid
b. Start, Measuring, At, Red, Tree
c. Specific, Measurable, Attainable, Relevant, Timed
d. Special, Measurable, Attainable, Revealed, Timed
2. When making your budget a good rule of thumb is to
increase the amount of money you expect to spend in the
next year by how much?
a.
b.
c.
d.
Triple
Double
Ten times
Five times
3. Sales activity usually follows listing activity after a lag of how
long?
a.
b.
c.
d.
2 to 3 months
6 to 8 weeks
4 to 7 weeks
4 to 7 months
4. According to the checklist for agents, how often should you
contact sellers?
a.
b.
c.
d.
Every 2 weeks
Once a week
Once a month
Every other month
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5. According to the checklist for agents, how often should you
prospect?
a.
b.
c.
d.
Once a week
Every other day
Five days a week
Three days a week
6. What is the importance of your USP?
a.
b.
c.
d.
Adds fluff to your advertising
Points out the uniqueness of you
Gives you and edge over the competition
All of the above
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SECTION TWO
FINANCING RESIDENTIAL REAL ESTATE
Learning Objectives
•
•
•
Real Estate Financing
Mortgage Markets
Effects Of Laws And Acts
Real estate practitioners need a concise working
knowledge of residential real estate financing in order to
provide helpful financial information to their clients and
customers. Keeping up with a number of lenders to determine
the most competitive rates, closing costs, total settlement
charges, margins, application fees and whether the interest
rate quoted will apply on the closing date will allow you to
recommend these services to potential clients. There are many
alternatives available to homeowners and buyers.
As a
professional, you should be aware of the options so that you
can advise your clients and assist them in making wise
decisions.
We use the terms mortgagor (borrower) and mortgagee
(lender) through out this text when referring to mortgages or
deeds of trust.
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CONVENTIONAL LOANS
Conventional loans, as compared to FHA or VA loans, are
not guaranteed or insured by the federal government.
Conventional loans can be applied for and funded at
commercial banks, insurance companies, savings and loan
associations, credit unions, mortgage brokers and mortgage
bankers. Each institution relies on its own policy to determine
the credit worthiness of potential customers, usually relying on
key factors like the borrower’s income, past credit history,
assets, and long term debts.
The secondary mortgage market has established some
standard ratios to determine the amounts of income necessary
to qualify for a particular size of monthly mortgage payment.
Monthly housing expense ratio:
Monthly PITI (principal, interest, taxes & insurance) gross monthly income must = 28% or less.
Total monthly fixed obligations ratio:
Total monthly obligations including housing expense
and other long-term debt (debts of 10 months or
longer generally) - gross monthly income must = 36%
or less.
Understanding these formulas will allow the real estate
practitioner to qualify a buyer prior to showing properties so
that he/she can know the price range the buyer can qualify for
and only show houses that the buyer can afford. Showing
houses to prospective purchasers that are above their price
range can be discouraging. When they later see houses that
are in their price range, it is tempting to compare them with the
more expensive homes. Conversely, if a real estate practitioner
shows homes below the purchaser’s price range, they can
become dissatisfied with the service they are receiving and find
a sales person that will show them properties that meet their
needs.
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Besides the lending ratios, it is important to remember
additional expenses such as loan origination fees and points.
Lenders charge origination fees based on the amount of the
loan. A percentage of the actual loan amount determines the
origination fee.
For example, the origination fee on a
$175,000.00 loan with a 1.5% fee will result in an origination fee
of $2,625.00. Although the borrower usually pays this fee, it is
negotiable. The contract could stipulate that either party pay
this or any other expense to the contract.
Points are another charge that a lender might place on
the origination of a new loan. They are an up-front charge by
the lender to increase the “effective yield” to the lender on the
loan. This fee allows the lender to loan money over a long
period of time for a lesser interest rate because they have
collected this fee up front. The amount of the fee is not the
same amount they would have collected if they had charged
the larger interest rate. However, by having the money at the
time of origination of the loan, they can reinvest it and expect
to gain an equal or better return than if they had charged the
larger rate for the period of the loan. One point is equal to
1/8% of interest charged. For example: A loan for 6 7/8% with
one point should produce effectively the same for the lender
as a 7% loan with no points.
Private mortgage insurance is normally required on all
loans when the loan-to-value ratio is greater than 80%. Private
mortgage insurance insures to the lender the difference in the
actual loan-to-value ratio and the 80% LTV. This guarantees the
bank a return of the amount loaned over 80% of the appraised
value or sales price whichever was less at the time of the loan
in the event of default by the borrower. It is expected that the
property will return the balance of the loaned amount. Lenders
are required to notify the borrower when the loan reaches 80%
of the original value and give them the opportunity to
discontinue the private mortgage insurance. Normally the
increase in value due to appreciation occurs much quicker
202
than the loan reduction process, so borrowers need to be
aware of these changes in value and discontinue the
mortgage insurance sooner if they so choose.
ADJUSTABLE RATE MORTGAGE LOANS
This type of mortgage has a rate that adjusts at the end of
a period of time specified in the agreement (the adjustment
period). The initial interest rate on an adjustable rate mortgage
(ARM) is often a lower percentage than the rate on a fixed rate
loan. The adjustment period is usually annual, but can be for
longer periods such as 3 years or 5 years. There are normally
two caps mentioned along with an ARM. These caps are
normally expressed as a “2 and 6 cap”. The cap set in the
original agreement controls the rate adjustment. The first
number is the maximum amount the interest rate can change
at the end of each adjustment period. It doesn’t necessarily
adjust that much, as we will see shortly, but it can adjust that
amount. The second number indicates the total amount of
adjustment allowed over the life of the loan. In our example,
the loan can adjust 2% at the end of each adjustment period
but can only adjust 6% total over the life of the loan.
The obvious advantage of the ARM is the lower interest
rate at the beginning of the loan term over a fixed rate loan. It
may be particularly attractive to borrowers whose situation is
such that they may not intend to stay in the house for the
whole life of the loan. A good example of this is a family that
frequently relocates due to job transfers or military service. If a
borrower plans to be in the home for an extended period of
time he/she may be well advised to consider a fixed rate over
an ARM due to the security of knowing his/her rate will continue
at the same payment for the life of the loan.
A third important number to consider in an ARM is the
margin. The margin is a number expressed in a percentage
203
that tells the borrower what rate the lender will be using. The
lending institution cannot arbitrarily increase the rate at the end
of the adjustment period. The lending institution bases its rate
on some investment medium such as a Treasury bill. The margin
is the amount above that medium the lending institution
intends on charging on the loan.
Let us suppose that the lender makes a loan for 5% with a
2 and 6 cap. The margin is 2% and the investment medium is
the Treasury bill from the Federal Reserve Bank in St. Louis,
Missouri. At the end of the first adjustment period the Treasury
bill is a 4 7/8%. This means the largest amount the bank can
charge is the Treasury bill rate of 4 7/8% plus the margin of 2% for
a total of 6 7/8%. This is less than the 2% cap the bank was
allowed to charge, but the rate was held down by the margin.
If the Treasury bill in the same example was 5 7/8% then the
maximum amount the lender would be able to charge would
be 7 7/8%, but because of the annual cap the loan could only
rise to 6 7/8%. As you can see, these caps and margins work to
control the extremes that could happen due to a political or
financial crisis that would cause interest rates to jump drastically
during a given period.
FIXED-RATE MORTGAGES
The rate of interest on a fixed-rate mortgage will stay the
same for the life of the loan. These loans can last up to 30 years
just as ARM loans do. Since the rate does not change the
payments remain constant on the principal and interest for the
life of the loan. If taxes and insurance (PITI) were included, the
payments may change as insurance and tax rates increase.
Because their payment is static, homeowners find it easier to
control their long-term budgeting and there is a certain
amount of security that goes along with this constant payment.
When interest rates are low, the fixed-rate is probably the
best choice in financing homes. This long-term commitment
204
from the bank is certainly an asset to any homeowner that is
expecting to remain in the home for an extended period of
time. If the homeowner is interested in paying additional
amounts to the lender in order to pay his note off early, the
fixed payment makes these calculations easier to keep up with
than an ARM.
Certainly, the fixed-rate mortgage is the
standard in the home financing industry. Points, origination
fees, and closing costs are the same on fixed rate loans as they
are on adjustable rate loans; the only real difference is the
interest rate adjustments.
FHA LOANS
The Federal Housing Administration (FHA) was created in
1934 as a partnership arrangement between the federal
government and mortgage lenders. FHA loans are insured by
the Department of Housing and Urban Affairs (HUD) and are
made by commercial banks, savings and loan associations and
all other sources for home loans, just as with conventional loans.
The insurance is paid for with premiums collected from
borrowers and protects lenders against losses from defaults and
foreclosures. The effect of such insurance is to reduce the risk to
lenders and thereby lower qualifying guidelines and interest
rates for borrowers. This type of loan eliminates almost all of the
lender’s risk, but does set guidelines for the loans:
1. The FHA sets the maximum amount of the loan for
different geographical areas.
2. The FHA sets the minimum down payment required.
3. The FHA sets the amount of mortgage insurance
premiums.
4. Loans are made on 1 to 4 unit, owner occupied
dwellings.
Section 203(b): The Housing and Urban Development
Reform Act of 1989, the Cranston-Gonzalez National Affordable
205
Housing Act of 1990 (1990 Act), and the Omnibus Budget
Reconciliation Act of 1990 (OBRA) resulted in significant
changes to the FHA’s single family mortgage loan insurance
program known as 203(b). Borrowers may include up to 100%
of their reasonable and customary closing costs in the
calculation used to determine the maximum mortgage
amount. However, the actual maximum mortgage amount is
restricted by the 97.75% and 98.75% loan-to-value limits applied
to the appraised value or sales price, whichever is lower.
The OBRA established maximum loan-to-value ratios that
cannot be exceeded and the act defines appraised value for
such purposes as the “appraiser’s estimate of value excluding
closing costs”. Under OBRA, the maximum loan-to-value ratios
are as follows:
1. For properties with an appraised value (excluding
closing costs) of $50,000.00 or less, the maximum LTV
ratio is 98.75% of the lesser of the appraised value or the
sales price (excluding closing costs).
2. For properties with an appraised value (excluding
closing costs) of more than $50,000.00, the maximum
LTV ratio is 97.75% of the lesser of the appraised value or
the sales price (excluding closing costs).
The method for determining the maximum insured
mortgage loan amount will require two calculations regardless
of property value. The maximum mortgage loan amount is the
lesser of the two calculations.
Calculation #1: The mortgage loan amount is computed
by adding 100% of the borrower’s closing costs to the
lesser of the sales price or appraised value, and
multiplying the result times a factor(s) specified by FHA. If
the property value is $50,000.00 or less then the factor is
97%. If the property value is more than $50,000.00, the
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factor is 97% on the first $25,000.00, 95% on the amount
between $25,000.00 and $125,000.00 and 90% on the
remainder.
Calculation #2: The mortgage loan amount is computed
by multiplying the appropriate maximum LTV ratio under
OBRA (98.75% or 97.75%) times the lesser of the appraised
value or sales price.
LOAN DISCOUNTS: The seller, borrower, or any other party to the
transaction may pay all or any part of the loan discount points
on a FHA insured mortgage loan. Each discount point is equal
to 1% of the loan amount.
INTEREST RATES: The interest rate on FHA loans is fully negotiable
between the lender and the borrower. The maximum interest
rate is not established by any statute or federal agency.
Rehab a Home with HUD's 203(k): The purchase of a house
that needs repair is often a “catch-22” situation, because the
bank won't lend the money to buy the house until the repairs
are complete, and the repairs can't be done until the house
has been purchased. HUD's 203(k) program allows the buyer to
purchase or refinance a property plus include in the loan the
cost of making the repairs and improvements. The FHA-insured
203(k) loan is provided through approved mortgage lenders
nationwide. It is available to persons wanting to occupy the
home, as well as to investors wanting to increase their rental
portfolio or resell the property, or to first time homebuyers
wanting to assume the loan for no down payment. The down
payment requirement for an owner-occupant is approximately
5% of the acquisition and repair costs of the property. An
investor has a down payment requirement of 15%.
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The following are some commonly asked questions about
FHA loans:
Is mortgage insurance required on FHA loans?
Yes, FHA requires mortgage insurance (MIP) on all 203(b)
loans. The "up-front" premium of 2.25% of the loan
amount may be financed into the loan or paid in cash at
closing. In addition, a monthly charge of 1/2% of the loan
amount (excluding financed closing costs) is paid each
year.
Are there income limits on FHA loans?
No, there is no maximum income. The borrower's income
is used only to determine how large a loan is permitted.
Are there limits on FHA loans?
Yes, FHA has maximum loan amounts, which vary from
county to county, state to state. The borrower's loan
amount, including financed closing costs, may not
exceed the maximum set by FHA.
Can some closing costs be financed?
Yes, the closing costs that can be financed (rolled in)
with
the
loan
are:
1%
origination
fee,
attorney/escrow/closing fees, recording fees, test,
inspection and certification fees, credit report and
appraisal fees.
How much of the down payment can be a gift or a loan?
The down payment can be 100% gift funds or 100% loan
from a family member. If a loan is used, the additional
loan payments must be used in calculating the back
ratio. If this is appropriate for your situation just add the
monthly repayment amount to "other debt" and use the
calculator to determine maximum loan amount.
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What rate is used for qualifying with FHA ARM loans?
On all FHA loan programs the borrower is qualified at the
initial rate.
VA LOANS
One of the main goals of the VA was to make home
buying easily accessible to those who served in the US armed
forces. Congress authorized VA to guarantee the repayment of
mortgage loans, up to a specified amount, granted to
qualified veterans and allow the veteran to make little or no
down payment on the purchase of a home. Aside from the
veteran's certificate of eligibility and the VA-assigned appraisal,
the application process is not much different from any other
type of mortgage loan.
Certain veterans, selected reservists, and National Guard
personnel are eligible for VA-guaranteed home loans. The
length of service required varies based upon the period of time
he or she has served.
The advantages of VA loans are as follows: no down
payment required in most cases, no monthly insurance
premiums, right to prepay loan without penalty, limitation on
buyer's closing costs. The maximum VA loan amount is set at
$203,000. The current programs available are a 30-year fixed
rate and a 15-year fixed rate. The VA guarantees these loans
to the lender. This guarantee represents a minimum of 25% of
the loan amount guaranteed to the lender in the event of
foreclosure. It is assumed that the property will bring at least
the additional 75% of value at the time of the foreclosure sale.
The Veterans’ Home Loan Indemnity and Restructuring
Act of 1989 and the OBRA resulted in significant changes to the
Veterans’ Affairs loan program.
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The maximum loan-to-value (LTV) ratio for VA loans is
guaranteed on residential properties as follows:
1. If the mortgage loan amount is $45,000.00 or less, the
maximum guarantee is 50% of the loan amount of
$22,500.00, whichever is lower.
2. If the mortgage loan amount is more than $45,000.00, but
not more than $56,250.00, the guarantee is $22,500 of the
loan amount.
3. If the mortgage loan amount is more than $56,250.00, but
not more than $203,000.00, the maximum guarantee is 40%
of the loan amount or $36,000.00, whichever is lower.
4. If the mortgage loan amount is more than $203,000.00, the
maximum guarantee is 25% of the loan amount or
$50,750.00, whichever is lower.
FUNDING FEE: The VA funding fee amounts are based on
the amount of the down payment and calculated as a
percentage of the mortgage loan amount as follows:
1. Down payment of less than 5%, the funding fee is 1.25% of
the loan amount.
2. Down payment of at least 5%, but less than 10%, the funding
fee is .75% of the loan amount.
3. Down payment of 10% or more, the funding fee is .5% of the
loan amount.
The veteran borrower has the option of adding the
funding fee to the mortgage loan amount or paying in full at
closing. Disabled veterans are not required to pay funding
fees. The total fixed obligation a veteran can have to qualify
for a VA loan is 41% of gross monthly income.
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LOAN DISCOUNT: Loan discount points represent 1% of the
loan amount and the amount of discount points is negotiable
between borrower and lender. The borrower, seller, or any
other party can now pay the discount points to the contract.
This is a big change in the manner in which VA loans were
handled. In the past the borrower/veteran was not allowed to
pay discount points. The discount points may now be financed
in any loan including interest rate reduction refinancing loans.
INTEREST RATES: The interest rates are freely negotiable
between the lender and the veteran/borrower. Maximum
interest rates are not established by any statute or federal
agency.
ASSUMABILITY: All VA loans obtained after March 1, 1998,
may be assumed if the substitute borrower is deemed to be
credit worthy. Lenders are permitted to change a maximum
assumption fee of $500.00 and the Department of Veteran’s
Affairs has an assumption fee of .005%. This can be extremely
important to the borrower in selling the home, particularly
during periods of high interest rates or tight money.
ASSUMABLE MORTGAGES
A mortgage loan is assumed when a written agreement is
executed between the lender and the purchaser of the
property subject to the mortgage. The primary responsibility for
repaying the loan is removed from the seller and placed upon
the new owner. The buyer takes over, or “assumes” the existing
loan.
Most lenders allow assumptions on adjustable rate
mortgages subject to the approval by the lender of the new
borrower. The existence of an assumable mortgage can be an
excellent tool when selling a home.
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REFINANCING LOANS
Refinancing home loans can be a smart move in some
cases. The real estate practitioner can be an asset to his/her
clients and customers when he/she knows about the
advantages and disadvantages of refinancing. Whether or not
to refinance depends on the circumstances of each individual
case. The positives for refinancing are to lower the interest rate,
extend the payments for a longer period of time and therefore
make them smaller, or to take the equity out of the home and
invest it in another investment such as a rental property.
Investment advisors disagree on the wisdom of such an
arrangement.
Let us assume that you have decided to refinance your
home and want to look at what you may gain in the
refinancing. Suppose you originated a $100,000.00 fixed-rate
mortgage loan three years ago at an annual interest rate of
10%. Since you have made only 36 monthly payments of
$877.57 each, the outstanding balance on your loan is
approximately $98,150.00. If the mortgage loan balance of
$98,150.00 is refinanced for the remaining term of the loan (324
months) at an annual interest rate of 8.5%, your new monthly
payment will be $773.84, roughly $100.00 per month less than
the present payment. Your lender will probably charge you 1
½% of origination fees and points to refinance the loan, and
you will have out-of-pocket expenses of at least $500.00 for
another appraisal, credit report and other items. These items
total $2,000.00, so it will take nearly two years for you to break
even.
GRADUATED PAYMENT MORTGAGE
The GPM is designed for homebuyers who expect their
income to increase over time. For the first few years of a GPM,
the homeowner pays a smaller monthly payment. This shortfall
212
is added to the principal balance each month, creating
negative amortization. This is defined as an increase in the
mortgage balance resulting from a monthly payment that is
insufficient to cover the monthly interest charge. The monthly
payment will begin to increase annually from years 6-30. The
buyer will usually pay a greater amount of interest over the life
of the loan using a GPM rather than a conventional loan. Also,
it is important to remember that with negative amortization the
homebuyer’s equity position in the property erodes during the
first five years of the loan.
GROWING EQUITY MORTGAGE
A GEM provides for a gradual increase in a consumer’s
monthly payments, with all of the increase applied to the
principal balance. The result is a relatively rapid accumulation
of equity and an acceleration of maturity. This offers borrowers
a lower monthly payment with predetermined increases, about
3 to 5% annually. Homebuyers who expect their incomes to
rise, or who are interested in paying off their loan faster will find
GEMs an appealing alternative. This type of loan is also known
as a rapid equity mortgage (REM) or early ownership mortgage
(EOM). The difference between a GEM and a GPM is that the
homeowner does not suffer the negative amortization that
happens with a GPM.
REVERSE ANNUITY MORTGAGE
A RAM allows senior citizens to retrieve money from the
equity in their homes through government-backed or privately
insured programs.
Under the Home Equity Conversion
Insurance Program, insured by the FHA, the lender pays the
borrower a single lump sum, a credit line, or monthly payments
for as long as the borrower lives in his/her home. No repayment
is required until the homeowner dies, sells the home, or
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permanently relocates. This program is open to homeowners
aged 62 or older, regardless of income level, who own their
homes either free and clear or nearly so. This is especially
attractive to senior citizens that have a great deal of equity
tied up in their homes but live on a small fixed income.
SHARED EQUITY MORTGAGE
Under a SEM, parties may enter into a sale-lease-back
arrangement with their children or other investors, selling the
property and then leasing it back for the remainder of their
lives. Sale proceeds are invested in a life annuity on behalf of
the parents. After deducting rent, the annuity payments go to
the parents.
THE SECONDARY MORTGAGE MARKET
This is an investor market in which blocks of residential
mortgage loans are purchased and assembled into mortgage
pools for the issuance of mortgage-backed securities.
FANNIE MAE
In 1938, the U.S. Congress created Fannie Mae, (Federal
National Mortgage Association) in response to the massive
upheavals in the housing finance system experienced during
the Great Depression. President Franklin D. Roosevelt signed
into law the National Housing Act that provided authority for
the formation of Fannie Mae as a subsidiary of the
Reconstruction Finance Corporation. Fannie Mae was created
to buy FHA-insured loans from mortgage lenders so that they, in
turn, could make more loans to consumers -- the start of the
modern secondary mortgage market. Ten years later, Fannie
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Mae was given authority to purchase loans guaranteed by the
Veterans Administration (VA) as well. Due to the success of
these programs, and general economic prosperity, the period
of the 1950’s, 1960’s, and 1970’s in America represented the
most successful national housing effort in history.
While American housing boomed, the ownership of
Fannie Mae changed. In 1954, the corporation became partly
owned by private stockholders. Fannie Mae issued nonvoting
preferred stock to the Secretary of the Treasury, as well as
nonvoting common stock. Mortgage lenders who were
required to own certain amounts of stock before they could sell
mortgages to Fannie Mae purchased the latter.
GINNIE MAE
The most significant step in Fannie Mae's evolution,
however, occurred in 1968 when Congress divided the original
Fannie Mae into two organizations: the current Fannie Mae and
the Government National Mortgage Association (Ginnie Mae).
Ginnie Mae remains a government agency within the
Department of Housing and Urban Development, helping to
finance government-assisted housing programs. Ginnie Mae
provides liquidity to the FHA/VA market primarily through its
mortgage-backed security guarantee activities. Under this
program, lenders originate loans and then package them into
pools of FHA-insured and VA-guaranteed mortgages. Ginnie
Mae guarantees timely payment of both principal and interest
to the investor. The lenders issue securities backed by the
mortgages and then sell the securities to institutional and other
investors.
FREDDIE MAC
Freddie
Mac,
(Federal
Home
Loan
Mortgage
Corporation) is a stockholder-owned corporation dedicated to
215
improving the quality of life in America's neighborhoods by
making the dream of decent, accessible housing a reality.
Freddie Mac increases the supply of money that mortgage
lenders can make available to homebuyers and multifamily
investors. The corporation buys mortgages from lenders,
packages the mortgages as securities and sells the securities to
investors, such as insurance companies and pension funds.
Freddie Mac is owned by its shareholders and, like other
corporations, is accountable to a board of directors and to its
shareholders. Freddie Mac has an 18-member board of
directors. The shareholders elect thirteen members annually.
The President of the United States appoints five members
annually. Anyone can own Freddie Mac stock, which is traded
on the New York Stock and Pacific Exchanges.
ADDITIONAL CONCERNS FOR
REAL ESTATE PROFESSIONALS
It is imperative that real estate practitioners be aware of
the various financial laws and regulations that affect the home
buying industry.
TRUTH IN LENDING ACT
The Truth in Lending Act requires creditors to provide
consumers with accurate and complete credit costs and terms.
Required terms must be disclosed in a clear and conspicuous
manner and in a form available to the purchaser. The creditor
must clearly display the finance charge and the annual
percentage rate. For a loan with a fixed term, information must
be displayed and explained accurately about total cost
including the down payment, total dollar amount of payments,
payment schedule, and any required collateral in case of
default, as well as other terms and conditions of the loan.
216
SAMPLE TRUTH IN LENDING STATEMENT
TOTAL OF PAYMENTS
FINANCE
AMOUNT
The amount the
APR
CHARGE
FINANCED
borrower will have
The cost of your
The dollar
The amount of
paid after he/she
credit at a yearly
amount the
credit provided
has made all
rate. (A)
credit will cost
to the
payments as
the borrower. (B) borrower. (C)
scheduled. (D)
The truth in lending disclosure is designed to give the
borrower information about the costs of his/her mortgage so
that he/she may compare these costs with those of other
mortgage programs or lenders.
A. The Annual Percentage Rate (APR) is the cost of credit
expressed as an annual rate. Because the buyer may be
paying loan discount points and other prepaid finance
charges at closing, the APR is often higher than the
interest rate of the loan. This APR can be compared to
the APR on other loan programs to reveal a consistent
means of comparing rates and programs. The APR is
different from the nominal interest rate because the APR
is computed from the amount financed and is based on
what the proposed payments will be on the actual loan
amount credited to the buyer at settlement.
B. The Finance Charge is the cost of credit expressed in
dollars. It is the total amount of interest calculated at the
interest rate over the life of the loan, plus prepaid
finance charges and the total amount of any required
mortgage insurance charged over the life of the
mortgage.
C. The Amount Financed is the loan amount applied for,
minus the prepaid finance charges. Prepaid finance
charges include items paid at or before settlement, such
217
as loan origination fees, commitment fees or discount
fees (points), adjusted interest and initial mortgage
insurance premium. The amount financed is lower than
the amount applied for because it represents a NET
figure. If you applied for $100,000 and the Prepaid
Finance Charges totaled $4000, the Amount Financed
would be $96,000.
Truth in lending regulations generally applies to loans that
are secured by residential property.
THE EQUAL CREDIT OPPORTUNITY ACT
This prohibits a creditor from discriminating against a
consumer on the basis of age, gender, marital status, or
reliance on income from public assistance programs. In
addition, a credit application cannot request information
pertaining to a consumer's race, color, religion, or national
origin. It cannot inquire about birth control practices or
intention to have children. In the case of unsecured, individual
credit, the creditor may not inquire about marital status, or
generally request information about a spouse or former spouse.
If a creditor denies an individual credit, the applicant must be
notified within a 30-day time period. Included in the denial shall
be a statement of the reason for the denial of credit, an
explanation of the Equal Credit Opportunity Act, and the name
and address of the agency which enforces the Act.
THE REAL ESTATE SETTLEMENT PROCEDURES ACT
RESPA is a consumer protection statute, first passed in
1974. One of its purposes is to help consumers become better
shoppers for settlement services. Another purpose is to
eliminate kickbacks and referral fees that unnecessarily
increase the costs of certain settlement services. RESPA requires
218
that borrowers receive disclosures at various times. Some
disclosures spell out the costs associated with the settlement;
outline lender servicing and escrow account practices, and
describe business relationships between settlement service
providers.
RESPA also prohibits certain practices that increase the
cost of settlement services. Section 8 of RESPA prohibits a
person from giving or accepting anything of value for referrals
of settlement service business related to a federally related
mortgage loan. It also prohibits a person from giving or
accepting any part of a charge for services that are not
performed. Section 9 of RESPA prohibits home sellers from
requiring homebuyers to purchase title insurance from a
particular company.
When borrowers apply for a mortgage loan, mortgage
brokers and/or lenders must give the borrowers:
Special Information Booklet, which contains consumer
information regarding various real estate settlement
services. (Required for purchase transactions only).
Good Faith Estimate (GFE) of settlement costs, which lists
the charges the buyer is likely to pay at settlement. This is
only an estimate and the actual charges may differ. If a
lender requires the borrower to use a particular settlement
provider, then the lender must disclose this requirement on
the GFE.
Mortgage Servicing Disclosure Statement, which discloses
to the borrower whether the lender intends to service the
loan or transfer it to another lender. It also provides
information about complaint resolution.
If the borrowers don't get these documents at the time of
application, the lender must mail them within three business
219
days of receiving the loan application. If the lender turns down
the loan within three days, however, then RESPA does not
require the lender to provide these documents. The RESPA
statute does not provide an explicit penalty for the failure to
provide the Special Information Booklet, Good Faith Estimate or
Mortgage Servicing Statement. Bank regulators, however, may
impose penalties on lenders who fail to comply with federal
law.
An Affiliated Business Arrangement (AfBA) Disclosure is
required whenever a settlement service provider involved in a
RESPA covered transaction refers the consumer to a provider
with whom the referring party has an ownership or other
beneficial interest.
The referring party must give the AfBA disclosure to the
consumer at or prior to the time of referral. The disclosure must
describe the business arrangement that exists between the two
providers and give the borrower an estimate of the second
provider's charges. Except in cases where a lender refers a
borrower to an attorney, credit reporting agency or real estate
appraiser to represent the lender's interest in the transaction,
the referring party may not require the consumer to use the
particular provider being referred.
The HUD-1 Settlement Statement is a standard form that
clearly shows all charges imposed on borrowers and sellers in
connection with the settlement. RESPA allows the borrower to
request to see the HUD-1 Settlement Statement one day before
the actual settlement. The settlement agent must then provide
the borrowers with a completed HUD-1 Settlement Statement
based on information known to the agent at that time.
The HUD-1 Settlement statement shows the actual settlement
costs of the loan transaction. Separate forms may be prepared
for the borrower and the seller. Where it is not the practice that
220
the borrower and seller attend settlement, the HUD-1 should be
mailed or delivered as soon as practicable after settlement.
The Initial Escrow Statement itemizes the estimated taxes,
insurance premiums and other charges anticipated to be paid
from the escrow account during the first twelve months of the
loan. It lists the escrow payment amount and any required
cushion. Although the statement is usually given at settlement,
the lender has 45 days from settlement to deliver it.
Loan services must deliver to borrowers an Annual Escrow
Statement once a year. The annual escrow account statement
summarizes all escrow account deposits and payments during
the service’s twelve-month computation year. It also notifies
the borrower of any shortages or surpluses in the account and
advises the borrower about the course of action being taken.
A Servicing Transfer Statement is required if the loan servicer
sells or assigns the servicing rights to a borrower's loan to
another loan servicer. Generally, the loan servicer must notify
the borrower 15 days before the effective date of the loan
transfer. As long as the borrower makes a timely payment to
the old servicer within 60 days of the loan transfer, the borrower
cannot be penalized. The notice must include the name and
address of the new servicer, toll-free telephone numbers, and
the date the new servicer will begin accepting payments.
Section 8: Kickbacks, Fee Splitting, and Unearned Fees
Section 8 of RESPA prohibits anyone from giving or
accepting a fee, kickback or any thing of value in exchange
for referrals of settlement service business involving a federally
related mortgage loan. In addition, RESPA prohibits fee splitting
and receiving unearned fees for services not actually
performed.
Section 9: Seller Required Title Insurance
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Section 9 of RESPA prohibits a seller from requiring the
homebuyer to use a particular title insurance company, either
directly or indirectly, as a condition of sale. Buyers may sue a
seller who violates this provision for an amount equal to three
times all charges made for the title insurance.
Section 10: Limits on Escrow Accounts
Section 10 of RESPA sets limits on the amounts that a
lender may require a borrower to put into an escrow account
for purposes of paying taxes, hazard insurance and other
charges related to the property. RESPA does not require lenders
to impose an escrow account on borrowers; however, certain
government loan programs or lenders may require escrow
accounts as a condition of the loan.
During the course of the loan, RESPA prohibits a lender
from charging excessive amounts for the escrow account.
Each month the lender may require a borrower to pay into the
escrow account no more than 1/12 of the total of all
disbursements payable during the year, plus an amount
necessary to pay for any shortage in the account. In addition,
the lender may require a cushion, not to exceed an amount
equal to 1/6 of the total disbursements for the year.
The lender must perform an escrow account analysis
once during the year and notify borrowers of any shortage. Any
excess of $50 or more must be returned to the borrower.
In conclusion, a real estate practitioner should be well
prepared with the facts on lending procedures as well as the
miscellaneous laws and regulations affecting the real estate
industry. Having a wealth of knowledge on these subjects will
enhance the real estate practitioner’s ability to provide toplevel service to his/her customers and clients.
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SECTION TWO QUIZ
Transfer your answers to the answer sheet
1. The monthly housing expense ratio is:
a. Total monthly obligations including housing expense &
other long-term debt - gross monthly income must = 36%
or less.
b. Monthly PITI (principal, interest, taxes & insurance) - gross
monthly income must = 28% or less.
c. Total monthly obligations + monthly PITI must = gross
monthly income.
d. A minimum of 40% of gross income can pay for housing
expenses.
2. The definition of points is:
a. An up front charge by the lender to increase the effective
rate of return to the lender on the loan.
b. A fee based on a percentage of the actual loan amount.
c. A cap controlling the rate adjustment.
d. Additional charge by the bank to increase profits for
investors.
3. The second cap number represents the maximum amount
the interest rate can change at the end of each adjustment
period.
a. True
b. False
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4. Which of the following does not apply to a Graduated
Payment Mortgage?
a. For the first few years of a GPM, the homeowner pays a
smaller monthly payment.
b. The monthly payment will begin to increase annually from
years 6 – 30.
c. A GPM provides for rapid accumulation of equity and an
acceleration of maturity.
d. The buyer will usually pay a greater amount of interest
over the life of the loan using a GPM rather than a
conventional loan.
5. Which of the following is not a FHA loan guideline?
a. The FHA sets the maximum amount of the loan for
different areas.
b. Loans are made on 1-4 unit, owner-occupied dwellings
c. The FHA sets the amount of mortgage insurance
premiums.
d. The FHA sets the maximum down payment required.
6. The interest rate on FHA loans is fully negotiable between the
lender and the borrower.
a. True
b. False
7. Mortgage insurance is not required on FHA loans.
a. True
b. False
224
8. Which of the following is not on a Truth in Lending
Statement?
a.
b.
c.
d.
Finance charge
Total number of payments
Amount financed
APR
9. RESPA prohibits anyone from giving or accepting a fee,
kickback or anything of value in exchange for referrals of
settlement service business involving a federally related
mortgage loan. In addition, RESPA prohibits real estate
practitioners from advising clients/customers on various
options in residential lending.
a. True
b. False
10. Certain veteran, Selected Reservists, National Guard
personnel, and their dependants are eligible for VAguaranteed home loans.
a. True
b. False
225
SECTION THREE
ENVIRONMENTAL ISSUESAND PROPERTY
INSPECTION PROBLEMS
Learning Objectives
•
•
Property Inspection Issues
Environmental And Resource Acts
Real estate practitioners must now face a myriad of
environmental issues that concern their industry. No longer
does the term “let the buyer beware” apply to real estate
transactions. Real estate practitioners need to learn how to
spot problem areas and situations in their properties in order to
correctly disclose them to their clients and customers.
LEAD-BASED PAINT
Although many older homes have historic value, class,
charm and style, they often have a serious lead problem.
These older homes were built to last much longer than today’s
modern homes, but the lead in the paint, dust, and soil can be
dangerous if not managed properly.
Sellers and landlords now have to disclose to potential
homebuyers or renters if their home contains lead-based paint,
or if they are aware of any lead-based paint hazards that may
exist. Sales contracts now include a “Lead Warning Statement”
about lead-based paint in the building. Buyers will have up to
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10 days to check for lead hazards. The United States
Department of Housing and Urban Development warns that 3
out of 4 homes built prior to 1978 have lead-based paint.
Lead exposure can harm young children and babies
even before they are born. Even children that seem healthy
can have high levels of lead in their bodies. Lead poisoning
can cause paralysis, brain damage and convulsions.
According to HUD, high concentrations of lead in the body
can:
Cause major health problems, especially in children under
7 years old
Damage a child’s brain, nervous system, kidneys, hearing,
or coordination
Affect learning
Cause behavior problems, blindness, even death
Cause problems in pregnancy and affect a baby’s
normal development
People can get lead in their bodies by breathing or
swallowing lead dust, or eating soil or paint chips with lead in
them. There are many options for reducing lead hazards. In
most cases, lead-based paint that is in good condition is not a
hazard. But, removing lead-based paint improperly can
increase the danger to your family.
Only a qualified
professional can determine if the paint in a home contains
lead, and give counsel as to how to deal with it.
Where is lead likely to be a hazard? Peeling, chipping,
chalking or cracking lead-based paint is a hazard and needs
immediate attention. The following areas should be checked:
windows and windowsills, doors and doorframes, stairs, railings,
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and banisters, and porches and fences. Lead can also show
up in drinking water that passes through lead pipes.
The EPA lead pamphlet "Protect Your Family From Lead In
Your Home" must be given to new tenants, or existing tenants
when they renew their lease. If the landlord knows there is leadbased paint in his rental units, including common areas, he
must disclose this information at the time that the pamphlet is
provided. The landlord is not required to remove lead-based
paint.
Children are especially susceptible to the hazard of lead
paint, and particularly vulnerable to its effects. Lead dust from
deteriorating lead paint which may be chipping, pealing,
cracking or just slowly rubbing away easily finds its way onto
things such as toys which young children regularly put in their
mouths. Children are also more likely to directly contact the
lead paint by chewing on various things in the house, such as
windowsills, that have been painted with lead paint.
Whereas lead paint is a potential health hazard to all, it is
especially so to children. High content of lead in the blood
during the developmental stages of children can interrupt the
normal growth and development patterns of young cells. Some
effects from lead poisoning are not detected until learning
defects and disabilities can be seen.
In his article, “Lead: A Hidden Danger in Many Older
Homes”, Stuart Leiberman, Esq. writes:
Prudence therefore suggests that all home purchasers
determine whether the home they are buying contains lead. It is
very common practice for homes to be sold with “contingencies”.
The most common contingencies are an acceptable termite
inspection and radon inspection. But there are few rules in real
estate, only customs. Parties are free to adjust their contracts as
they deem fit. In the case of an older home purchase, cautious
purchasers --especially those with young children, may wish to
consider an acceptable lead inspection as one of the purchase
302
contingencies. In the last ten years there has been a tremendous
amount of litigation nationwide over injuries allegedly attributed to
lead contamination. Older paint manufacturers, distributors and
retailers have been included in these mammoth cases, and
plaintiffs' attorneys have collected a sizable war chest of shared
information. Their clients, often people who came into prolonged
contact with lead as children, are alleged to be suffering from
irreversible brain damage. Home purchasers never are interested
in buying into these kinds of horrifying lawsuits. They might
therefore consider confronting this issue before the purchase. If
you already own a house with this problem, a professional should
be consulted to evaluate your particular situation and define your
available options.
ASBESTOS
There are several types of asbestos fibers that may be
found in a home. In the past, asbestos fibers were added to a
variety of products to add durability, insulation properties and
fire resistance and can be found in many types of building
materials, products and insulation. You can’t tell whether a
material contains asbestos simply by looking at it, unless it is
labeled. However, a qualified asbestos professional can
positively identify asbestos materials with a special type of
microscope. The use of asbestos as an insulation was banned in
1978.
Asbestos, once known as the “miracle mineral”, was used
in products for four reasons: 1) to strengthen the product
material; 2) for thermal insulation within a product; 3) for
thermal or acoustical insulation or decoration on exposed
surfaces; and 4) for fire protection. Asbestos type materials can
be found on, or in: heating equipment, fireplaces, wood/coal
burning stoves and their components, resilient floor tiles, their
backings and adhesives, cement sheets, millboards and paper
used as insulation around fireplaces and stoves, soundproofing
or decorative materials sprayed on walls and ceilings, patching
and joint compounds for walls and ceilings, textured paints,
303
roofing and siding shingles, and artificial ashes and embers in
gas fired fireplaces.
The mere presence of asbestos materials in a home is
usually not a serious problem or hazard. The danger is that
asbestos materials may be, or become damaged, or disturbed
over time. Damaged asbestos may release asbestos fibers and
become a health hazard. Asbestos materials that would
crumble easily if handled, or that has been sawed, scraped or
sanded into a powder, is most likely to be a health hazard.
According to the Environmental Protection Agency, "the best
thing to do with asbestos materials in good condition is to leave
them alone. Disturbing it may create a health hazard where
none existed before". Naturally, asbestos materials first need to
be identified evaluated and determined to be in GOOD
CONDITION by a qualified asbestos professional before leaving
it alone. The use of asbestos in buildings has been banned
since 1978, so any home built prior to that year should be
evaluated for asbestos danger.
Studies have shown that breathing high levels of asbestos
fibers can lead to an increased risk of: lung cancer,
mesothelioma (cancer of the lining of the chest and
abdominal cavity) and the lungs being scarred with fibrous
tissue. The risk of these cancers increases with the number of
asbestos fibers inhaled. Smokers are even more at risk when
inhaling these fibers. The symptoms of the diseases do not
usually appear until 20 to 30 years after the first exposure of the
inhaled asbestos fibers. People who get asbestosis have usually
been exposed to high levels of asbestos fibers for a long time.
Most people are exposed to small amounts of asbestos fibers
daily and usually do not develop these health problems.
304
RADON
Radon is the second leading cause of lung cancer after
smoking. The radioactive gas can enter a home through cracks
and openings in floors and walls that are in contact with the
ground. Radon can also seep into well water. Radon comes
from the decay of uranium, a natural radioactive element
commonly present in soils and rock. Each year an estimated
14,000 people die from lung cancer caused by prolonged
exposure to radon in air. Clearly, the presence of elevated
radon levels in a home’s air is a risk to human health.
Millions of homes and buildings contain high levels of
radon gas. As a means of prevention, EPA and the Office of
the Surgeon General recommend that all homes below the
third floor be tested for Radon. Because Radon is invisible and
odorless, a simple test is the only way to determine if a home
has high radon levels.
The HUD Section 203(k) mortgage-financing program is
the primary tool for rehabilitating and improving single-family
homes. This program allows homebuyers to finance the
purchase and repair or improvement of a home using a single
mortgage loan. Part of the 203(k) mortgage proceeds must
be used to pay the costs of rehabilitating or improving a
residential property. To qualify, the total cost of the eligible
repairs or improvements, including fixes to reduce radon levels,
must be at least $5,000. The 203(k) program is an important tool
for
expanding
home
ownership,
revitalizing
homes,
neighborhoods and communities, and for making homes
healthier and safer for those who occupy them.
305
RESOURCE CONSERVATION AND RECOVERY ACT
The history of RCRA begins in 1965 when Congress passed
the Solid Waste Disposal Act. This law was amended in 1970
with the Resource Recovery act. Congress again revisited these
measures in 1976, this time to create and pass the Resource
Conservation and Recovery Act. Since then, Congress has
amended RCRA twice, once in 1980 and in 1984. The 1984
amendments are the most significant, dealing with Hazardous
and Solid wastes. RCRA gave EPA the authority to control
hazardous waste from the "cradle-to-grave." This includes the
generation, transportation, treatment, storage, and disposal of
hazardous waste. RCRA also set forth a framework for the
management of non-hazardous wastes.
RCRA has four main goals: to decrease the amount of
hazardous waste produced; to encourage the efficient use
and conservation of energy and natural resources; to prevent
harm to people and to the environment; and to see that
hazardous materials and wastes are properly handled and
disposed of in a safe manner.
The 1984 amendments to RCRA enabled EPA to address
environmental problems that could result from underground
tanks storing petroleum and other hazardous substances. RCRA
focuses only on active and future facility and does not address
abandoned or historical sites.
RCRA subtitle C pertains to the storage, transportation,
labeling, listing and identification of hazardous wastes.
However, it is often difficult to determine what is and what is not
a hazardous waste as defined and regulated by RCRA.
Upon attempting to determine if a waste is hazardous by
RCRA's standards, it must first be determined if the substance is
considered a "solid waste" by RCRA. All hazardous substances
regulated by RCRA are also first considered to be "solid waste."
306
However, determining what a solid waste is can be difficult as
well. First, the term "solid" can be misleading, for "solid waste"
can come in almost any form: solid, semi-solid, liquid, or
gaseous state.
It also requires EPA regulated tests to determine if the
material is to be considered a waste or a product. Such tests
are not always clear, but depend upon the nature of the
substance and the type of management required in handling
it. Many recycled materials specified by EPA are regulated as
solid wastes by RCRA.
There are two primary ways to determine if a substance is
a regulated hazardous waste by RCRA. The first is if the
substance is listed by RCRA as a controlled waste. The second
way is to test it for one of four characteristic properties:
Ignitability, Reactivity, Corrosively, or Toxicity.
There are two other categories of waste that are
regulated by RCRA: solid waste that has been mixed with
hazardous waste, and solid waste that is from a storage,
treatment or disposal facility. There are also some exemptions
from these categories: "materials that are disposed of in public
sewer systems, industrial discharges that are subject of Clean
Water Act permitting requirements, residues from fossil fuel
combustion, and certain "mining" wastes."1
UNDERGROUND STORAGE TANKS
The year 1998 marks the deadline by which all
underground storage tanks installed before 1988 must either
meet government standards or be removed or abandoned. By
December 22, 1998 all UST owners and operators who have
tanks that do not meet EPA standards under Subtitle I of RCRA
will be subject to heavy fines and penalties. The regulations
307
apply to tanks holding 110 or more gallons of petroleum
products or other hazardous substances.
However, there are significant exemptions from this. In
“1998 Underground Storage Tank Upgrade Requirements Loom
Large” Stephen Ricca writes, "EPA's program exempts tanks
containing RCRA wastes, storm or wastewater collections
systems, and farm or residential tanks of up to 1100 gallon
capacity. Also exempt are heating oil tanks for on-site
consumption, septic tanks, certain pipeline facilities, surface
impoundments, pits, ponds, lagoons, flow-through process
tanks, liquid traps or associated gathering lines directly related
to certain oil, gas operations and storage tanks in basements
and other underground areas.”
Since 1988 all new USTs and connected piping have to be
constructed out of fiberglass-reinforced steel or plastic, or
cathodically protected steel. Some older tanks require
upgrades including interior lining, or cathode protection, or a
combination of the two. See an expert for specific details that
pertain to tank upgrading and to find any state laws pertaining
to UST upgrading.
All new USTs are also required to have fail-safe devices
ranging from catch basins, overfill protection, and leak
detection to pipe leak monitoring. Many older tanks may also
have to be upgraded and retrofitted with the above devices.
Again, see an expert for details about tank upgrading and
installation and other state laws that may apply.
The alternative to upgrading old tanks is removing them
from the ground, or filling and sealing the tank and
abandoning it.
There are federal and state regulations
concerning removal and abandonment of USTs. See a
specialist to make sure you meet all of these requirements if you
choose to remove or permanently abandon a UST.
308
Purchasing property with an old UST that is not in
compliance with the new EPA standards could possibly incur
liability on the purchaser to perform the costly measures
required to bring the tank into compliance or to remove or
abandon it. It is wise to make a thorough inquiry and on-site
investigation to determine if there are any USTs and to
determine if they require attention according to RCRA Subtitle
I. There is no guarantee that the seller would be liable for not
disclosing an old UST. However, sellers should also be aware
that if the tank would not be discovered upon a reasonable
inspection by the buyer, you might have a duty to disclose it to
any potential buyer.
Again, the deadline for having all USTs in compliance with
RCRA is December 22, 1998. If you discover a UST on property
that you are assisting a buyer of a seller, you may want to seek
expert advice to determine if and how it should be brought
into compliance with the RCRA regulations.
COMPREHENSIVE ENVIRONMENTAL RESPONSE,
COMPENSATION AND LIABILITY ACT (CERCLA)
Passed in 1980, CERCLA is sister to the RCRA. CERCLA is
one of the farthest-reaching and most important of the
environmental laws concerning real estate. The law is designed
to provide means for cleaning up environmental hazards that
pose a threat to people and the environment. It enforces
financial liability of responsible parties, and provides a fund to
pay for the clean up of hazardous cites if no responsible party
can be found or compelled to pay for the clean up. For this
reason the law is also known as "Superfund." CERCLA also
established the National Priority List of environmental hazard
sites.
309
Potentially liable parties include:
1. Generators of the hazardous material.
2. Those who arranged for the transportation of the
material to the site.
3. Present owners of the land where the hazardous
material was found.
4. Former owners or operator of the land (if that party
owned the land when the hazardous material was left at
the site.
"A responsible party's liability is strict, joint and several, and
retroactive. Strict liability means that the government does not
need to prove that a [Potentially Responsible Party] caused the
hazardous condition. Joint and several liability means that any
single PRP can be held responsible for the entire cost of
cleanup at a site regardless of the quantity of hazardous
substances he actually contributed to the site. All the
government need prove is that the PRP contributed some
quantity of the hazardous substance to the site-requiring
cleanup. Retroactive liability simply means that if the PRP
disposed of some hazardous waste before the CERCLA statute
was enacted in 1980, it would currently be liable under CERCLA
even if the disposal was in compliance with the law that existed
prior to 1980."2
There are two primary defenses that may be taken
against CERCLA liability: the third party defense, and the
innocent landowner defense. The third party defense rests on
proving that the hazardous material was brought to the site by
an act or omission of a third party totally unrelated to the
landowner. For this defense to be taken, the third party can
have had no contractual agreement or relationship with the
landowner. The landowner must also demonstrate that he took
310
reasonable precautions in preventing the material from
becoming located on his land. If an employee, agent, or
tenant of the landowner put the material there, then the third
party defense is invalid.
One court has even found the generator of hazardous
waste liable for contamination caused by a transporter due to
the nature of the business relationship held between the
generator and the transporter. This is so even if the owner
arranged to have the waste transported to one cite and it was
taken to another without authorization. (O'Neil v. Picillo, 682 F.
Supp. 706 (D.R.I. 1988), aff'd, 883 F. 2d 176 (1st Cir. 1989)).
The innocent landowner defense was added to CERCLA
in 1986 in order to provide some relief to landowners and
expand the Superfund. Now owners that can prove that they
did not contribute to any of the hazardous waste, and did not
know about the hazardous waste at the time of purchase are
not liable under CERCLA. Owners must also demonstrate that
they made a reasonable effort to ascertain if the property was
contaminated at the time of purchase, and acted promptly
and responsibly once the hazardous material was discovered.
Government agencies that acquire contaminated
property through condemnation or owners who acquire the
contaminated property through inheritance are also not liable.
However another condition that must be met is the
diligence done in ascertaining the prior owners use of the land.
A responsible inquiry must be made by the purchaser to insure
that the property does not contain hazardous waste
contamination. The courts consider several factors when
determining if this has been done in line with common good
business practice.
1. Any specialized knowledge or experience of the new
landowner
311
2. The relationship of the purchase price to the value of
the property if uncontaminated
3. Commonly known or reasonably
information about the property
ascertainable
4. The obviousness of the presence or likely presence of
contamination at the property
5. The ability to detect
appropriate inspection3
such
contamination
by
Even so, relatively few landowners have been able to
successfully invoke either of these defenses in court.
A large issue in corporate CERCLA liability is that of
“piercing the corporate veil”. Piercing the corporate veil refers
to holding parent corporations responsible for actions, and in
this case hazardous contamination, done by a subsidiary
corporation. The EPA looks at various factors when determining
when to pierce the corporate veil such as officers acting for
both corporations and oversight and involvement in the
subsidiary's finances by the parent. It depends generally upon
the overall involvement and control of the subsidiary by the
parent. In specific circumstances the officers of a company
may be held personally liable depending on the officer's
ownership of company stock, power and authority in the
management of the company, and authority over waste
handling and disposal.
Successor companies have also been held liable for the
contamination done by a company they have bought out.
Lenders can be held liable for contamination that
happens on the property of the borrower if it can be shown
that the lender is in practice and is the owner and operator of
312
the property or has "participated in the management of the
property." Lenders may attempt to plead the "Security Interest
Exemption" which holds that lenders are not liable if they have
simply maintained proper interest in their loan collateral as long
as they have not directed the management of the property as
well.
Lenders, parent corporations, and successor corporations
need all be aware of the possible significant liability for cleanup
of hazardous waste they may bear even toward other
companies and the land to which they have an interest.
PROPERTY INSPECTION PROBLEMS
The following excerpt is from Red Flags Property Inspection
Guide by James C. Prendergast:
Real estate brokers and agents have always been
responsible for faithfully representing the condition of a property
without concealing any known defects. Recently, the courts and
legislatures of various states have given brokers and agents the
additional duty of inspecting a property for any visible defects
(Red Flags) that may affect its value or desirability, and of
disclosing them to prospective buyers. This is a growing trend and
real estate professionals nationwide will soon be required to
inspect properties for Red Flags.4
Real estate practitioners need to school themselves on
recognizing these visual signs or indications of defects known as
“red flags”. “Often, problems cost many thousands of dollars to
correct, or they adversely affect a home’s resale value, or an
unsafe condition may contribute to an injury. In such cases, a
buyer often looks for someone to blame and files suit against
the seller, usually including the real estate brokers involved in
the purchase.”5
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The following are some common causes for structural
defects:
Expansive Soils – When exposed to water, these soils, usually
clay, absorb the water and swell. In dry conditions they
shrink.
This swelling and shrinking can damage the
foundation of a home. Check the soil on your property. “If
soil is black, soft, and sticky during the wet season, or if
cracks appear on the ground in the dry season, the soil is
probably expansive”.6
Fills – This is soil that has been moved and placed artificially,
common in hillside developments, building tracts on level
ground, and adjacent to bays, lakes, rivers, and marshes. If
done correctly, fills are very dense and not a red flag.
However, poorly and loosely constructed fills will settle when
they get wet or are built upon.
Freezing Ground – “Since water expands when it freezes and
shrinks when it thaws, if structures built in frigid areas are not
designed to withstand the pressure of freezing ground, their
foundations may be subject to movement and damage.”7 A
basement allows the builder to extend the home’s
foundation below the freeze level so that movement is
minimal. But, if drainage is poor and water is allowed to find
its way into the basement, some freezing damage can
occur to the foundation. Prendergast points out, “Damage
caused by freezing ground is likely to occur within the first
few years, and grows more and more severe each winter.”8
Collapsing Soils, Sinkholes, and Voids – Common in southern
states, these occur when soft and loose soils are subjected to
heavy loads, like a house, and small voids and large caverns
develop beneath the earth, which can collapse and cause
sinkholes.
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Land sliding – Although most common in the west, landslides
can occur anywhere steep slopes are combined with weak
rock structures. They happen when the ground is saturated
with water and usually are slow moving.
Poor Drainage – When water is allowed to pool next to the
foundation of the house and seep under or bleed through
the basement walls, structural damage can occur. Real
estate practitioners should look for drainage pipes that
empty out at the base of the house instead of away from
the house as a potential drainage problem.
Structural Defects – These construction defects are the
underlying cause of distress in many properties. “Undersized
beams, improper nailing, and improper construction
procedures in general cause defects in a structure. Such
defects are usually very difficult to isolate. Where evidence
of distress is observed and no specific causes can be
identified, a structural or construction defect may be the
reason.”9
Besides latent structural defects, the real estate practitioner
must be on the lookout for red flags on the exterior and interior
of the home, as well as problems on the surrounding property
and structures. James C. Prendergast notes the following
examples:
Cracks in sidewalks, driveways and decks: Hairline cracks are
not a problem, but any crack wide enough to stick a pencil
into indicates a defect. Any crack raised enough to trip over
is a safety hazard and an indication of uneven ground
movement.
Cracks in foundations: There will always be some cracks in
every foundation. Real estate practitioners should look for
several severe cracks, or one crack showing suspicious
foundation movement, or many hairline cracks clustered in
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one place.
Horizontal cracks, although ugly, are not
considered red flags because they are cold joints. This
occurs during construction when all the concrete is not
poured at the same time.
Visually distorted structure: When a structure has been
affected by foundational movement, walls will move and be
visually out of line. Garage doors and front doors will not fit
correctly in their frames and stick and bind. Wall bulges,
cracks at the corners of windows and doors, shimmied doors
show that there has been significant movement.
Drainage: When water gathers in puddles next to the
foundation, it can seep under the home, causing basement
flooding, wood rot, damage to heat ducts and swelling of
wood floors. Water should be transported away from the
house through gutters and downspouts leading out to the
driveway or street. The ground should slope away from the
house to prevent puddling.
Roof, window and flashing leakage: Any wood and wall
staining is evidence of leakage and is a red flag. On the
roof, green moss, missing or curling and separating shingles,
erosion, blisters, etc. are signs of leakage. If any areas on the
ceiling or around the windows have recently been painted
over, there may be water stains underneath.
Hazardous vegetation: Good sized trees and bushes less
than five feet from the house or large trees less than fifteen
feet away can be hazardous. Their roots can grow under
the foundation and cause damage. Dead or unhealthy
trees can topple onto the house during a storm.
Septic systems: Indications of a malfunctioning system
include a strong sewage smell of discolored water ponding
near the location of the system.
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Retaining walls: These walls are built to hold soil that would
otherwise fall down. Wood, rock, or concrete walls should
last 100 years or longer. Untreated wood or Douglas fir walls
will only last about 10 to 20 years. A wall that bulges or tilts
indicates that water is building up behind it and pushing it
forward.
Swimming pools and spas: If the water is not level, this
indicates that the pool is tilted and is a red flag. There
should be no cracks other than a few minor or hairline
cracks.
Illegal additions: This is a common red flag. Many of these
structures are built without permit, and often the electrical,
plumbing and other elements are not safe or built to code.
“If there is an indication of an illegal or non conforming
addition, research city or county files for building permits.
Any discrepancy or omission of information that comes to
your attention during the research should be well
documented for disclosure purposes.”10
Basements and crawl spaces: Check the inside of the
foundation from the basement for cracks using the same
criteria as the outside. Watch out for white, powdery
deposits on the walls as well as water stains. These mineral
deposits are an indication of repeated occurrences of
moisture seepage. If there is a “sump pump”, it most likely
was installed due to incoming water. This evidence of
previous water damage or previous flooding needs to be
appropriately disclosed.
Wall cracks: “Almost every home has a few hairline cracks,
caused by shrinkage of wood.
However, differential
movement of the structure may occur, caused by
foundation movement, or structural defect which can cause
significant wall cracking.”11 Look for cracks hidden behind
curtains.
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Concealed red flags: It is common for an owner to paint and
patch up homes before selling. Sometimes red flags like
cracks, stains, and sticking doors and windows are
concealed. Patched surfaces with a different texture from
the rest of the walls, or cracks that can be felt underneath
wallpaper are suspect.
House alignment: Floors should not slope. Shuffle walking
across the floor or rolling a ball can reveal sloping. Sticking
doors and windows are symptoms that the shape of the
window, door or frame has been altered by the movement
of the walls and floors. An uneven space at the top or
bottom of a door indicates that the frame is distorted.
Sagging beams: Any sagging that is obvious to the real
estate practitioner is a red flag and needs inspection.
Electrical System: Burn marks near switches or plugs are red
flags. Extension cords underneath carpets or stapled along
baseboards are also hazardous. There should not be any
exposed wiring.
Water Heater: There should be a temperature/pressure relief
valve to allow overheated water to be released. Gas
heaters located in the garage should be mounted at least
18 inches off the floor to minimize the chance of gasoline
fumes building up near the floor and being ignited by the
water heater pilot light.
Stairways: Staircases with undersized steps, or single steps
between rooms are a tripping hazard and red flag.
Peter G. Miller writes in Worth magazine/Advisor, “WHO WINS
WITH DISCLOSURE? Pitfalls in the tell-all movement in real
estate.”
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When it comes to buying a home, no one wants to
walk away with a lemon. The question is, how much
information about a home's defects must be disclosed
by law?
As a matter of practice, homeowners and their brokers
looking to sell a property typically reveal "material"
defects to a prospective buyer, such as termites feasting
on the home's foundation. But judging what is or is not a
material defect, proving what is actually known, or even
determining what should be known are hardly clear-cut
matters. The result: Courts nationwide are now clogged
with lawsuits filed by homebuyers.
To resolve the problem of excessive litigation,
mandatory seller disclosure forms are now required by
law in 25 states. "On balance, the forms will reduce
litigation," says Ralph Holmen, senior counsel for the
National Association of Realtors. Already, says Holmen, a
number of major real estate brokers are reporting fewer
suits as use of the disclosure forms has spread.
The eventual winners of this tell-all movement? Real
estate brokers may come out on top. State and local
chapters of the NAR lobbied heavily for disclosure rules in
order to reduce a broker's liability in lawsuits based on
nondisclosure problems. Since the new disclosure rules
focus on sellers, premiums for what's known as "errors and
omissions" insurance, a kind of malpractice coverage for
real estate brokers, are expected to fall. So far these
premium costs have held steady, but experts say the
rules will have an impact in the future.
But even as disclosure standards become increasingly
common, buyers and sellers nationwide still need to
tread carefully. State laws governing disclosure vary
widely, creating much confusion as to what a buyer and
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seller must know to arrive at a handshake. Examples from
around the country show that, depending on the state;
disclosure can pose problems for buyers and sellers alike:
* Wisconsin sellers must disclose under penalty of law
"defects in [a home's] roof." But unless there is a glaring,
visible problem, most roof damage, like rotted wood,
can go undetected. Few owners (or brokers) are trained
as roofers, engineers, builders, or architects.
* Rose Pothier, a Santa Ana attorney, points out that in
California, disclosure statements do not have be
completed by sellers when a property faces a
foreclosure or government sale, or when it is held by an
estate or trust.
* Virginia owners need not complete disclosure forms if
they sell properties in "as is" condition. But this means
savvy buyers there should discount their offer for an "as is"
property. Virginia owners must also tell buyers if there are
"any substances, materials, or environmental hazards
(including but not limited to asbestos, radon gas, leadbased paint, underground storage tanks) on or affecting
the property." Yet even if an army of inspectors combs
the real estate, how can they possibly know about
conditions next door that may "affect" the owner's
domain?
* In at least one state, disclosure has created more
lawsuits. The Agency Law Quarterly reports: "The state
with the most disclosure has had the highest number of
claims. California lawyers have learned that disclosure
does not guarantee a fail-safe transaction. In fact,
disclosure, as practiced on the West Coast, typically
raises buyer expectations to unrealistic levels." Says ALQ
publisher Frank Cook: "Disclosure gives lawyers something
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to go to court with. Where things were gray before,
suddenly they are black and white."
How should disclosure be handled by buyers and
sellers alike? There are some basic rules that should be
followed:
* Buyers should always stipulate that home inspections
are a condition of the sale. Home inspectors are critical
since they act as independent professionals in
documenting the condition of a house. If the inspection
is not satisfactory, the buyer can ditch the transaction
and get his or her deposit back.
* Sellers should not fill out disclosure forms or write
contract clauses themselves. They should enlist the aid of
a real estate attorney or broker. By doing it right upfront,
they'll avoid costly battles down the road.
* Sellers who live in states where disclosure is mandated
by law should take care when completing generic
questionnaires--laws vary as to what can be stated. For
example, Wisconsin permits sellers to answer questions by
marking "See expert's report," while Texans may choose
"Unknown." In cases like these, sellers should rely on
expert reports. Disclosure then becomes part of an
inspector's purview, thereby reducing seller liability--that
is, if sellers have answered truthfully.
* Consider escrow accounts and home warranties to
pay for any repairs if you're selling. To cut costs if there is
a problem that cannot be resolved before closing, a
contract can limit seller repair costs to just those funds
placed in an escrow account. Limited home warranties,
which owners generally purchase through real estate
brokers, can also provide protection against major
structural defects and system failures, such as clogged
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plumbing, that occur after the sale. Before setting up an
account, sellers should check with a local real estate
lawyer to find out if these accounts are allowed in their
state.
* Include a mediation clause in the sales agreement.
Real estate mediation panels don't prohibit one person
from suing another, but buyers and sellers should check
first how local panels are conducted. Panels stacked
with local real estate brokers can compromise
mediation, since brokers work with one another and
share information. They also, by the way, use mediation
hearings to identify potentially lucrative future
transactions.
Robert N. Bass, a Phoenix attorney with a large real
estate practice, says that many Arizona contracts require
mediation by an outside intermediary in the event of a
dispute between buyers and sellers or between buyers,
sellers, and brokers. "I have had several situations where
broker clients have received 'demand' letters from
attorneys threatening litigation," Bass notes. "It has given
me some pleasure to remind them of their client's
obligation under the contract to first try mediation with a
view toward settling before litigation is filed."
The real estate practitioner must stay updated on the
environmental issues that affect his/her business. Lead-based
paint, asbestos, radon, and the many environmental
regulations as well as property inspection red flags are
important concerns to real estate professionals. By being
aware of the legal requirements, agents can provide quality
service to their clients and customers.
1
Dennison, 9-11.
ibid., 3.
ibid., 6.
Prendergast, v.
5
ibid., v.
6
ibid., 5.
7
ibid., 5.
8
ibid., 6.
9
ibid., 7.
10
ibid., 30.
11
ibid., 30.
2
3
4
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SECTION THREE QUIZ
Transfer your answers to the answer sheet
1. “Let the buyer beware” is now the rule-of-thumb real estate
professionals should go by in regards to property inspection.
a. True
b. False
2. How long do potential homebuyers have to check for lead
hazards according the “Lead Warning Statement” in the
sales contract?
a.
b.
c.
d.
2 weeks
10 days
2 months
12 months
3. The use of asbestos in buildings has been banned since:
a.
b.
c.
d.
1976
1980
1978
1878
4. The HUD Section 203(k) mortgage-financing program is the
primary tool for rehabilitating and improving single-family
homes, which includes the cost of reducing radon levels.
a. True
b. False
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5. Which is not a goal of the Resource Conservation and
Recovery Act?
a. to decrease the amount of hazardous waste produced
b. to prevent harm to people and to the environment
c. to see that hazardous materials and wastes are properly
handled and disposed of in a safe manner.
d. to discourage the efficient use and conservation of
energy and natural resources.
6. Heating oil and septic tanks are not included in the 1998 UST
deadline.
a. True
b. False
7. When soil expands in wet conditions and shrinks during dry
spells, thus damaging the home’s foundation, it is called:
a.
b.
c.
d.
Fills
Collapsing Soils
Expansive Soils
Landslides
8. Which of the following is a red flag that the building structure
is poorly aligned?
a.
b.
c.
d.
Sloping floors
Sticking doors and windows
An uneven space at the top of bottom of a door
all of the above
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SECTION FOUR
ISSUES IN AGENCY LAW
Learning Objectives
•
•
•
•
Agency Law
Duties to clients and customers
Agency Ethics
Buyer Agency issues and understandings
What is an agency relationship? It is defined as a legal
relationship in which one person, the agent, acts for and on
behalf of another, the employer, otherwise known as the
principal. The agency relationship is founded on an express or
implied contract between the parties. What does that mean
exactly? An agency relationship is usually one of trust and
confidence between the two parties, a fiduciary relationship.
The concept of agency gives the real estate agent his/her
identity because it involves the rights, duties, and liabilities of
three parties: the principal, or employer; the agent, or broker;
and a fourth party, the customer or client. The National
Association of Realtors Code of Ethics describes the agency
relationship this way:
“When representing a buyer, seller,
landlord, tenant, or other client as an agent, REALTORS®
pledge themselves to protect and promote the interests of their
client. This obligation of absolute fidelity to the client's interests is
primary, but it does not relieve REALTORS® of their obligation to
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treat all parties honestly. When serving a buyer, seller, landlord,
tenant or other party in a non-agency capacity, REALTORS®
remain obligated to treat all parties honestly.”
AGENCY RELATIONSHIPS
How are agency relationships created? When the
principal gives authority to the broker to act or perform as his
“special agent”, and the broker agrees to the delegation of
authority to act, an agency relationship has been created. For
example, a listing contract is a broker’s employment contract
and gives him/her the primary responsibility to find a ready,
willing and able buyer for the property. This contractual
relationship creates a “special agency.”
The agency
relationship does not require a written contract or that the
agent be compensated by the principal. The conduct or
actions of the agent, even unintentional, can create an
agency relationship.
The following
relationships:
are
methods
of
creating
agency
Expressed – the agency has been clearly stated, either in
writing or orally, in words.
Implied – when the real estate practitioner has allowed
the appearance of representation.
Ratification – when agency is later acknowledged or
restated in an implied relationship.
Showing listed properties that meet the buyer’s criteria
concerning size, location, or price does not create an agency
relationship. Describing the amenities of a property and
making factual representations pertaining to its condition does
not create an agency relationship. An agency relationship is
not created by preparing a standard “Offer to Purchase” form
by inserting the terms of the buyer’s offer into the blank spaces
on the form. An agency relationship is not created by promptly
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transmitting any and all offers made by the buyer to the seller
or the seller’s broker or agent. An agency relationship is
created when an agent steps beyond providing market
information to facilitate the completion of a transaction, and
instead becomes a negotiator for the buyer. At that point, an
implied agency has been created.
Agency relationships do not require a written contract to
be considered an actual relationship unless specifically stated
so in state law. The agency relationship also does not require
that the agent be compensated by the principal in order for an
agency relationship to exist. This relationship can be created
by the CONDUCT of the parties toward each other regardless
of what term or label they use, or do not use, to describe their
relationship. It is important for the real estate practitioners to
understand that agency relationships can result unintentionally,
or inadvertently, due to the ACTIONS of the agent.
When an agency relationship has been created, the real
estate practitioner owes a specific set of duties to the client. At
this point, it will be helpful to clarify the difference between
clients and customers. A customer is a person who purchases
property with the assistance of a real estate practitioner who is
not his agent. The customer is not being represented and does
not have the protection of the fiduciary relationship. The agent
owes the customer honesty and fairness in dealing. A client,
however, is the person who has employed the agent to
perform a service for a fee. Your initial contact with the
potential customer or client can determine what sort of
relationship will be beneficial to all parties. The following
categories of buyers should become clients:
Business associates
Friends and relatives
Previous clients
Buyers with whom the agent has a planned future
business relationship
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Buyers who desire representation as clients
Buyers met through an open house or who call for
information on a listing should be given only customer-level
service. To help you recognize agency relationships, remember
that you can give advice to clients but only information to
customers.
Your firm should have a developed policy that specifies all
the alternative agency relationships it intends to provide to the
public.
SINGLE AGENCY
This is the practice of representing either the seller or
buyer, but never both in the same transaction. The seller
agency, where all sellers are clients and all buyers are
customers, is the most common. Since the broker is trying to
find a ready, willing and able buyer for the seller, the buyers
must understand that the sales associate showing properties to
them represents the seller and cannot advise them. The broker
is representing the seller in a fiduciary capacity and it is the
broker’s responsibility to inform the prospective buyer as soon
as possible. The priority at a seller brokerage is to get listings.
These firms may work with buyers as customers, but never for
them, as clients.
There have been scores of lawsuits brought against real
estate practitioners, and licenses have been revoked because
buyer customers believed the seller-agent was “on their side”.
It is very important to disclose to a buyer-customer who you
really work for as soon as possible. Since the buyer probably
begins to place trust in the real estate practitioner towards the
beginning of the relationship, you must be prompt in providing
them with all the information they need to decide how much
trust to place in you.
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SUBAGENCY
This is the practice of acting as the cooperating agent of
another agent (the listing agent) in a real estate transaction. It
used to be common practice for the listing contract to
authorize the appointment of subagents through the use of the
Multiple Listing Service of the local real estate board or
association. By making listed properties available through the
MLS system, all participants had the opportunity to show the
property to potential purchasers.
With the unilateral
agreement of subagency the seller knew that the practitioner
showing his property was, in fact, representing him. This system
was great for sellers because it allowed a much broader
market of buyers who might be interested in purchasing their
property.
In 1992 the National Association of Realtors changed its
MLS policy to read:
NAR’s multiple listing policy shall be modified to delete
the mandatory offer of subagency and make offers of
subagency optional. Participants submitting listings to
the MLS must, however, offer cooperation to other MLS
participants in the form of subagency or cooperation
with buyer agents or both. All offers of subagency or
cooperation made through an MLS must include an offer
of compensation.
Although not everyone is a member of NAR, this policy
seems to be the trend of the entire market.
DUAL AGENCY
The practice of representing both the seller and buyer in
the same (or related) transaction with the knowledge and
consent of all parties prior to representation is called dual
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agency. If the broker acts for both the seller and the buyer
without knowledge or consent of both parties, he/she is an
undisclosed dual agent and is considered to be in breach of
the license law. Undisclosed dual agency can result from any
one of the following:
A cooperating broker, who is a subagent and owes
fiduciary duties to the seller, represents the buyer in the
transaction.
A broker purchases property listed with his/her firm without
the knowledge and consent of his/her principal.
An in-house sale, in which different salespersons from the
listing office represent the seller and buyer. (Each state
has, in some cases, different interpretations of dual
agency. Be sure to consult your state law book for the
interpretation in your area.)
Real estate practitioners must be careful not to make
statements that, in the heat of the deal, might be taken as
advice and lead the buyer into believing there is
representation. A good rule of thumb to avoid accidental
undisclosed dual agency is to tell buyers not to discuss anything
with you that they would not tell the seller directly.
If undisclosed dual agency has occurred, the seller can
seek any or all of the following remedies:
Rescission – a legal remedy that terminates a contract
and attempts to restore the parties to their original
positions before the transaction occurred.
Forfeiture of commission – an agent who breaches his/her
fiduciary duties is not entitled to be paid and can be
compelled to return any compensation or real estate
commission received.
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Damages - includes the difference between the sales
price and the price specified in a higher offer that the
practitioner failed to present to the seller, or any profits
made by a broker who purchased his/her principal’s
property and resold it for a profit without the knowledge
and consent of the seller.
NO AGENCY
This is the practice of acting as a middleman or consultant
to render certain specific services in a real estate transaction
without an agency relationship with any party (facilitator
concept). The practitioner’s task is to bring both parties to the
table and get an agreement. The practitioner must be
cautious to not unduly influence either party or otherwise
facilitate the transaction. This concept may also be referred to
as a “transaction broker” in some locations. In most states
written acknowledgement by the unrepresented parties is
required prior to the signing of any contract.
DUTIES TO YOUR CLIENT
A real estate practitioner who becomes an agent of a
seller or buyer is considered a fiduciary, which is a person who
holds something in trust for another, and owes six specific duties
to the client: Loyalty, Obedience, Disclosure, Confidentiality,
Reasonable Care, Due Diligence, and Accounting. Any failure
on the part of the agent to faithfully perform these duties can
constitute fraudulent and dishonest dealings.
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LOYALTY
This duty obligates an agent to act at all times solely in the
best interest of the client to the exclusion of all other interests,
including his own. The duty of loyalty prohibits the real estate
practitioner from acting for more than one party in a
transaction. The parties in such a real estate transaction have
adverse interests and the practitioner could not be loyal to
both parties.
OBEDIENCE
The agent must obey all legal instructions of his/her client.
If these instructions are, in the opinions of the agent, contrary to
the best interests of his/her client, then it is the agent’s
responsibility to disclose the facts and opinions upon which
his/her belief is based. This being done, the agent must then
follow the client’s decision. If the client insists on instructing the
agent to an illegal action, the agent should immediately
withdraw representation.
DISCLOSURE
The agent must reveal to his/her client all material facts,
reports and rumors known by the agent that could have a
reasonable effect on the decision of the client about the
property or transaction. Specifically this means that an agent
must disclose the following to the seller/client:
All facts that affect the value of the seller’s property
Any relationships of the agent to a prospective buyer
All information concerning the ability or willingness of the
potential buyer to complete the sale or offer at a higher
price
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The agent must avoid a personal interest in the client’s
property unless he/she obtains the client’s permission, and the
agent discloses all pertinent information that could influence
the client’s decision to deal with that agent, and all parties
involved understand that the agent is dealing for his/her own
benefit.
CONFIDENTIALITY
The real estate agent is the safeguard of his client’s
confidence and secrets. The agent may not disclose any
information that could weaken or damage his/her client’s
bargaining position. Confidentiality extends even beyond the
initial transaction; the agent may never use any harmful
information about the client in the future.
Of course,
confidentiality does not mean the agent can withhold any
known material facts concerning the condition of the property
from the potential customer or misrepresent the condition of
the property in any way.
REASONABLE CARE AND DUE DILIGENCE
This duty is best summarized by saying the agent is wise to
always have the best interests of the client in mind, to be
reasonable in the showing of the client’s property, and to be
diligent in his/her representation of the client’s position.
ACCOUNTING
According to the Rules of Conduct, the agent is bound by
law to account for all money or property entrusted to him/her
that belongs to the client. The real estate practitioner must
safeguard any moneys, deeds, or other documents in his/her
possession that relates to real estate transactions.
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TERMINATING AGENCY RELATIONSHIPS
The following are methods of terminating agency relationships:
Expiration of the agency contract
Completion of the task contemplated by the agency
Impossibility of completion
Rescission by either party
Agreement of the parties
AGENCY ETHICS
Agency law was at one time neither complex nor
mysterious. It functioned effectively for many years to define
and protect the rights of principals, brokers, and the public.
However, with the emergence of buyer brokerage, and the
increasing problems with undisclosed dual agency, it is
becoming more difficult to make the agency relationship clear.
Deborah H. Long, author of Doing the Right Thing, a Real Estate
Practitioner’s Guide to Ethical Decision Making, writes, “Few
professionals work so closely with two adversarial parties as do
real estate agents. Agents who work for sellers frequently work
with buyers, and almost as often, agents who work for buyers
also work with sellers – in the same transaction”.1 According to
the Association of Real Estate License Law Officials, there were
26,000 complaints against real estate agents in 1993 resulting in
over 3,700 agents losing their licenses through suspension or
revocation, or paid an administrative fine.2 In the issue of
agency relationships, real estate practitioners have to be very
clear and cautious to make ethical decisions. Long points out,
“We often have a difficult time doing the right thing for a few
reasons: first, confusing, complex, and sometimes contradictory
laws, rules, and codes of conduct govern real estate
practitioners; and second, practitioners lack decision-making
experience confronting ethical dilemmas”.3 She describes four
methods by which people make ethical decisions.
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END RESULT ETHICS
This person, when faced with an ethical dilemma, will
make a list of the “pros and cons of the situation, see which list
is longer, and act accordingly. An end-results thinker does not
see things as ‘right’ or ‘wrong’, but as ‘desirable’ or
‘undesirable’. If an action leads to the greatest possible
balance of good consequences or to the least possible
balance of bad consequences, the action is ethical”.4 An end
results thinker is primarily concerned with their own happiness
and avoiding punishment when they make decisions.
RULE OR LAW ETHICS
Long writes, “The rule thinker is primarily concerned with
the importance of rules or laws of a society, believing that
effective laws apply to everyone and to all circumstances and
are based on the fundamental moral truths”.5 A rule or law
ethics person is primarily concerned with “being a good
citizen.” Law ethics become complicated when several laws
contradict each other, as they often do in real estate.
SOCIAL CONTRACT ETHICS
Long say’s “Individuals who consider their community’s
best interest when making an ethical decision are using social
contract ethics”.6 Real estate practitioners belong to several
communities, their firm, and the local association of
REALTORS, as well as the community they live in, each with its
own set of rules, customs and ethics. An individual concerned
with social contract ethics responds to society when making his
decisions.
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TRANSFORMATIONAL ETHICS
Long writes, “The term ‘transformational ethics’ suggests
that each person brings a unique perspective to an ethical
dilemma. Unlike the other philosophies, which focus on the
outer world – on consequences, rules and societal norms –
transformational ethics focuses on what lies within each person
conscience. Conscience may be defined as the ‘voice from
within’.”7 A person using this ethical system would try to respect
the rights of all people in making his/her decision. The obvious
limitation to transformational ethics is that it is highly personal
and subjective.
It is very important for real estate practitioners to maintain
high ethical standards in their agency relationships. Your
business ethics reveal your core values and principles and your
commitment to doing the right thing.
BUYER AGENCY
National surveys have indicated that most Buyers of real
estate thought that the sales agent represented them in the
transaction. “Buyers assumed that real estate agents worked
for the buyer when showing properties. This assumption on the
part of the buyer prompted them to treat the real estate agent
as a friend and confidant throughout the transaction. Not only
did this situation do the buyers a disservice but it also placed
the agent at great risk of undisclosed dual agency”.8
Traditionally, the agent has always represented the seller’s best
interest of getting the highest price and best terms. Times are
changing. Some of the reasons that buyer/client representation
is a growing trend:
The increasing complexity of real estate transactions;
The rise of consumer protection laws and the decline
of caveat emptor – “buyer beware”;
411
Buyers are more educated about the effects of
customer or client representation;
The rising tide of litigation.9
BUYERS AGENCY DUTIES TO THE CLIENT
Buyer Representation entitles the prospective homebuyer to
client level services such as:
UNDIVIDED LOYALTY
The agent must always act in the buyer’s best interest.
OBEDIENCE
The agent must obey all lawful instructions of the client.
FULL DISCLOSURE
The agent must investigate and reveal facts to the buyer such
as:
The seller's motivations
Existence of other offers
Status of earnest money
Seller's financial condition
Property's true worth/value
Commission split with other brokers
Legal effect of important contract provisions
Relationships between the other agent and the principal
*Refer to your state law to determine its interpretation of these
duties.
412
REASONABLE SKILL & CARE
The buyer agent should:
Analyze market data to determine the property’s true
value and arrive at a reasonable purchase price and
advise the buyer.
Discover material facts and disclose them to the buyer.
Investigate these material facts to determine their impact
on the property's value.
Develop a negotiating strategy to assist the buyer (to
purchase the property).
CONFIDENTIALITY
This prohibits the Buyer's agent from disclosing any facts or
information that was given to or acquired by the agent to any
other party. Information gained must be kept confidential
forever unless the Client releases the Agent. Because of this
responsibility of confidentiality the agent should refrain from
collecting confidential information such as financial information
about the customer, before the agency agreement has been
discussed completely and signed.
ACCOUNTABILITY
When a buyer chooses to work with a buyer’s agent, he/she
should expect the agent to:
Develop a list of homes that meet the buyer’s
specifications and price range.
413
Provide detailed printouts of information about those
homes.
Perform a Comparative Market Analysis (CMA).
Ask a number of questions on the buyer’s behalf to
determine why the seller is selling and how long the home
has been on the market.
Recommend other trustworthy professionals such as
lenders, mortgage brokers, closing attorneys and property
inspectors.
Protect the buyer’s bargaining position and negotiate
aggressively for the buyer.
Seek advantageous financing for the buyer.
REPRESENTATION FORMS
The concept of agency is becoming increasingly more
complex as more customers seek buyer representation. The
buyer agency can be a lucrative alternative to the traditional
seller representation. However, the new dynamic obscures the
traditional identity of the real estate agent, making him/her
vulnerable to many risks including: failing to appropriately
disclose agency relationships, undisclosed dual agency, and
conflicts of interest like a buyer/customer or a seller/client
becoming interested in one of the broker’s listings. It is
paramount that agents protect themselves from these risks by
thorough training and education in agency relationships, and
through use of concise disclosure forms required by your state
licensing board. A buyer agency agreement specifies what
each party is responsible for in the relationship. “The majority of
disputes between agents and client result from an ‘expectation
414
gap’. Quite frequently the buyer-client expected to receive
more services than the agent delivered. This expectation can
be created by an ambitious presentation on the benefits of
representation or the buyer may perceive that he will receive
more than the agent is promising.”10
BUYER REPRESENTATION IN REAL ESTATE
In Buyer Representation in Real Estate, Dianna Wilson
Brouthers and Roger Turcotte emphasize the importance of
gaining informed consent in order to minimize the risk:
Rule #1: Disclose significant facts. “We must provide consumers
with all the information they require in order to ask for their
informed consent to act as their agent.”
Rule #2: Offer alternatives. “An agent must tell a consumer all
of the alternatives when asking for their informed consent. An
agent must be very careful not to sell the buyer on one
alternative over another. Agency choices must be presented
objectively.”
Rule #3: Confirm the buyer’s understanding of their decision.11
Several
described:
types
of
buyer
agency
relationships
are
Exclusive Right to Represent: This written agreement grants a
broker the exclusive right to represent a buyer. The buyer
agent is entitled to compensation if the buyer purchases a
property from anyone at any time during the period of the
agreement. This form of representation is known as an exclusive
buyer agency agreement.
Exclusive Agency: This is an agreement giving a broker the right
to represent a buyer for a specified period of time. However,
415
the buyer reserves the right to purchase a property, without the
use of a buyer agent, directly from the seller. This form of
representation is known as an exclusive agency buyer agency
agreement.
Open Agency Agreement: An agreement that allows a buyer
to work with a number of agents at the same time. The buyer is
only required to compensate the broker who actually sells
him/her property. This is known as an open buyer agency
agreement.
It is also important that the buyer understand that they
have certain responsibilities to the agent. Brouthers and
Turcotte point out these responsibilities:
The buyer should not call other agencies for property
information. If they do, they must notify the agent that
they are working with a buyer’s agent.
If a buyer visits an open house unaccompanied by their
agent, they should inform the agent holding the open
house that they have an exclusive representation
agreement with a buyer’s agent.
A buyer should not call for property information from
private sellers. If they do, they must inform the property
owner that they are represented exclusively by a buyer’s
agent.12
The buyer should be aware that contacting other
agencies or FSBOs without their buyer agent hinders the
agent’s ability to successfully represent them. Also, the buyer
must know that they may be responsible for paying the buyer
agent’s commission regardless of whether the buyer purchases
the home directly from the seller or through another agent.
“Although a buyer agent fee can be paid from different
sources, the buyer clients must understand that they are
responsible for ensuring that their agent is paid the fee agreed
The fee can be
to in the buyer agency agreement.”13
financed through the sales contract, or directly paid to the
416
agent outside of the transaction, thus removing the fee issue
from the negotiations. Also, the seller or seller’s agent can pay
the fee.
PAYMENT OF FEES
There are several types of fees that a buyer’s agent can
negotiate:
Contingency fee – the agent is paid only if the client buys
a property during their relationship.
Non-contingency fee – the agent is paid regardless of
whether the client buys a property.
Consultant fee – the agent charges a fee based on the
performance of a task, assisting the buyer in the purchase.
These fees can be computed on the basis of a percentage of
the selling or list price, a flat fee, or an hourly fee.
The following excerpt is from International Real Estate Digest,
“Alternative Methods of Compensation; Buyer Agency Fee
Structure”, by Corey Scholtka:
In buyer representation, the buyer and the buyer's agent
determine the commission fee, rather than the seller. The fee may
be determined from several options, including:
Percentage of the total purchase price (fixed or open-ended)
Hourly fee (normally non-refundable)
Flat fee
Many buyers' agents are offering a flat fee in response to
consumer demand. The flat fee is advantageous to the buyer in
that the agent will be paid a fixed amount no matter at what
price the home is purchased, or any incentives the broker offers.
This cooperative fee may be more or less than the fee the buyer
417
and his/her broker have agreed to, so a credit or debit may need
to be applied at closing.
Although compensation from a seller or listing agent does not
mean a buyer's broker owes any duties to the seller, there is a
growing trend among buyer representatives of respectfully
declining the cooperative fee from the listing broker. Consumer
advocates claim that knowledgeable buyer brokers do not
accept the cooperative split.
For legal and accounting reasons, it is best to disburse the real
estate fees from the purchase price at closing. This practice
removes any doubt that the buyer's agent has any relationship
with the seller or listing company. The Buyer has additional
protection when the buyer's agent is paid from the transaction,
rather than the listing company after closing. The buyer (who has a
contract with, and owes a commission to the buyer's agent) is
assured that his/ her agent has been paid in full at closing.
In this scenario the buyer's agent takes the fee directly through
the transaction (instead of the cooperative fee). The listing agent
takes the same amount that he/she would have taken had this
been a cooperative fee split, and the seller receives the same net
price. The fee is more appropriately distributed, so neither buyer or
seller pay additional commission.
In summary, it is important for the buyer broker to
understand that the relationship created is as important as the
traditional relationships that have been created with sellers.
The buyer has the right to expect total allegiance from the
agent he/she has employed. The compensation received by
the agent is for services rendered and agents need to be sure
that the service has in fact been rendered. As our market
continues to change these relationships will also continue to
change. By keeping abreast of the latest changes in state law
as they relate to agency and buyer representation the
practitioner can better serve in the capacity of buyer
representation.
418
1
Long, 55.
ibid., 1.
3
ibid., ix.
4
ibid., 22.
5
ibid., 25.
6
ibid., 26.
7
ibid., 29.
8
Brouthers, 11.
9
“History of Buyer Agency”
10
Brouthers, 35.
11
ibid., 33.
12
ibid., 22.
13
ibid., 23.
2
419
SECTION FOUR QUIZ
Transfer your answers to the answer sheet
1. A person who, when faced with an ethical dilemma, will
make a list of the “pros and cons of the situation, see which
list is longer, and act accordingly” is an example of someone
who uses which type of ethical system:
a.
b.
c.
d.
Social Contract Ethics
Rule or Law Ethics
End Results Ethics
Transformational Ethics
2. Which of the following creates an agency relationship?
a. Showing listed properties that meet the buyer’s criteria
concerning size, location or price.
b. The real estate practitioner becomes a negotiator for the
buyer.
c. Preparing a standard “Offer to Purchase” form by inserting
the terms of the buyer’s offer into the blank spaces.
d. Transmitting any and all offers made by the buyer to the
seller or the seller’s broker or agent.
3. Which of the following should not be given client-level
services?
a.
b.
c.
d.
business associates
friends and relatives
previous clients
buyer met through an open house
420
4. The practice of acting as a middleman by bringing both
parties to the table to get an agreement is known as
undisclosed dual agency.
a. True
b. False
5. The real estate practitioner must safeguard his/her client’s
confidence even beyond the initial transaction.
a. True
b. False
6. Which of the following can constitute an agency
relationship?
a. Unintentional actions or conduct by the real estate
practitioner
b. A written contract
c. Compensation
d. All of the above
7. The practice of representing either the seller or the buyer,
but never both in the same transaction is called single
agency.
a. True
b. False
8. Acting as the cooperating agent of another agent in a real
estate transaction is known as:
a.
b.
c.
d.
Subagency
Cooperative agency
Buyer agency
Dual agency
421
9. Which of the following can the seller seek if undisclosed dual
agency has occurred?
a.
b.
c.
d.
damages
forfeiture of commission
rescission
all of the above
10. The real estate practitioner must obey all legal instructions
of the client, even if, in the opinion of the real estate
practitioner, they are contrary to the best interests of the
client.
a. True
b. False
422
REAL ESTATE UPDATE VOL. III
FINAL EXAM
Transfer your answers to the answer sheet!
1. A broker is permitted to represent both the seller and the buyer in
the same transaction when
a. the principals are not aware of such action.
b. the broker is a subagent rather than the agent of the seller.
c. commissions are collected from both parties.
d. both parties have been informed and agree to the dual
representation.
2. The purpose of the Real Estate Settlement Procedures Act (RESPA) is
to
a. see that buyers do not borrow more money than they can repay.
b. make real estate brokers more responsive to the needs of buyers.
c. help sellers know how much money is required to purchase the
property.
d. see that buyers and sellers know all of their settlement costs.
3. The relationship of a broker to his or her client is that of a(n)
a. trustee.
b. subagent.
c. fiduciary.
d. attorney in fact.
4. Included in the regulations of the Superfund which was established
to cleanup uncontrolled hazardous-waste sites are
a. exemptions to responsibility for neighboring properties.
b. release of liability of owner who is not responsible for
contamination.
c. no provision for recovery reimbursement for cleanup costs.
d. provisions for retroactive retraction liability.
5. A mortgagor is the one who
a. gives the mortgage.
b. holds the mortgage.
c. provides the mortgage funds.
d. forecloses on the mortgage.
FINAL EXAM PAGE 2
6. The largest factor in your success or failure will be whether or not you have a
plan. Looking at the big picture will help keep you motivated during business
cycles. Constantly examine the business climate and adjust yourself for the shifts in
the market place. How far ahead should you be planning for your personal
strategic plan?
a. One year
b. Two years
c. Five years
d. Ten years
7. Fannie Mae, Ginnie Mae, and Freddie Mac have in common the purpose of
a. originating residential mortgage loans.
b. purchasing existing mortgage loans.
c. insuring residential mortgage loans.
d. guaranteeing existing mortgage loans.
8. The object of your personal marketing plan, your external perception, is to
accurately show?
a. Your 12-month business plan.
b. Your long-term strategic plan.
c. The average time your listings sell in.
d. Your internal realities.
9. An FHA-insured mortgage loan would be obtained from which of the
following?
a. The Federal Housing Administration
b. The Department of Housing and Urban Development
c. Any qualified lending institution
d. Any qualified insuring institution
10. How often during the next 8 years will a baby boomer turn 50?
a. Once every hour.
b. Once every minute.
c. Ten times per day.
d. Ten times per week.
FINAL EXAM PAGE 3
11. The second home market is rising. The estimated growth in this market is which
of the following?
a. 12% annually.
b. 400,000 homes per year.
c. 15% annually.
d. 500,000 homes per year.
12. Which of the following is NOT true about asbestos?
a. It was commonly used as insulation.
b. Removal can cause further contamination of a building.
c. HUD requires all asbestos-containing materials to be removed from
residential buildings.
d. It is most dangerous when airborne.
13. In regulations regarding lead-based paints HUD requires that
a. homeowners test for presence.
b. paint must be removed from surfaces before selling.
c. known paint hazards must be disclosed.
d. only licensed contractors may deal with removal.
14. The discount points charged on a VA guaranteed mortgage loan could
be paid by which of the following?
a. The buyer
b. The seller
c. Financed into the loan
d. All of the above
15. When setting your annual goals it is important to plan hourly, weekly and
monthly guides for your activities. The first step is to:
a. Determine the number of sales you want to make.
b. Determine the number of listings you want to obtain.
c. Decide the market you plan to specialize in.
d. Decide the income you are willing to commit to for the next 12 months.
16. The interest in a property held by the owner in excess of any liens
against it is called
a. hypothecation.
b. subordination.
c. leverage.
d. equity.
FINAL EXAM PAGE 4
17. The principal distinction between the primary mortgage market and
the secondary mortgage market is in the
a. insuring versus the guaranteeing of mortgage loans.
b. origination versus the purchase of mortgage loans.
c. use of mortgages versus the use of deeds of trust.
d. use of discount points versus the use of origination fees.
18. Freddie Mac is part of the secondary mortgage market and is
a. Federally owned
b. Owned by shareholders
c. A subsidiary of Fannie Mae
d. Is Federal National Mortgage Association.
19. Which of the following loans to individuals is NOT affected by the
Truth in Lending Law implemented by Regulation Z, that sets forth certain
requirements regarding real estate loans?
a. Household use
b. Business use
c. Room additions
d. Swimming pools
20. Radon is
a. only found in the eastern United States.
b. easy to detect because of its odor.
c. a known human carcinogen.
d. not found in older homes.
21. Fannie Mae
a. makes FHA loans.
b. buys FHA loans.
c. services FHA loans.
d. insures FHA loans.
22. Before signing a buyer agency agreement a licensee would NOT
a. explain forms of agency available.
b. obtain financial information from the buyer.
c. inform the buyer of the charges or compensation for services.
d. describe specific services to be provided.
FINAL EXAM PAGE 5
23. The real estate broker's responsibility to keep the principal informed of all of
the facts that could affect a transaction is the duty of
a. care.
b. disclosure.
c. obedience.
d. accounting.
24. A seller has listed her home with a broker for $90,000, and the broker tells a
prospective buyer to submit a low offer because the seller is desperate to sell. The
buyer offers $85,000 and the seller accepts it. In this situation,
a. the broker has violated his agency relationship with the seller.
b. the broker was unethical, but the seller did get to sell her
property.
c. the broker acted properly to obtain a quick offer on the
property.
d. any broker is authorized to encourage such bids for the property.
25. Agency relationships may be terminated by which of the following
a. Expiration of the agency contract?
b. Impossibility of completion contemplated by the agreement
c. Rescission of the agreement by either party
d. All of the above.
26. By executing a listing agreement with a seller, a real estate broker in most
cases has become
a. a procuring cause.
b. obligated to open a special trust account.
c. an agent of the seller.
d. responsible for sharing commissions.
27. Conventional loans are
a. Insured by the Federal Government.
b. Guaranteed by the Federal Government
c. Regulated by the American Bankers Liability and responsibility act
d. None of the above.
FINAL EXAM PAGE 6
28. Under an exclusive agency buyer agency agreement, the real estate broker
would NOT be entitled to a commission
a. if the broker sells the buyer a listing from another firm.
b. if the property is a FSBO.
c. if the buyer finds a suitable property without the broker.
d. if the buyer cancels the agreement of sale.
29. If a buyer obtains a $150,000 mortgage with 4 points, how much will the lender
charge at closing
a. $2,000
b. $200
c. $6,000
d. $40,000
30. Which of the following would be considered to be a dual agency
a. The broker acting for both the buyer and the seller in the same
transaction
b. Brokers cooperating with each other
c. The broker representing different principals
d. The broker listing and selling the same property