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Financing Real Estate Transactions

( Originally Published 1924 )



Questions

What are the sources of finance for the real estate dealer? Indicate something of the difficulties of using each of these sources. In what essential has the mortgage changed in modern times? What are the principal features of a mortgage? Why can mortgages not be made for the full value of the property and still be secure? Explain the amortization principle. How does the second or "junior" mortgage differ from the first or "senior" mortgage? Mention the advantages and disadvantages of mortgages as a means of financing real estate transactions. What is the disadvantage that has recently been overcome, and how was it overcome? What is the outstanding characteristic of the land contract? In what respect is the land contract weak, and how may its weakness be remedied? Describe a building and loan association. What are its advantages and disadvantages? What are the chief sources of farm financing? Show how the farmers' needs for different types of credit are met by the present agencies. How does the Federal Farm Loan System make its loans?

ONE of the greatest problems of the real estate dealer is financing the transactions which he proposes to customers. It is not possible for him to sell his commodity as the ordinary commodity is sold, for the purchase price in most cases exceeds the funds which the purchaser can command. There are few people who would not like to own their homes if they thought that they could finance them, and many undeveloped business sites await the coming of the capital necessary to enable their exploitation. In such cases, the dealer must devise means by which the purchaser's funds can be made to serve as the basis of the. transaction and the remainder can be secured from some other source.

It is frequently said that real estate dealing is the only business that requires no capital; it could more accurately be said that in no business is success more definitely limited by capital resources than in real estate dealing. To an increasing degree credit plays an essential part in real estate buying and selling, and credit thus utilized or made available is not merely a paper or a bank balance. The extension of credit is the advance of bricks and mortar, lumber and labor, necessary to the erection and ownership of a home. The dealer who provides credit facilities for his customers actually places these requisites in their hands. His ability to serve them depends upon the extent to which he can command finance. Financial connections and resources are consequently of greatest significance to him. He must bridge the gap that exists between the customer's desires and needs and his financial resources. To the extent that this gap is bridged, the dealer is able to realize his aims, increase his sales, and build up the community. It is not of any civic significance that ninety-nine per cent of the population of a country desire to own their homes; it is when that desire becomes effective and they are able to purchase that the community is benefited. It is of no practical benefit to a city to possess good sites and facilities; it is the utilization of those sites and facilities that builds up the commonwealth. In both of these developments the part played by the dealer is the leading role. He must constantly help his customers to own homes, and he ought constantly to push the proper development of his community. This is the creative, progressive leadership which every dealer ought to set for his goal. It should be pointed out here, however, that unlimited, unwise granting of credit in real estate transactions is both dangerous and undesirable. Without the proper qualifications no one is entitled to credit, and one of those qualifications is demonstrated ability to save.

Through the old forms of financing real estate, such as the first mortgage (which will be explained later on) not over fifty or sixty per cent of the purchase price of real estate can be financed. In other words, the buyer must first accumulate enough to pay nearly half of the purchase price before he can own any real estate. This is undoubtedly a higher percentage of the purchase price than safe financing requires, and the problem in real estate financing is to reduce that initial outlay to a mini-mum, and yet keep the cost of such financing within reasonable bounds. Many good things have been accomplished by the first mortgage, and it is an indispensable instrument, but the margin of safety can never be reduced much below where it now stands. Mortgage financing is handicapped by the fact that the value of real estate is constantly fluctuating, and under a forced sale, the most desirable real estate may not bring a satisfactory proportion of its normal value. Under the first mortgage system the security of the loan is the primary essential. In a fluctuating market, in order to be safe, the mortgage must be written for only a portion of the value of the property. After the first mortgage has been placed, the security of further loans is decreased, and the cost of such loans increased. Thus on second mortgages, which are subordinate to first mortgages, the cost is sometimes as high as fifteen per cent per annum of the face value. This cost is prohibitive, and the whole purpose of real estate financing is defeated by it. A number of means of reducing the gap and at the same time making it safe have been devised and are now tried and approved. These will be discussed along with the older forms of mortgages.

Sources of Finance for Real Estate Transactions.—What are the sources from which the dealer can draw the money necessary to finance his operations? There are eight of these sources: (1) banks, both commercial and savings ; (2) insurance companies ; (3) building and loan associations; (4) private investors either by the sale of large mortgages or through the sale of small mortgage bonds; (5) industrial concerns ; (6) mortgage brokers ; (7) the Federal Farm Loan System, and (8) trust funds.

Commercial banks are not anxious to invest their funds in mortgages or other real estate securities on account of their lack of liquidity. The members of the Federal Re-serve System are allowed to lend one-third of their time deposits on real estate, but they do not take full advantage of this privilege frequently. Savings banks are a better source for the real estate dealer to secure loans.

Insurance companies are very rapidly extending their operations in the field of small housing loans. Particularly since the Great War some of the large life insurance companies have been liberal in granting such loans. The dealer will find it a great asset to be in connection with some large company from which he can secure money. The company usually allows a small commission in addition to the opportunity which such a connection gives for rendering a service and gaining prestige. Usually the large companies have their agents in large places, but the dealer can frequently develop contacts that will prove valuable and eventually he can get an agency.

The structure of building and loan associations will be discussed later; the dealer will frequently find it to his advantage to organize and promote a building and loan association in order to be able to more adequately finance his transactions. While he may not have absolute control over the funds of the organization, he can at least profit from them as much as any one else.

The other sources of finance are familiar enough to require no special explanation. The machinery set up by the Federal Farm Loan System will be explained later. The mortgage brokers must be cultivated individually as in the case of private investors. Industrial concerns in some of the large centers of this country are interested in providing homes for their employees and can be persuaded to furnish some or all of the money necessary to finance them. Usually, however, they get into touch with some large insurance company or other strong financial institution for help in carrying the large financial burden which such a program involves, giving, first mortgages to the insurance companies and taking second mortgages for that portion which the insurance companies cannot furnish. Trust funds are of two sorts, those of estates and other properties held in trust and those in the hands of a trustee for the purpose of supervising the issuance of bonds. In each case the dealer in order to avail himself of the funds would have to get in touch with the trust company.

The Mortgage. The mortgage is a very old form of security given for the repayment of a loan. In essence it is the granting of title to real estate in consideration of securing a loan, such grant to be null and void if the loan is repaid. In early times, any default on the part of the borrower resulted in actual loss of all rights and equity in the property mortgaged to secure the repayment. That principle is not now recognized; the present mortgage is used solely as a means of guaranteeing to the lender that the amount of the loan shall be returned, with interest, in accordance with its terms. In case of default, then, the lender possesses title to the real estate only to the extent that is necessary for him to secure the repayment of the loan.

Principal Features of the Mortgage. The principal features of the mortgage consist of (1) the transfer of title, as indicated above; (2) the conditions which shall be considered as constituting a default; (3) the method of procedure in case of foreclosure, and (4) signatures and witnesses. It is not to be understood that mortgage forms are the same in every state nor that every form contains all these features, but these are general. It is not necessary to comment upon the transfer of title, which is essentially the same as that in a deed.' The conditions which constitute a default may be included in two groups. The first of these is a failure to pay either the interest or principal according to the terms of the bond or note which the mortgage is given to secure ; the second has to do with insurance and upkeep of the property. These provisions are made in order to preserve the value of the property which secures the payment. If insurance, for example, were not carried, it would easily be possible for the major part of the property to be destroyed in a single catastrophe. This part of the mortgage naturally contains provisions for the carrying of insurance in the name and for the benefit of the mortgagee.' Likewise, it might be possible in the length of time for which some mortgages run, for the borrower to allow the buildings and equipment of the real estate pledged to deteriorate, or even to be moved off the property or razed so that the security of the mortgage would be destroyed. The mortgage, therefore, carries the provision that in case any-thing of this sort should be attempted, the full amount of the mortgage and interest becomes due and payable, and the lender can proceed against the owner in the same manner as in case of default of payment in due course.

As previously stated, in ancient times, default in payment caused title and possession to pass to the lender. But sometimes this worked great hardship and unfairness on the borrower, who had given the mortgage for only a portion of the value of the property. Changes have consequently been made in the method of procedure so that in case of default and foreclosure the lender's rights are satisfied when he secures the repayment of the loan with interest. In order to assure this, the lender in foreclosing must ask for a sale of the property or such part of it as is necessary to pay his loan and the expenses of legal proceedings. He consequently makes application to a court for satisfaction of his rights. and the court orders a sale of the property to effect the satisfaction. This is usually a sheriff's sale at public auction. At such a sale the creditor may be represented and bid, and he may buy the property and satisfy his own claim against it. Such funds as are left from the sale after the debt and the costs of proceedings are paid belong to the borrower and are said to represent his equity in the property. The fairness of such an arrangement is obvious.

The signature and witness are the same to this as to other legal documents and can be studied in the document itself.

The Basis of Security in the Mortgage. Since the real estate mortgage is itself the guarantee of the repayment of a .loan, the security of the loan depends upon the value of the property mortgaged. In case of foreclosure, the lender must be able to realize from the sale of the real estate sufficient funds to cover his advances. If he has lent too large a portion of the value of the property, he may not be able to realize on it. Consequently, he must lend conservatively. The first mortgage ordinarily is not written for more than forty per cent of the value of vacant land, or sixty per cent of improved, income-earning property. In most states the limit is fixed by law for all trust funds. An appraisal of the property is first secured from those who are capable of estimating its value accurately, and the loan is based upon this appraisal. Obviously, if the loan covered the total amount of the value of the property, it would not be secure. Fluctuations in value or a scarcity of buyers might cause the property to bring far under its true normal value. These factors have to be taken into consideration in determining the amount which will be lent on mortgage. To reduce the margin between the normal value and the amount which can be safely lent would be a great boon to real estate development. It would enable owners to realize upon their investments; in other words, it would increase the fluidity of real estate holdings. This end can he attained by more accurate methods of appraisal and by the stabilization of real estate values.

The Amortization Principle. Another method of reducing this margin is found in the plan of amortization of loans on real estate. Under this pan one of the conditions of the mortgage is that a certain amount be paid on the debt at regular stated intervals. The sum thus set is large enough to cover not only the interest on the mortgage, but something in addition to be applied toward the liquidation of the mortgage itself. At the beginning of the contract, the amount in excess of the interest is small, but as these small amounts are deducted from the face of the mortgage, the interest decreases, and consequently more of the fixed payment is applied toward extinguishing the mortgage. Thus through the continued payment of a comparatively small sum each month, the whole debt is much more easily paid than if it had to be met all at once. For example, a man buys a $20,000 property and mortgages it for half its value, or $1o,000, and agrees to meet the payment of the mortgage in accordance with the amortization plan, paying altogether toward interest and principal $100 a month. At the end of the first month he is credited with the payment of a total of $l00, $58.33 of which goes toward the payment of interest on $10,000 for one month, the remaining $41.66 being applied to the payment of the principal. For the second month he pays $58.01 interest on $9,959.33, instead of $58.33 on $10,000. At the end of the month his payment is $100 as before, and he receives credit for $41.99 on the unpaid principal. Thus with a fixed amount paid each month, the principal is gradually reduced and consequently the interest charge is reduced. Gradually more and more of the money paid goes to discharge the debt itself instead of merely meeting the interest when it falls due.'

Another method of handling the amortization plan sometimes called the "installment method" is favored by some concerns because it simplifies the bookkeeping. This plan is to have a definite sum payable each month in addition to the interest. Since payments on the principal are made at regular intervals and in large round sums, it is much easier to figure the interest each month. This plan, however, does not meet the approval of borrowers so much as the strict amortization payments. For the amount to be paid varies slightly every month. At first it is great on account of the heavy interest charges, but as the payments are made, this amount is gradually reduced and the borrower is paying less and less every month.

One of the good features of either of these plans is that it keeps the funds invested in real estate in a constantly fluid condition. When a regular mortgage is given for a long term, the funds are tied up permanently ; under the amortization plan, the funds constantly flow back to the original investor for reinvestment. Other advantages will be shown in the discussion of land contracts.

The Second Mortgage. There is a special form of mortgage known as the "second mortgage," which is common. In form and principle it is the same as the instrument which has been described, and which is commonly known as a first mortgage ; the peculiarity of the second mortgage lies in the fact that it is subordinate to the first mortgage, and the rights which it conveys in the property mortgaged are secondary to those covered by the first mortgage. It is a second lien on the property, and is commonly referred to as a "junior mortgage." The same term and the same general principles apply to third mortgages. This fact of subordination to the first mortgage gives rise to certain special conditions and precautions taken to insure the rights of the lender on a second mortgage. It is customary to include in a second mortgage a condition which will enable the holder to pay the interest and principal on a superior mortgage if they should be in default.' It is evident that this is the only way in which the holder of the second mortgage could protect his interests in case of threatened foreclosure by the holder of the first mortgage.

Another provision sometimes made is that the second mortgage shall always retain its position of subordination to the first mortgage or any obligation of like amount which may take the place of the first mortgage actually on the property at the time the second mortgage is given. Without this provision, when the first mortgage was due and settled, the second would become a first mortgage. In case the owner wanted to settle the first mortgage by giving another first for all or a part of it, he would be unable to do so on account of this priority of the second mortgage.

Another feature of second mortgages should be noted. Their cost is always higher than that of first mortgages. This is quite natural, for the security is less. And they carry with them liability for the first mortgage in case of threatened foreclosure. Thus their security is doubly weak: they are subject to loss on account of a decrease in the value of the real estate which secures them, be-cause they are written on a higher percentage of its value, and they in effect assume the liability of the first mortgage. As indicated above, their cost is not infrequently as high as fifteen per cent per annum. It is to the advantage of the dealer, however, to cut this cost to a mini-mum, and a great deal of thought has been put upon ways and means of doing so.

Advantages of Mortgages. There are two distinct ad-vantages in the practice of mortgaging real estate, one to the investor, and one to the owner. Mortgages enable the investor to put his money out safely and at the same time, realize a comparatively high return on it. It is quite generally conceded that the return on real estate mortgages is higher than that on any other form of investment of equal security.' Since they are based upon the land itself and its appurtenances, it is not possible for the entire equity to be destroyed, and if the loan is conservative, any loss is unlikely.

But at the same time that the lender gains from the high rate of return, the borrower also gains. The funds that he is able to secure through mortgaging his real estate are placed at his disposal for investment in other enterprises. In case he is able to place these funds in an enterprise that will gain for him more than the rate of interest which he has to pay on the mortgage, he is the gainer. Such an investment is not hard to find; particularly if the borrower operates his own business, he will probably be able to secure more than the five and a half or six per cent which he would be required to pay on the mortgage. This explains why properties of great value are frequently kept under mortgage perpetually.

Mortgage Bond Issues. Mortgages possess one disadvantage ; they are usually given for such large amounts that an investor with only a small amount to invest can-not purchase them. In order to overcome this handicap and to make their advantages available to larger numbers, and draw the surplus funds of the small investor into this field, the mortgage bond has been developed.

Mortgage bonds are bonds issued upon the security of mortgages, usually on improved real estate, the buildings and improvements, and all income received from them.

A mortgage of a large amount is placed with a trustee and bonds in denominations of $1,000, $500, and $100 are issued upon the security of that mortgage. These bonds are then sold to anyone who, has the small amount necessary to pay for them. The trustee undertakes to supervise and inspect at intervals the property upon which the mortgage and the bonds are issued, and see that the provisions of the mortgage are observed. The bond purchaser is thus relieved of all details of looking after the property; he simply clips his interest coupons and presents the bond for payment upon its maturity.

The retirement of the bonds is usually provided for out of the proceeds of the operation of the property upon which they are issued, a certain amount of such earnings being deposited each month with the trustee and applied toward the payment of interest on the bonds and the retirement of the bonds. The sum thus deposited usually amounts to one-twelfth of the amount of principal, interest, and taxes due for the current year. In case the monthly payment is not made, the trustee is entitled to take possession of the property and operate it in the interest of the bond holders. If the original mortgages are issued on conservative percentages of the value of the property and the usual precautions are taken regarding title, valuation, etc., these mortgage bonds are as safe an investment as the first mortgages upon which they are founded. The opportunity which they give the small investor of getting what has always been considered a desirable security, is in their favor, and they serve as a means of accumulating funds for investment in real estate improvement which without them would not be available.

Land Contracts. Another one of the means used to reduce the amount necessary in the initial payment on real estate is the land contract. This instrument is a contract to purchase real estate, given by the purchaser with his initial payment. The land contract may be given as a first lien on the property, or it may take the place of a second mortgage, with a first mortgage resting as the first lien. The distinguishing feature of it is that it usually promises to pay small sums toward the purchase price of the property at frequent intervals. The most common form is that in which the purchaser agrees to pay every month, but payments every six months are also found.

In these payments a certain amount is set aside for interest upon the unpaid balance of the purchase price, and the rest goes toward the payment of the principal. The amount of the payments is arranged to settle the whole indebtedness in a certain number of years. By this plan a person can purchase, for example, a $10,000 home by the payment of ten per cent or $1,000 down, and by giving a land contract for the remaining $9,000. A common arrangement would be for him to pay on the $9,000 one per cent a month or $90, including interest. Another method is that of paying $90 a month plus interest, just as in the case of the amortization of a mortgage. The former is more common and is used here for illustration. At the end of the first month, $52.50 of the $90.00 payment would be charged for interest, assuming a rate of seven per cent, while $37.50 would apply toward the payment of the principal. At the end of the second month interest has to be paid on only $8,962.50, which is $52.28. A larger amount of the payment can therefore be applied toward the principal. Thus the amount applying toward the payment of the principal constantly increases, and at the end of a certain period the whole debt is liquidated.

One of the outstanding differences between such a land contract and the ordinary sale of land is that it does not pass the legal title to the purchaser ; it is merely an agreement to sell. Provisions are made in the contract for title to pass to the purchaser after a certain amount has been paid. The balance unpaid is covered by a first mortgage which is given back to the seller.

The advantage of the land contract from the point of view of the buyer is that it enables him to purchase and have possession of the property with a small initial outlay of money. It hastens the day of his ownership; it bridges the gap between his needs and his financial re-sources. From the standpoint of the seller, it also has its advantages. It makes this property a more liquid form of investment. This is accomplished because of the in-crease in the number of buyers. Everyone who has the initial small payment and the possibility of earning in the future can step into the market for real estate and become an effective buyer. In the second place, the land contract is desirable to the seller because of its safety. He does not lose title to his property but merely grants the right to use it. In case of default in payments to be made by the buyer, the owner can secure possession, although the courts have in general been unwilling to allow possession to revert to the seller too easily. In different states the process by which he recovers possession varies, and it is more difficult in some than in others. There is an effort to secure less complicated procedure so that sellers will be made more willing to take land contracts. The attitude of the courts is designed to protect all possible equity which the buyer may have obtained in the property. Consequently, regardless of the provisions of the contract, the courts take the attitude of making it difficult to fore-close.

The difficulties of obtaining possession in case of default and the length of time it requires to get the entire purchase price out of a land contract cause high rates of discount to be charged when land contracts are purchased. This is an objection to the land contract which can be overcome only by the passage of laws that will make the contract a more acceptable form of investment. In some states this problem has been attacked, but in general it is not appreciated how general the use of the land contract is. An investigation recently made by the Mortgage and Finance Division of the National Association of Real Estate Boards shows that "in thirty-seven states forty-five per cent of current dwelling sales are made on land contract, fourteen per cent of business property sales and fifty-one per cent of vacant lot sales; in the Middle Western states, where contracts are most extensively used, dwelling sales sixty-five per cent, business property sales twenty per cent, and vacant lot sales eighty-five per cent." These statistics are sufficient to show the importance of the instrument and the need for a revision of laws concerning them.

Another objection which the seller has to the land contract, is that it produces comparatively little money at the time of sale. In other words, the sale has to be financed by the seller. He gets the return agreed upon for his money, but frequently he prefers the money itself. It will be noted also that this sort of financing on the part of the real estate operator requires large funds. He must be able to finance his sales for years; unless he has large financial resources, this cannot be done.

Building and Loan Associations. Another means of financing the real estate transaction, particularly the purchase of the home, is through a building and loan association. These institutions until recenty were comparatively unknown in America, although the first here was organized in 1831. But their rapid growth in recent years, both in number and in assets, has indicated their ability to meet a general need. At the present time, there are over ten thousand such associations in the United States, and their assets are over three billion dollars. In the city of Philadelphia alone there are over two thousand five hundred with assets of over four hundred million dollars.

The plan upon which most building and loan associations work is cooperative. Each member of the association purchases stock in the association and is entitled to borrow from the association funds in order to finance the building of a home. The stock is paid for in small weekly or monthly installments. When the stock thus purchased equals in value the amount of the loan se-cured, the loan is satisfied and the member surrenders the stock. Naturally not all the members of the association can finance the building of a home out of the association funds, but the funds collected are used almost exclusively in extending building loans. Every borrower pays the current rate of interest, so that the association is able to pay to the subscribers of stock a sufficiently high rate to make the stock attractive even to the general public.

Loans are secured by first, and in at least two states, Pennsylvania and Maryland, by second mortgages, and are placed at the discretion of the board of directors or such officers as they may select for the purpose. Losses by building and loan associations are exceedingly small in comparison to their investments. This is partly to be accounted for by the fact that loans are made only to members of the association who are known to the officers making the loan and they are usually placed only upon local real estate, the value of which can be well known to the committee. It is estimated that the average amount of the building and loan association loan is about sixty-six and two-thirds per cent of the value of the property securing it. In some instances the amount lent is as high as ninety-three per cent,' but this is very unusual. Usually the ultimate cost of such loans is not much greater to the borrower than the rate of interest current in the community.

There are several advantages in the building and loan associations both to the community and to the individual. The most conspicuous of these is the stimulus which they give to home ownership. The members of these associations are in large measure unable to finance the purchase of a home through the regular channels, and unless they are helped by some such organization or arrangement by which the financing is made easy and simple, they would never purchase. In addition, by requiring the small weekly or monthly payments on stock, these associations perform a great service in stimulating habits of thrift and saving. Since they are cooperative institutions, the members share in all profits and are thus further encouraged to thrift, and educated to the advantages of saving and investing. The building and loan association is an institution whose aids and benefits extend chiefly to families of moderate circumstances. For that reason its progress is a great asset to the nation. Its members, who might easily drift into homeless, unattached wanderers, are converted into thrifty, permanent members of their communities, rooted to the homes they own and occupy.

Farm Financing. The financial needs of the farmer are peculiar; the nature of his business makes them so. His investment in fixed capital, represented by buildings and land, is very large ; his turnover of working capital, represented in crops and livestock, is very slow, varying from six months to five years. While the farm lands dealer is particularly interested in the fixed capital in-vestment, he cannot succeed unless the farmer can secure in addition to this fixed capital some sort of help in financing his working capital needs. Consequently, some discussion of the whole plan of financing the farmer is pertinent to the subject.

There are three types of credit which the farmer needs: short time credit needed for harvesting and marketing the crops; intermediate credit, needed for all operations which require more than six months and less than five years, such as the planting and growing of crops, and the production of livestock; and long time credit, needed in order to finance the purchase of his farm.

The means of meeting the first of these needs is provided by the Federal Reserve System and the local banks. It is the need for the usual banking accommodation loan which matures in less than six months, usually in about three. When the farmer comes to the expenses of harvesting and marketing, he needs additional funds, which he will be able to repay as soon as the process is over and his products are on the market. The ordinary commercial bank credit can supply this need and still keep its assets in the liquid condition necessary to successful commercial banking.

The need for intermediate credit for use in the production of farm products which requires from six months to five years, was never met until the passage in the spring of 1923 of the "Agricultural Credits Act." According to the terms of this act, banks are to be organized under the Federal Farm Loan Board for the purpose of discounting agricultural paper originating in the production of farm products. The paper eligible for such discount must have a maturity of not less than six months nor more than five years. The banks having rediscounted the paper are entitled to issue bonds upon it as security and offer such bonds to the public. The capital of these intermediate banks is subscribed in part by the government and careful restrictions are placed upon the types of paper which are eligible for rediscount. It is distinctly a system organized for the assistance of the farmer. How successful it will be in operation remains to be seen; that the need exists for some relief such as that which this system proposes to meet cannot be denied. It is to be hoped that it will be successful, and if it is so, it will prove a great ally to the farm land dealer and to the farmer in bringing successful operation of farms.

The purchase of the land itself is the phase of farm financing in which the dealer is particularly interested. This problem has also had the attention of the government and legislation has attempted to solve it. Much of this need has been provided by the regular farm mortgage, secured through private negotiation or through the farm mortgage companies. It is said that ninety-five per cent of the farmer's long time credit needs are still met in this way. Objections have been made to this means, however. It is true that interest rates on such mortgages vary widely in different sections of the country. There have been many instances in which farmers were charged excessive rates. The term of the loan is, furthermore, fixed sometimes at too short a period. This results in hardship on the part of the farmer either by forcing him to meet a large obligation at one time or by subjecting him to extra charges for renewal, when, as a matter of fact, the loan should have been made originally to run for a greater number of years. In addition, since the amount of the mortgage all falls due at once, while it should be liquidated out of the income from the farm over a number of years, it is said that this form of credit is not adapted to the farmer's needs. The Federal Farm Loan Act was passed to overcome these difficulties. Under its provisions twelve Federal Farm Loan Banks were established in twelve districts which were provided in the Act. The general supervision of these banks was placed in the hands of the Federal Farm Loan Board, at Washington. Each bank elects its own officers and passes upon its loans. Other matters of detail are left to the local officers.

Loans are made for periods of not less than five years and not more than forty. They are based upon the security of the land, and consequently cannot exceed fifty per cent of its appraised value, plus twenty per cent of the value of the buildings on the farm. The loan is made on condition of its being amortized according to the plan described on page 16o. The payments to be made annually or semiannually remain the same throughout the life of the mortgage, and at the end of that time the loan is cancelled. Since the principal sum never has to be paid at once, as under the old system of mortgaging, the system has popularized the expression for its loans, "The mortgage that never comes due. The amount of the monthly payments automatically fixes the number of years over which the payments will run; these are usually fixed so that the whole loan with interest will be repaid in about thirty-three years. After the first five years, the borrower is privileged to make as large payments toward extinguishing the loan as he desires, without any extra charge. Loans are not made directly to farmers, how-ever, but to associations composed of at least ten borrowing farmers known as farm loan associations. In other words, the farmer who wishes to secure a loan must join an association. His application is then examined by the association, his farm appraised, and the application approved or disapproved. If approved, the application goes to the Federal Land Bank which passes on both the application and the appraisal, and the appraisal is further subject to review by the chief appraiser of the system. The farmer must also subscribe to stock in the association to the amount of five per cent of the loan which he desires. The stock he thus purchases is held as collateral on his loan.

If the loan is accepted by the Land Bank, it is secured by a first mortgage in favor of the bank. The Lank can in turn deposit this mortgage with a designated official of the system and secure mortgage bonds based upon it as security. These bonds can be offered to the public for sale, and since they are exempt from government, state, and local taxation, they have proved popular with the investing public. With the proceeds realized from the sale of the bonds the Land Bank buys another mortgage and the process is repeated. Thus the advantages of the various plans of financing, such as the amortization plan and the mortgage bond issue, which have been pointed out in this chapter, are utilized in the Federal Farm Loan System.

Since these securities are tax exempt, this system has met with much opposition from farm mortgage bankers and others dealing in farm securities. It is urged that the plan discriminates against these companies. Whether in the end it will benefit the farmer remains to be seen; temporarily it would seem to be a great boon.'

SUMMARY

1. The large sums involved in real estate transactions make financing one of the dealer's greatest problems. Strong financial connections or large resources are essential to greatest success in real estate practice.

2. There are several sources to which the real estate dealer can go in order to secure aid in financing his transactions, including banks, insurance companies, building and loan associations, private investors, industrial concerns, mortgage brokers, the Federal Farm Loan System, and trust companies.

3. The mortgage is a pledge of real estate given to guarantee the repayment of a loan. It is given with a note or bond representing the amount of the loan. The principal features of a mortgage are : (I) the transfer of title to the property pledged ; (2) the conditions which shall be considered as constituting a default; (3) the method to be used in f ore-closure in case the conditions agreed upon are not fulfilled (4) the signatures and witnesses.

4. Mortgages cannot be given for more than sixty per cent of the value of improved land and forty per cent of unimproved land and at the same time remain safe because of the difficulty of securing accurate appraisals of the actual value of the property and because of the fluctuations in the value of real estate.

5. The principle of amortizing loans has become very common in recent years. In the amortization of a loan a certain fixed amount is paid in at regular stated intervals so that the whole amount of the loan, including interest, is liquidated in a given period of time.

6. Second or junior mortgages are given for loans above the amount that can be secured on a first mortgage. A junior mortgage may, in some circumstances, be almost as safe as a first mortgage, but ordinarily they are less safe and con sequently cost more. It is usually provided in the second mortgage that in case of default on the first mortgage the holder of the second mortgage may assume the first and himself conduct the foreclosure proceedings.

7. Mortgage bond issues have been devised to give the small investor an opportunity to invest in real estate securities and at the same time to make available for real estate development the large sums represented by the savings of private individuals who would find it difficult to accumulate enough to buy a large first mortgage. The mortgage bond is a bond issued by a trustee who holds as security for the bonds a first mortgage on improved real estate. The trustee cares for the property and attends to all details connected with the issuing of the bonds so that the investor is protected by his services.

8. A land contract is a contract to sell real estate upon condition of the payment of a certain amount of money in a prescribed manner. It enables the man with little money to secure an interest in real estate and eventually to own property. The seller urges two objections against the land con-tract ; it is difficult to regain possession given under a land contract, and a sale under a land contract realizes comparatively little money at once.

9. The building and loan association collects savings from its members and sells its stock to them, lending the money thus obtained chiefly for the purposes of building. Building and loan associations have grown until their present assets are greater than the total capital and surplus of national banks.

10. The farmer needs tnree types of credit: short term credit for the purpose of harvesting his crops, intermediate credit for planting his crops and bringing them to maturity, or for raising livestock, and long time credit for the purchase of his farm and equipment. The Federal Banking System can provide the first of these types, the Federal Intermediate Credit Banks are designed to meet the second, and the third is provided for by the Federal Farm Loan System.



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