Real Estate Investor Terms & Definitions
Assumption of Mortgage – Taking title and assuming the payments on an existing mortgage. A “due on sale clause” may prohibit an assumption without the consent of the lender.
Asset Protection – Creating methods of limiting personal liability, and protecting your real and personal property from harm. Asset protection can take on many forms including; Limited Liability Companies, tax shelters and planning, trusts, property insurance, living wills, umbrella insurance policies and more. You may call the RPOA office for a list of member referred financial planners and lawyers.
Balloon Mortgage – A mortgage that does not result in the loan being paid off at the end of the term. The last payment is substantially higher than those made during the life of the loan. Commonly referred to as a partially amortized loan. Most land contracts actually work in this manner without the protection of a mortgage.
Balloon Payment – The final payment of principal of a balloon mortgage, possibly representing a large part of the original loan.
Capital Gain – The difference between the sales price and the adjusted basis of a capital asset. Capital gains are either long term or short term. Long-term capital gains are assets that have been held for one year or more. Short-term capital gains are taxed at ordinary income rates.
Capitalization Rate – A percentage rate at which future income is converted to present value. Future rights to income of a multi-unit property are defined as present worth. The formula is;
Value = Net Operating Income / Capitalization Rate (expressed as a percent).
Cash Flow – The sum of money produced from an income property after all expenses and mortgage payments including principal and interest have been made. Cash flow can be expressed as either before-tax or after-tax. Profit and Loss statements are used to track cash flow for specific periods of time.
Contingency – A condition included as part of a contract which requires the completion of a certain act or the occurrence of an event before the contract becomes binding. Allows a buyer to limit their liability until they have had a chance to discover or uncover more information about a property. Two examples of common contingency clauses would be obtaining a mortgage at a certain rate of interest, and a certain period of time to conduct structural and mechanical inspections of the property.
Contract – An agreement based on a promise or set of promises which result in legally enforceable obligations between two or more parties. The following elements are essential for a contract to be valid and enforceable:
- There must be an offer and an acceptance.
- There must be consideration. Legally sufficient consideration that was bargained for and by each entity as promised.
- Contracting parties must have legal capacity. Participants must be of sound mind and of legal age to form contracts.
- There must be reality of consent on the part of both parties. Duress, fraud, coercion or undue influence are normally void-able at the option of the innocent party.
- The object of the contract must be legal.
- The contract must be in proper legal form.
Rights under contracts are valuable property rights which may be sold or transferred to third parties.
Deed – A written document, usually under seal, conveying some property interest from a grantor to a grantee. Transfer of deeds need to be notarized and recorded with the Register of Deeds. This gives constructive notice to third parties that title has been conveyed.
Deed of Trust – A deed to real property which serves the same purpose as a mortgage but instead of two parties, three parties are involved. The third party holds title for the benefit of the lender.
Due-On-Sale Clause – A clause in many mortgages which allows the lender to require the borrower to repay the outstanding balance when the property is sold or “interest” in the property is conveyed to another party. Also known as a non-assumption clause, the effect is that mortgages with such a clause are non-assumable unless the lender permits the assumption.
Equitable Title – The ownership interest that one has in real property upon the consumption of a valid sales contract. (This is the status of a land contract buyer.) With acceptance of a deed, the equitable title becomes legal title to the property.
Equity – The amount of a property’s fair market value over the outstanding indebtedness.
1031 Tax Deferred Exchange – A legal method of deferring capital gains taxes by exchanging one qualified like-kind property for another qualified like-kind property that is of an equal or greater value. A qualified intermediary must be used. Time periods are strictly enforced and include a 45 day identification period and 180 days total to close the sale of the new property. Reverse exchanges are also possible.
First Mortgage – A lien on property in which the lender’s claims are superior to the rights of subsequent lenders and other contractor liens.
Foreclosure – A legal procedure by which mortgaged property in default by the borrower is sold to satisfy the mortgage debt.
Fraud – A misrepresentation of a material fact which is made knowing its falsity and with intent to deceive a party relying on the facts to make an informed decision. Fraud exists when the misrepresentation of the facts results in detriment or injury to the deceived party. Fraud can be written or verbal or nondisclosure where there is a duty to inform. Fraud is a defense against the enforcement of a contract.
Fully Amortized Mortgage – A loan that is fully repaid at maturity by periodic reduction of the principal. The first part of each payment covers interest on the outstanding debt and the remainder of the payment reduces the outstanding debt.
Gross Income Multiplier – A rule of thumb used in estimating the market value of multi-unit rental property. The multiplier is obtained by dividing the sales price of comparable properties by their gross annual rent. A number of these results can be averaged and then used as a multiplier of rents for the rental property you are evaluating. Helps determine what the market is paying for similar properties.
Land Contract – A legal agreement between two parties in which the seller passes possession of the property to a buyer but retains title until the purchase price is paid in full.
Lease – An agreement between a landlord (lessor) and a tenant (lessee) to use and have exclusive use but not ownership of real estate for a period of time in consideration for the payment of rent. A lease creates rights and responsibilities for both the landlord and the tenant. Leases are defined by, and subject to, both property law and contract law. It is always best to use a lease that has been reviewed by a real estate attorney, such as the Standard Rental or Lease Agreements available from the RPOA.
Lease Option – A lease which includes a clause giving the tenant (lessee) the right to buy the property at a predetermined price. Most often establishes time limits to exercise the option. Part or all of the rent collected may go toward part of the purchase price.
Leverage – Use of borrowed capital to finance the purchase of real estate. Leverage magnifies the risks and returns on investment through the use of borrowed funds.
Lien – Legally recognized right to enforce a claim to the property of another for the payment of a debt or obligation. A lien may be voluntary like the creation of a mortgage or involuntary such as the imposition of a mechanic’s lien or tax lien. Liens become an encumbrance on property and thus diminishes the value of property.
Mortgage – An interest created by a person in regards to a particular property to secure payment of a debt. Real estate financing involves two obligations. The promissory note or bond in which the borrower agrees to pay back a sum of money borrowed. The mortgage is the secondary financing obligation in which the borrower agrees to pledge property to secure the debt created by the note or bond.
No Money Down – A real estate sale in which the buyer does not put any money down and thus finances 100 % of the purchase price.
Paper – A term used to denote a promissory note or mortgage taken by the seller as part of the sales price rather than receiving the entire sales price in cash. Paper can be either kept and the interest and principle payments will be collected by the seller, or it can be sold to an investor. Sometimes the terms “buying or selling paper” is used. This means that someone is buying something such as an existing land contract.
Piggyback Loan – A loan involving two lenders but only one mortgage. Each lender does not have to participate on an equal basis. This does not create a second mortgage as both loans are secured by the same mortgage.
PITI – An acronym for the four monthly payments required under many real estate loans. They are: Principal, Interest, Taxes, and Insurance. Many times taxes and insurance are bundled into your monthly loan payment in the form of escrow, and paid by the lender when they become due.
Quitclaim Deed – A deed, which conveys only the interest a party may have in a property without making any warranties of title. Useful in clearing up doubtful claims such as dower rights or disputed liens. Also used to convey title from individual owners to a Limited Liability Company.
Rate of Return – A percentage relationship between the price of an investment and net income.
Redemption Period – The legal right of a borrower to make good on a defaulted loan within a statutory period of time and thus regain the property.
Sandwich Lease – A lease agreement created when a lessee (tenant) sublets the property to another person. The person in the “sandwich” is a lessee to one party and a lessor to another party.
Self-directed IRA – A Roth IRA investment that allows the investor to invest in real property at their own discretion. An excellent way too grow retirement investments at better than stock market rates. Money also grows tax-free as long as you keep it inside the IRA. Not all investment firms offer this vehicle.
Seller Financing – A loan made by the seller to the buyer to cover all or part of the sales price. Also called owner financing. Useful when the buyer is unable to qualify for a conventional loan. Land contracts are an example of seller financing.
Sheriff’s Deed – A deed given to a buyer when property is sold through a court action in order to satisfy a judgment for money or foreclosure of a mortgage.
Sheriff’s Sale – A forced sale of property, the proceeds of which go to satisfy the unpaid claims of the debtor. The legal conveyance of any property sold during a sheriff’s sale will be done by a sheriff’s deed.
Subject to Mortgage – A real estate transaction in which the purchaser takes over the existing mortgage payments from the seller, but assumes no personal liability for the mortgage.
Trust – A legal relationship under which title to property is transferred to a person known as a trustee who has control over the property and must manage it for another person known as the beneficiary.
Variable Rate Mortgage – A mortgage with an interest rate that can move up or down depending on an agreed-to index. The mortgage usually stipulates a maximum annual increase and a maximum total interest rate that the lender may charge. Sometimes useful in short term real estate investments as the beginning interest rate will most often be lower than longer-term investment rates.
Warranty Deed – A type of deed used to convey real property in which the grantor makes formal assurance as to the quality of the title to the property.
Zoning – A local government receives the power of zoning from the state. A zoning ordinance has two major parts; 1) the text which contains various regulations and standards, and 2) the map which divides an area into different districts. The zoning map is constantly updated and indicates the zoning status of each parcel of land in a community. Two purposes of zoning are to carry out the plan of the municipality and to preserve property values. Zoning establishes land-use districts; residential, commercial, industrial, and agricultural. Each of these districts is divided further to better identify permitted land use. For example R-1 would be single family residential and R-2 would represent multi-family uses. Zoning uses can change with a new plan or if a property is not used for its specified zoning for a period of time. It is a good idea to file for property use verification before purchasing an investment property.
This is for informational purposes only and is not intended as legal, real estate, or financial advice. The individual investor is responsible for investigating and verifying the validity of this information and should consult with a qualified attorney, real estate broker and/or accountant before investing.