Question/Answer Memo for January 21-27, 2014
This memo deals with questions posed by your e-mails regarding the Freddie Mac single-family residential deed of trust form used in Missouri. [Actually, it deals with the questions you raised and also includes some questions from the students in previous year's classes as well.]
1. Are these terms “take it or leave it,” or is there room for negotiation?
No, there’s typically no negotiation (except with respect to what interest rate you'll pay and how many "points," if any, you'll pay on the loan. As to the substantive terms (the "boilerplate," if you will), if you want a mortgage loan from a bank to acquire a home that you’re going to use as a primary residence, you pretty much have to accept this form without changes in the boilerplate language.
Keep in mind that banks want to be able to sell their mortgage loans on the secondary market. They can’t sell a mortgage loan to Freddie Mac unless the mortgage is documented on a form approved by Freddie Mac. And Freddie Mac won’t agree to buy a mortgage loan secured by the borrower’s principal residence unless that loan is documented on this form. If the bank agrees with you to change the terms, that loan no longer qualifies to be sold to Freddie, and unless the bank can find another investor to purchase it, the bank would have to hold it in the bank’s own loan portfolio. As a result, there's typically no negotiation.
2. In ¶ 1, why is the Lender given such flexibility in deciding whether to accept or apply payments that are insufficient to bring the loan current?
Later in the course, we'll talk about default and acceleration and when the Lender can declare a default. If I'm the Lender, and you make a payment that isn't enough to satisfy your monthly payment, I'd like to have the flexibility to either (a) apply that payment to unpaid interest and/or principal, or (b) return the payment and instead say "pay the full amount as you promised." If I have a good working relationship with you as the Borrower, I might be willing to take approach (a). If I don't have a good working relationship with you, and you have been a frequent slow pay, and I think you are trying to set me up for an argument that we had some agreement for a reduced payment amount, I may instead choose to return the partial payment and insist upon full performance, so as to minimize the risk of a waiver or estoppel claim being asserted against me. The flexibility allows the Lender to decide what is the most prudent course it should take in the management/collection of this loan.
3. ¶ 1 talks about the Lender's ability to accept partial payment without having to immediately apply them to the loan balance. What does the Lender actually do with the money in that situation? Do they put it in a separate holding account? It seems it would be risky to hold a check without cashing it if you are dealing with a borrower that cannot make payment in full.
This paragraph purports to give the Lender maximum flexibility in terms of how it chooses to handle a payment that is not sufficient to satisfy the Borrower's obligation (for example, the Borrower's monthly payment is $1,000, but the payment is only $500). This flexibility is critical in the modern mortgage market. For example, you might make your payments to US Bank, where you originally got your mortgage, but it is likely that US Bank sold the loan to Fannie Mae, Freddie Mac, or another secondary market investor, and that now US Bank is only "servicing" the loan (collecting the payments each month as the agent for the investor). Thus, if your loan is in default and you make a partial payment, it may take several weeks for the servicer to let the investor know, and for the investor to decide what to do, and to communicate that back to the servicer. [Sometimes, these issues are resolved by the investor's servicing guidelines so that authority is delegated to the servicer; other times, the servicer may have to get explicit instructions from the investor.] The form is designed to allow the lender to have time to decide whether to accept a partial payment or return it, without being subject to the argument that by accepting the check and not immediately returning it, the lender/investor had somehow waived its ability to insist on the borrower's timely full performance.
Usually, lenders tend not to accept partial payments on loans in default. Most of the time, their servicers are instructed to return those payments to the borrower, precisely because the lender doesn't want to create a risk that it might be deemed to have waived its rights by accepting less than the agreed-upon performance. But I expect that in many cases, a borrower that isn't otherwise in default makes a mistake and writes a check for the wrong amount, and the servicer may immediately deposit the check but may not catch right way (because of neglect or computer problems) that the payment was "short." In that situation, the lender or servicer might well apply the partial payment to the debt immediately and simply contact the borrower to pay the difference immediately, or alternatively it might decide to reimburse the partial payment and require the borrower to send a check for the full amount (the form is meant to give them the flexibility to proceed either way). There is not any legal requirement that such a partial payment would have to be held in any particular way or in any particular type of account.
4. If the Lender starts a foreclosure of the Deed of Trust and the Borrower and the Lender agree to a "deed in lieu of foreclosure" where the Borrower just deeds the property back to the Lender, has the Lender accepted the property without recourse against the Borrower, or is the Borrower still liable?
Missouri is generally a "full recourse" state. If I borrow money to buy a house, and I don't pay it back, and the lender forecloses, and the foreclosure sale price isn't enough to pay off the debt, then as the borrower I remain liable for the "deficiency" (the unpaid balance), and the lender can get a deficiency judgment against me and can go after my other assets to collect that judgment. [Other states, like California, have anti-deficiency laws that effectively make home loans in that state "nonrecourse" loans.]
In a "deed in lieu" transaction, the Borrower and the Lender agree that the Borrower will just deed the land to the Lender, rather than the Lender going through a foreclosure sale. [We'll discuss deeds in lieu and "short sales" later in the class, in conjunction with talking about foreclosure.] The Borrower can't just unilaterally do a "deed in lieu," because like any transfer, the Lender would have to accept it. And in some cases (as we'll discuss), the Lender can't accept a deed in lieu and has to foreclose instead (particularly where there are other lienholders that the Lender needs to "wipe out" in order to deliver a clear title to the mortgaged land).
Because a deed in lieu is an agreement between the Borrower and the Lender, they can make whatever agreement they want. Often, the Borrower offers a deed in lieu in exchange for a complete release of liability on the debt. ["I'll deed you the property right back, today, if you'll agree not to sue me on the debt."] If the Lender accepts the deed on those terms, then the Borrower has no more personal liability on the debt. If the Lender refuses, the parties could negotiate for a partial release.
5. Would this form be used in financing the purchase of a duplex?
Yes, but only if the Borrower also executed the 1-4 Family Rider mentioned in the Definitions at the beginning of the form (¶ H). The 1-4 Family Rider has additional terms in it that would be appropriate where the nature of the property is a "multi-family" building like a duplex, triplex, or quadplex building. Execution of the Rider would incorporate those additional terms into the Deed of Trust.
6. If the buyer of the land is going to hold title to the land in a trust, would the Borrower be the trust or the individual beneficiaries of the trust?
The "Borrower" under the Deed of Trust will be the person who holds title to the mortgaged land, because the purpose of the Deed of Trust is to create a valid lien against the land (so that the Lender can foreclose and deliver title to the land in the event of default on the loan). So if the owner of the land is going to be a trust, then the trust has to be identified as the Borrower, and the person executing the document has to have the authority to bind the Trust.
7. What is RESPA and how does it relate to real estate transfers?
RESPA is the acronym for the Real Estate Settlement Practices Act, enacted by Congress in the 1970s. It was enacted in response to what Congress perceived as abusive practices in the real estate settlement industry (for example, the practice of title insurers, lenders, or other service providers paying "kickbacks" to brokers for referrals). For our purposes in a class on Real Estate Finance, one of the relevant RESPA provisions governs how much a lender can require me to pay into escrow for taxes and insurance. Some lenders were requiring borrowers to keep an escrow of several times the expected annual taxes and insurance, and under the typical mortgage agreement, the lender doesn't have to pay interest to the borrower on that escrow balance. That means the lender is getting the interest-free use of the Borrower's money. In RESPA, Congress said that a lender can require an escrow, but the "cushion" in the escrow can't exceed more than 2 additional months (i.e., if the annual taxes and insurance were $2,400 a year, or $200 per month, the total escrow account could not go over $2,800 (a two-month, or $400, cushion over the expected annual cost of the taxes and insurance).
8. ¶ 11 talks about how the Borrower would be in default if the federal government initiates a civil asset forfeiture of the mortgaged property. Why would the government not take the property subject to the existing mortgage?
¶ 11 of the Deed of Trust does not resolve whether or not the government would take the property subject to the mortgage or whether the forfeiture would extinguish the mortgage. That would be resolved by the terms of the civil forfeiture statute. All that ¶ 11 does is to state that if the government institutes a civil forfeiture action, that constitutes a default and allows the lender to pursue its default remedies.
9. Civil forfeiture cases can take a long time to complete —a process that would be made significantly more complex by the default and acceleration of the mortgage—so if the prosecutor was seeking to bring more pressure on the defendant, why wouldn't the prosecutor either not bring the forfeiture action or notify the lender of its initiation?
If the property that the prosecutor wants to forfeit is subject to a mortgage, the prosecutor would HAVE to notify the lender; the lender's lien is a property right, and that property can't be extinguished by government action without due process of law, so the prosecutor would HAVE to notify the lender and join the lender.
10. On page 3 of the form, there is a space for the property address, but I don't see a place for the legal description of the property. Is this inserted into the body of the document, or attached as an exhibit?
One or the other. You'll notice that on page 3, there's a little bit of "white space" in the form between the language granting the lien (at the top of the page) and the language indicating the property address. The lender could type/insert the legal description into that white space, and would do so if the description is relatively short (for example, if the description is merely a numbered Lot/Block description based on a recorded subdivision map). By contrast, if the legal description was a long, metes-and-bounds legal description that wouldn't fit in that space, the Lender would stick "See Property Description on Exhibit A" and would then attach the legal description as Exhibit A.
11. Why is there an occupancy requirement in ¶ 6?
The occupancy requirement is related to the lender's criteria for underwriting the mortgage loan. Different mortgage loan arrangements present different types of risk characteristics. For example, lenders might plausibly expect that borrowers who own their homes and use them as their primary residences will maintain the homes reasonably well. By contrast, if the borrower is not going to live in the home but is instead going to rent it out, the lender might expect the property to suffer greater wear and tear (a tenant occupying it may not take as good a care of the property) and the lender might be concerned that if the rental market goes soft, the borrower may not be able to rent the property (or rent it for enough to repay the mortgage). Thus, a lender would probably choose to underwrite mortgage loans for owner-occupied property on more favorable terms than for rental properties. [By "underwrite," I mean to establish the terms on which the lender will make the loan, e.g., what interest rate lender will charge, how large a loan lender will make (stated differently, what loan-to-value ratio will lender require?).] For a “second” home or vacation home that isn’t going to be rented out, the lender might have yet another set of underwriting standards.
Also, keep in mind that in the modern mortgage market, the typical mortgage loan is going to be securitized. Private investors investing in mortgage-backed securities want to know that the mortgages that back the securities have similar risk characteristics. If I'm investing in residential mortgage-backed securities on primary residences, I don't want it to be the case that a bunch of mortgages in the securitization pool are actually not owner-occupied, but are instead rented and tenant-occupied. Thus, someone who was securitizing a pool of owner-occupied residential mortgages would want to insist that the mortgages to be purchased for the pool would have to have an "owner-occupied" requirement like in ¶ 6.
So this provision is customary whenever the lender is making a loan to a borrower that it is going to live in the home. That doesn't mean that I couldn't get a mortgage loan if I was buying a house that I planned to rent out to tenants. That loan just wouldn't be documented on this particular standard form. The lender would have a different form that it would use, or perhaps it would add on a "Rider" that had the effect of modifying the occupancy requirement in ¶ 6.
12. If occupancy is so necessary/beneficial, why is the requirement only for the first year?
Probably for two reasons: (1) The mortgage could be in place for 15-30 years, depending on the term, and things can change in that time. The one-year requirement reflects an understanding of the parties that if 6 years into the term, the borrower is transferred and decides to hold the home unoccupied while trying to sell it (which could take awhile in a soft market), that fact alone shouldn’t throw the loan into default if the borrower is otherwise continuing to make payments, keep the home insured, etc. (2) As a practical matter, if the borrower has to move in and occupy the property for a year, that’s enough hassle that it minimizes the risk (at least theoretically) that the loan is really being taken out to acquire a rental home or a non-owner-occupied home.
13. During the housing boom, lots of people bought houses with the intention of “flipping them” or fixing them up and reselling them quickly. How did they get around ¶ 6, and what is the penalty for noncompliance?
If someone bought a house for that purpose, but got a mortgage issued on the Freddie form, then one of two things happened: (1) the person lied and said that he/she was going to occupy the home, or (2) the lender messed up (intentionally or negligently) and issued the mortgage loan as if the property was going to be owner-occupied. In many cases, it was that the borrower lied. In other cases, the lender knew the borrower was going to flip the house and simply didn't care or decided not to enforce ¶ 6.
As far as consequences are concerned, there are two sets of consequences. The first is to the character of the borrower/lender relationship. If the borrower lied (or if the borrower honestly intended to occupy the property, but then never did), then the covenant in ¶ 6 is violated and that entitles the Lender to pursue its rights under ¶ 22 to accelerate the debt (to demand full payment of the entire balance all at once, immediately) and to foreclose on the property if the borrower doesn't pay off the full accelerated balance of the mortgage loan.
The second is the possibility of treating the borrower’s conduct as a crime against the public interest. If the borrower affirmatively made material misrepresentations in making a loan application, it could also result in the borrower being criminally prosecuted under either federal or state law (depending upon whether the lender is a federally-related lender, as would be the case with most banks).
14. How would the occupancy requirement affect a wealthy person who is purchasing the home as a secondary or seasonal residence? Does this mean it is impossible for a person to get a mortgage to purchase a second home?
No, people get mortgage loans for vacation homes all the time. But such a mortgage loan would not be appropriate to document using the standard Fannie/Freddie mortgage/deed of trust form. Such a mortgage loan should be underwritten under different standards than the standards that would apply to a mortgage loan to be secured by the borrower’s principal residence, and thus such a mortgage loan would be issued on a different mortgage form (one which didn't have a provision like ¶ 6). The same would be true if the borrower was looking to buy the home, renovate it, and immediately "flip" it (i.e., resell it) without ever occupying it.
The risk characteristics for an owner-occupied home are different from non-owner-occupied homes, and this would affect the loan terms. Repayment on a vacation home might be perceived as riskier, especially if the borrower is still paying off a mortgage on their primary residence. If the borrower lost a job or part of the borrower’s income, the borrower might be able to keep paying the mortgage on its primary home but not the vacation home. If the home isn’t occupied, it may be subject to a higher risk of being damaged (e.g., water damage due to burst pipes while no one’s there). As a result, for a vacation home, a bank might require a greater down payment (or a lower loan to value ratio, like 75% or 80%, as compared to the 90% or 95% that might be appropriate for a primary residence). Likewise, if someone is in the business of buying, renovating, and flipping houses, then if I loan them the money to buy and renovate a house, I'm really financing a business operation rather than the purchase of a home — and so the loan should be underwritten using entirely different criteria.
Keep in mind that buyers of mortgaged-backed securities expect that all of the mortgages in the "pool" (all the mortgages that serve as collateral for the repayment of the particular mortgage-backed securities) will have comparable risk characteristics. So if I were buying securities backed by mortgages issued on this form, I would not expect the pool to include mortgages backed by vacation homes (or, perhaps, that no more than a small percentage of the mortgages in the pool would be secured by vacation homes). [Note that one of the "Riders" listed in the form is a "Second Home Rider" which by its terms modifies the language of ¶ 6 to eliminate the "principal residence" requirement. Thus, the issuer of mortgaged-backed securities could make sure, in reviewing the pool, that no more than a certain percentage of the mortgages in the pool were issued with a Second Home Rider.]
15. Would ¶ 6 foreclose the ability of the borrower to use the property as a home day care or for some other business use?
Good question. Again, all ¶ 6 does is to require the Borrower to occupy the premises as its principal residence. It does not purport to limit other uses, so it would not prevent the Borrower from operating a day care center in the home as long as it was the Borrower's principal residence. Of course, there might be other public or private limitations on the Borrower's ability to do that, such as zoning restrictions or private restrictive covenants that would allow the city or the neighbors to block a day care center operation.
16. Is it typical for there to be a mortgage insurance clause like ¶ 10, which affords protection to the lender, but not a title insurance clause, which would afford some protection to the buyer? Is title insurance ever mandatory? What determines if a Lender requires mortgage insurance?
These questions require a little bit more background about both mortgage insurance (typically called "private mortgage insurance") and title insurance.
Title insurance protects the insured party against the risk that there is some unknown or undiscoverable problem with the insured party’s title. For example, suppose that Green buys land and receives a deed from Smith, who appears to be the owner of the land according to a search of the public land records. It turns out, however, that the “Smith” who delivered the deed to Green was actually Jones — an imposter pretending to be Smith — and that the real Smith never signed the deed. Green’s title would be invalid, but if Green had obtained a policy of title insurance at the time he bought the property, the title insurer would indemnify Green against this loss (up to the maximum coverage of the policy).
When you buy land, and you get a mortgage loan to finance the purchase, it is common for there to be two separate title insurance policies issued — both an “Owner’s” policy and a “Loan” policy. The Owner’s policy protects you, as the owner, from the loss you would suffer if your title turned out to be defective. The Lender’s policy would protect the mortgage lender against the risk of the loss it would suffer if your title was defective and, as a result, the lender wasn't able to foreclose (or the land’s value was reduced because of some title defect so that the sale proceeds weren’t enough to pay off the debt).
If you are getting a mortgage loan, a Loan Policy of title insurance is mandatory. The lender won’t make the loan without it, because Fannie Mae, Freddie Mac, and other secondary market purchasers won’t buy mortgage loans if there’s not a Loan Policy of title insurance that insures the validity and priority of that mortgage. Thus, the borrower (typically) ends up paying for the cost of this policy as part of the closing costs associated with buying land.
An Owner’s Policy isn’t required — as a buyer, I could decide to go without title insurance (in other words, to "self-insure") — but it isn't a good idea. If my title turns out to have been defective, I'm likely to lose the equity I had accumulated by paying down the mortgage (or by virtue of any appreciation in value). Even worse, if the title insurer pays off the Lender, the title insurer is then subrogated to the Lender's rights under the loan documents, meaning that the title insurer could sue me to collect the promissory note (i.e., I would still have to pay back the rest of the money, even if I lost my title). If I have an Owner's Policy, the title insurer would have to compensate me for the lost equity and could not be subrogated against me.
The Freddie form doesn’t talk about title insurance, because title insurance works differently than other forms of loss insurance. If I buy property insurance, or car insurance, or mortgage insurance, I have to pay a premium each month or each 6 months or each year, and it protects me against loss during that period. Then, for the next period, I’ve got to renew the insurance, and pay another premium for the next term. So during a mortgage that might last 30 years, the lender has to ensure that the borrower keeps the property insured each year during the term, and that the coverage doesn’t lapse due to nonpayment of premiums.
But title insurance is different. I only pay the premium one time, and it protects me for as long as own the property. Once the coverage is in force, I don’t have to “renew it.” So there’s no reason to include any covenants in the mortgage about it.
Mortgage insurance is different. It protects the lender against the risk that the borrower defaults, that the lender has to foreclose, and that the property won’t sell for enough for the lender to recover the full amount of the debt. For example, if I’m borrowing 125% of the value of my home, there’s a good risk that if I default, there would be a deficiency left after the house was sold at foreclosure. PMI coverage protects the lender against the risk of that deficiency.
The higher the loan-to-value ratio (LTV) of the mortgage, the greater the risk. If the LTV is 50% (i.e., if the original loan amount is $50,000 and the FMV of the mortgaged land is $100,000), the risk of a potential deficiency is minimal, because the land would have to depreciate by more than 50%). If the LTV ratio is 95%, any decline more than 5% in value could result in the mortgage being "underwater" or "undersecured," which would result in a loss/deficiency if the borrower defaulted and the lender had to foreclose. Thus, as a general rule, the higher the LTV, the more likely that the lender will require PMI coverage as a condition of making the loan in the first place.
The precise PMI requirements are dictated for most loans by Fannie, Freddie, and other secondary market purchasers. For certain types of loans, Fannie and Freddie will require a certain level of PMI coverage until the LTV ratio is reduced below a certain threshold (such as 75% or 80%); if a lender makes such a loan and PMI coverage is not in place, secondary market purchasers won't buy that loan. As a result, it is common for ¶ 10 to be included in residential mortgage forms, where LTV of 90-95% are common. You would not see a similar provision in a commercial mortgage, where the typical LTV would be more like 60-70% or less.
17. What determines if a lender requires private mortgage insurance?
As mentioned above, if a lender wants to be able to sell its mortgage to Fannie or Freddie, it will have to require the borrower to obtain and carry PMI coverage as long as the loan is above the LTV threshold required by Fannie or Freddie.
18. ¶ 10 talks about a “nonrefundable loss reserve in lieu of Mortgage Insurance.” What does this mean? Does the Borrower have any rights or assurances that the Lender will not use this as extra profit rather than paying interest to the Borrower or crediting it to the mortgage debt?
This provision doesn’t come up commonly. Theoretically, it protects the lender who has a borrower that is required to have PMI coverage but who, for some reason, can’t obtain PMI coverage.
If a borrower couldn’t get it, this provision would allow the lender to require the borrower to set aside in a reserve the amount it had been paying in PMI premiums (or that it would have paid in PMI premiums if it could have gotten coverage). Essentially, this provision allows the lender to function as a PMI insurer. If a loss happens, the lender won’t have access to the PMI insurer, so the lender will have to “eat the loss,” but will at least be able to apply whatever amount is accumulated in the loss reserve against that loss). However, the amount is nonrefundable, and Borrower can’t get it back if Borrower in fact pays off the loan. This isn’t surprising, if you think about it — I don’t get a refund of my car insurance premiums for the past six months just because I didn’t have an accident. If those sums had been paid to a PMI insurer, the borrower wouldn’t have gotten them back. And in this case, the lender would be functioning as a de facto PMI insurer, so the provision allows the lender to keep the loss reserve (even if it never suffers a loss) in the same way a PMI insurer could keep all the premiums even if it never had to pay off a claim under the PMI policy.
Again, this provision rarely comes up. More likely, if a particular borrower was turned down for PMI coverage, it is more likely that the Borrower simply wouldn't qualify for the mortgage loan and thus no mortgage loan would've been made.
19. What would be considered "miscellaneous proceeds" as described in ¶ 11?
The term is actually defined, back in the portion of the form prior to ¶ 1, and it means "any compensation, settlement, award of damages, or proceeds paid by any third party (other than insurance proceeds paid under the coverages described in Section 5) for: (i) damage to, or destruction of, the Property; (ii) condemnation or other taking of all or any part of the Property; (iii) conveyance in lieu of condemnation; or (iv) misrepresentations of, or omissions as to, the value and/or condition of the Property." Thus, it would include casualty insurance payments for casualty damage to the property, a condemnation award (if part or all of the mortgaged property was taken by the government by eminent domain), sale proceeds if the borrower sold the property to the government in lieu of condemnation, or any damage recovery the borrower received in a suit against a third party (typically, the prior owner from whom the borrower acquired the property) in a tort action for misrepresentation or fraud ("e.g., you represented that the roof was watertight, but that was false and the roof has to be replaced").
20. Are the provisions of ¶ 18 enforceable? They would seem to prevent someone from selling their property. Also, would they apply if the borrower was selling the property via a "contract for deed"?
Yes. We'll spend at least one class later in the course discussing "due on sale" or "due on transfer" clauses like the one in ¶ 18. The short answer is that yes, such provisions are enforceable as a matter of federal law by virtue of the Garn-St. Germain Act, passed by Congress in 1982. [Prior to that, some state courts had held that due on transfer clauses were an unreasonable restraint on alienation.]
And yes, the due on sale clause would be triggered if the borrower tried to sell the house on a "contract for deed." [Under a "contract for deed," the buyer pays the price in installments but does not receive a deed until it has paid the entire purchase price, even though the buyer typically takes possession while making the installment payments.] We'll talk more about contracts for deed later in the course, but the short answer here is that you can't use a Contract for Deed to get around the application of the due-on-sale clause in the mortgage. Thus, if you try to sell the house, the lender can accelerate your mortgage and demand that you pay off the accelerated balance in full. From the lender's perspective, this makes sense; the lender had agreed to loan you money to enable you to purchase/own this real estate. But if you're going to sell it, why should you be able to effectively loan the buyer the funds that the original lender loaned you? The lender will instead likely say, "You repay us what you owe us. If your buyer needs a loan to be able to purchase the land from you, your buyer can come to us for a loan."
21. How common is it for the lender to require the borrower to pay the escrow funds described in ¶ 3?
It’s almost universal. Again, Fannie and Freddie’s underwriting standards typically require that mortgages be established with escrows for taxes, casualty insurance premiums, and private mortgage insurance premiums (and, in some states, for any applicable homeowner association dues).
This makes sense for several reasons. First, for most borrowers, these expenses can be substantial. For example, the total annual real estate taxes and property insurance on my home are over $3,000 a year. Further, they are legally due once a year — real estate taxes are usually due in December; property insurance premiums are due annually, whenever the previous year's term of coverage expires. It is easier for most borrowers to "budget" these expenses on a monthly basis (by setting aside 1/12 of the annual amount each month) than it is to pay them all in one month. An escrow account allows for the borrower to pay into escrow each month to accumulate sufficient funds to pay the taxes and the insurance premium when they come due.
Second, the escrow is beneficial to the lender, too. The lender faces a significant risk if these sums aren’t paid. If real estate taxes aren’t paid, the taxing authority gets a tax lien on the property that is SENIOR to (has priority over) the mortgage lender. If the casualty insurance premium doesn’t get paid, the insurance gets cancelled, and then if the house burns down, the lender’s collateral is gone (at least the house, anyway), with no insurance proceeds to substitute for the destruction. The lender doesn't want to risk that the Borrower fails to pay its taxes because the Borrower failed to show appropriate discipline and blew all of the Borrower's remaining funds on Christmas presents. So the lender requires the borrower to escrow 1/12 of the cost of these items each month into an account controlled by the lender, and then by paying those expenses directly when they come due from the funds in the escrow account, the lender makes sure that these risks (loss of priority or loss of the collateral) do not come to pass.
The potential concern is that the lender will require the borrower to escrow too much money — more than is actually necessary to pay the taxes, insurance, PMI, etc. — and that the lender will then extra profit by earning the “float” (interest) on the excess escrow funds. Borrowers don’t like that because they’re losing the use of this money (and the lender is getting it, essentially on an interest-free basis!). Federal regulations (we’ll see these later in the course) do place a limit on the amount that lenders can charge in an attempt to prevent lenders from accumulating too large of an escrow cushion, but that doesn’t get the borrower interest for the use of his/her money.
22. Can the Borrower get the Lender to waive the escrow requirement?
In the residential setting, most lenders aren’t going to do that. First, if the lender waived the escrow requirement, it wouldn't be able to sell that mortgage loan on the secondary market (Fannie, Freddie, and other secondary market purchasers require escrows for taxes, insurance, and the like).
By contrast, in the commercial setting, it is much more common for the lender to agree to waive escrow and allow the borrower to pay taxes and insurance directly. Of course, in commercial transactions, the size of the escrow accounts would be substantially larger, so the magnitude of the “lost use value” would be much, much higher.
23. Under ¶ 3, the form talks about the borrower having to pay into escrow for “leasehold payments or ground rents on the Property, if any.” What does this mean?
It is very rare that this portion of ¶ 3 would come up. When most of us buy homes, we’re buying a fee simple absolute interest in the land and the home. If I have a fee simple absolute, I’m not paying “rent” to anybody. So I’m only going to have to escrow for real estate taxes, casualty insurance and perhaps PMI (depending upon whether the LTV on my loan and whether the LTV makes PMI coverage mandatory).
Sometimes, though, a house or a building will be built by someone on land that they are only leasing. This type of lease is called a ground lease. Suppose Rule owns a vacant parcel of land. I want to buy it and build a home on it. Rule doesn’t want to sell it, but would be willing to lease it to me for $200/month for a term of 70 years. Then I build the home on the leased land, and we agree that I own the home. [Under the terms of the ground lease, I may or may not have the right to remove the home from the land at the end of the lease term.]
If I entered into a ground lease, the one obvious problem is this: what happens if I default on the rent payments? Under landlord-tenant law, Rule could terminate the lease, substantially complicating the ability of the mortgage lender to foreclose on the home (under the derivative title rule, termination of the lease would have the effect of terminating the mortgage on the leasehold estate). So if the lender was going to making a mortgage loan on a building that is sitting on ground leased land, the lender is going to require the borrower to also escrow funds to make the ground rent payments under the ground lease. This way, the lender knows the ground rents have been paid (so that termination of the ground lease won't happen).
If we’re lucky, we may have an opportunity to talk briefly about ground leases toward the end of the class, in talking more about commercial real estate financing (where development on ground leased land is suprisingly common).
24. What is a borrower's recourse under RESPA if there is a discrepancy in the escrow funds that the borrower believes is due to the lender's mismanagement or fraudulent use of the funds? I see that there is a requirement that the lender make an annual accounting of the escrow funds, but it seems pretty easy for the lender to request more funds whenever they decide they need more to pay the fees for which the escrow funds are allotted.
We will talk a little more later in the class about RESPA and escrow funds. Essentially, RESPA places a limit on the amount of funds that the lender can require to be put into escrow at the beginning of the loan, equal to the expected annual payments plus a two-month cushion. This is designed to prevent the Lender from requiring an excessive escrow deposit (and thus profiting from the extra float). RESPA also requires the Lender to provide an annual accounting throughout the loan term.
RESPA permits the Lender (or its loan servicer) to increase the escrow payments, after giving notice, to the extent necessary to address increases in taxes, insurance, etc. But the Lender's discretion with respect to those increases is not unlimited; it still can't accumulate an excessive cushion. If it does, a lender is subject to the risk of administrative sanctions and fines. [Most courts have said that borrowers don't have a private right of action under RESPA.]
By contrast, the question seems to contemplate the possibility of the lender using escrow funds to throw office parties or the like. Obviously, if the Lender does that, a Borrower might actually bring a breach of contract action against the Lender (rather than proceeding under RESPA) under the theory that Lender has expressly or impliedly agreed only to disburse escrow funds for the payment of Escrow Items.
25. What is the homestead exemption and why must it be waived [¶ 26]?
Every state allows debtors to retain certain of their assets free and clear of the claims of creditors generally. For example, in Missouri, Missouri statutes allow a debtor to keep up to $15,000 in the value of their homestead (principal residence) as exempt from general creditor claims. This means that if Uphoff gets a judgment against me, he could have my home sold to satisfy the judgment, but the first $15,000 of the sale proceeds would have to be paid to me before anything was paid to Uphoff. This way, I could use those proceeds to secure some other place to live. The idea is that creditors shouldn’t be able to take ALL of my assets and leave me destitute, without a place to live, at which point I would become a public charge.
In some states, the homestead exemption is even more generous (well, generous to debtors; for creditors, not so much). For example, in Oklahoma, the homestead exemption is unlimited!
Implicitly, if someone borrows money to buy a home and grants a mortgage loan to finance that purchase (what is called a "purchase money" mortgage), that should constitute a waiver of the homestead exemption. Obviously, it would be unjust enrichment for me to borrow $500,000 from Bank to buy a home, stiff the Bank, and then claim to keep the house free and clear based on a homestead exemption; but for the Bank's loan, I would not have been able to acquire the home in the first place.] Under the traditional rules of mortgage law (we'll see this later in the course in Chapter 7), a homestead exemption would not be capable of being taken or enforced against a purchase money mortgagee.
Just in case state law is not explicit in that regard, form mortgages/deeds of trust typically make it explicit that by taking out the mortgage loan and granting the mortgage, borrower is waiving any right to claim homestead exemption against the mortgage lender. These waivers have been consistently upheld as valid, at least as against mortgage lenders who are providing purchase money financing (i.e., a loan where the loan proceeds are financing the borrower’s acquiring the land). Thus, in the event of default, the lender could proceed to accelerate the loan, foreclose, and apply ALL of the sale proceeds (if needed) to repayment of the mortgage loan, without regard to the homestead exemption that the borrower could have claimed as against other creditors.
26. Who would typically be the trustee under the deed of trust? An attorney? A different third party? What kind of regulations apply to them to make sure they remain neutral between the lender and the borrower?
In deed of trust states, the practice varies. In many states, it is customary for the lender to name the lender’s attorney as trustee under the deed of trust.
Essentially, the trustee’s “duties” are for the most part limited to the duty to comply with the statute authorizing the trustee to sell the property (in most deed of trust states, this happens privately, through nonjudicial power of sale foreclosure). The statute governing this type of foreclosure requires the trustee to give certain notices, publish certain legal notices of the sale in the newspaper, and then conduct the sale. Case law has placed some “gloss” on the statutes and have held trustees liable where they have engaged behavior like self-dealing or facilitating collusive behavior between the lender and bidders. [We’ll talk more about the power of sale foreclosure process in a few weeks’ time.]
If the trustee is also a lawyer for the lender, state bars in some states have held that the lawyer can get into an ethical bind if the lawyer is representing the lender and also serving as the trustee. There’s some debate over whether that’s the proper view — a trustee under a deed of trust isn’t really a “trustee” in the fiduciary sense — but it is worth being cautious. In my practice, as soon as I got any word that the borrower was going to attempt to contest the foreclosure process, I would have a lawyer at another firm substituted as trustee and have that lawyer conduct the foreclosure sale.
27. I don’t understand ¶ 25. Why is this there? Why can’t the trustee simply let the borrower live in the home as long as the borrower makes its payments and complies with the mortgage terms?
This provision is a "form over substance" kind of provision that, in my judgment, is dubious and probably shouldn't be included. ¶ 25 purports to say that until the Borrower pays back the loan in full, the Lender and the Trustee are just "leasing" the property to the Borrower, so that if the borrower defaults, the lender can argue that the lease is terminated and can demand the borrower to surrender possession after default. That DOES NOT WORK under mortgage law. The borrower is NOT a tenant. Period. End of story. The borrower is the owner of the property, until a foreclosure sale takes place. A lender can’t just get around foreclosure law simply by arguing that the parties have agreed this is a lease.
Historically, ¶ 25 was included in the form so that if the Lender foreclosed and bought the property at the foreclosure sale, the Lender could argue that the borrower was effectively a holdover tenant and thus the Lender could bring an unlawful detainer action to recover possession (the same kind of quick judicial process a landlord uses to evict a defaulting tenant). But that's not even necessary anymore, because Missouri modified its unlawful detainer statute to make it express that a foreclosure sale buyer can bring an unlawful detainer action against the former owner. But the provision has just never been removed from the form.
28. Does the provision in ¶ 19 operate as a form of statutory redemption?
No. As we’ll talk about later in the course, statutory redemption is a right that is granted in some states by statute that allows the borrower to redeem the property AFTER a foreclosure sale has already occurred. [We do have statutory redemption in Missouri, but it is used very rarely.]
¶ 19 is different. It applies BEFORE a foreclosure sale has taken place. It allows me to “reinstate” the mortgage after the lender has accelerated the mortgage debt following my default. Once the lender accelerates the debt and demands payment of the full balance of the debt, at common law I could only stop the foreclosure by paying off the full balance of the debt. I couldn’t just make only the payments I had missed. But under ¶ 19, I have the right to reinstate by virtue of contract. I can make up the payments I missed, and reimburse the lender for its costs of collection incurred to that date, and the lender then has to reinstate my loan and allow me to resume making regular monthly payments.
29. What are the purposes of the Riders mentioned in the definitions?
Sometimes, there are loans that from an underwriting perspective are appropriate for this mortgage form, but where there is some peculiar aspect of the transaction for which the standard form is somehow insufficient. In these circumstances, the parties will use the standard form, but with one or more "Riders" needed to modify the standard form to account for the peculiarity of the particular transaction.
For example, suppose I’m buying a condo. The lender will want the "Condo Rider" attached, because it contains a few additional “Covenants” appropriate where the home is a condo — i.e., I promise to pay my condo association fees when they’re due, I promise to abide by the condo rules and regulations, etc. By executing the Rider, the deed of trust is deemed to include these additional covenants as well as the ones in the standard form document.
Or suppose I’m buying a vacation home that I’m only going to use myself, but not rent out. In that case, the “Second Home” Rider would be appropriate. [It contains a provision that qualifies the Occupancy provision in the standard form, which would be inappropriate for a Second Home, and it also contains a Covenant in which the borrower agrees not to rent the property or enter into a timesharing arrangement (or its equivalent) with respect to the property.]
Where there is a common transaction that doesn’t perfectly fit the standard form, and some “tweak” is necessary, one or more of the Riders may be required for that transaction. The 1-4 Family Rider would be used where the borrower is buying a duplex, triplex, or quadruplex where the borrower was going to be living in one unit and renting out the others. It places constraints on the borrower in terms of the kinds of leases that it could enter into.
Some of the other Riders (Adjustable Rate, Balloon Payment, Biweekly Payment) are actually Riders to the Promissory Note, rather than to the Deed of Trust. They would be used in case the loan repayment terms called for an adjustable interest rate, a balloon payment, or in case the borrower agreed to make bi-weekly payments rather than monthly payments (by making bi-weekly payments, the borrower can either pay the loan off quicker or fractionally reduce its payments).
30. Would the Riders ever be incorporated directly into the Deed of Trust?
There's no prohibition on that, but again, keep in mind — lenders use the form because they want to be able to preserve their ability to sell the loans on the secondary market. If they don't use the standard form, they can't sell the loan to Fannie or Freddie. Thus, the lender would instead just use the standard Rider rather than modifying the terms of the Deed of Trust directly.
31. In ¶ 9, it says the lender reserves the right to pay sums necessary to protect its interest in the property and to add those amounts to the debt. How serious must the threat be in order for the lender to rightfully incur these expenses and add them to the debt?
In some cases, the threats are clear. For example, if borrower failed to pay real estate taxes, that would give rise to a tax lien that would have priority over the lender. To prevent that from happening, the lender could pay the taxes and add that amount to the debt secured by the mortgage. Likewise, if the borrower has abandoned the house, the lender could come in and secure the home (e.g., installing new locks) to prevent the house from being vandalized.
In other cases, it may not be so clear. For example, it says lender can make “repairs.” Suppose that lender is foreclosing, borrower is out of the house, and the walls are worn and dirty. Lender wants to put a fresh coat of paint on them, thinking that the house will be more attractive and may sell for a higher price. Is that a “repair”? The language isn’t clear, so if the lender did this, and later tried to pursue the borrower for a judgment for an amount that included the painting costs, a court might have to decide whether that expense was covered by ¶ 9.
32. Would ¶ 21, which deals with Hazardous Substances, apply to a house that had been contaminated by meth production? How would the lender treat it if the meth lab was discovered but the borrower was unable to pay for the remediation?
Probably so; I suspect that courts would say that running a meth lab on the property would violate the covenants in ¶ 21 (although I've not seen specific cases, but I also haven't looked for specific cases, either). If the Borrower couldn't pay for the remediation, the Lender could certainly pay the cost and add that to the debt under ¶ 9 (discussed in the preceding question). If the Lender can then sell the property for enough money to cover the entire debt (including the remediation costs that the Lender had to advance), the Lender can recoup the expense that way. If the Lender cannot sell the property for enough at foreclosure to recoup the entire remediation cost, the Borrower would still be liable for the unreimbursed costs, either based on the borrower's personal liability on the mortgage debt or, alternatively, based on liability for "waste" (and running a meth lab would undoubtedly constitute "waste").
33. Just before the Uniform Covenants begin, on page 3, the form says that “Borrower warrants and will defend generally the title to the Property.” Is that the case even if the borrower received a warranty deed? Or does the responsibility then fall to the sellers that conveyed the property by a warranty deed? Does this mean that the borrower and the lender need to have title insurance?
This language is a warranty of title just like what you would see in a regular warranty deed. In fact, you might call this a “warranty mortgage” or a “warranty deed of trust.” Essentially, this is the Borrower saying “Lender, I agree to indemnify you if you suffer a loss because my title is bad.” This is usually of no particular consequence to the borrower, because (a) Lender will separately require a Loan Policy of title insurance which will provide the primary indemnity against this risk, and (b) if the borrower chooses to get an Owner's Policy of title insurance, any liability for breach of this warranty based on a preexisting title defect would be covered by the owner’s policy.
If Borrower buys a home and the seller’s title was in fact defective, then the Seller might have liability to the Borrower if Borrower suffers a loss due to a title defect. Probably, Borrower is first going to file a title insurance claim on its Owner's Policy and get paid by the title insurance company. Perhaps the title insurance company might then go after the Seller for breach of a deed warranty under a subrogation theory (having paid the Borrower, the title insurer would stand in the Borrower's shoes).
This does NOT mean that the Buyer has to have title insurance. As the Buyer, I could "self-insure" against that risk rather than buy an Owner's Policy. But then, if there was a title defect and the Lender suffered a loss and sued me, I would have to defend that litigation and potentially make good the loss; if I have an Owner's Policy, the title insurer would have to defend that litigation and make good the loss.
34. Is there a penalty for early prepayment?
If this form is also used in conjunction with the standard Fannie/Freddie promissory note, then no. Under the standard Fannie/Freddie promissory note, the note can be prepaid without penalty at any time. This was contrary to the common law rule, which was called the “perfect tender in time rule.” Under that rule, the lender had the right to insist on timely payment exactly in accordance with the terms of the mortgage, and borrower could not prepay without the lender’s consent. But under the standard Fannie/Freddie note, the borrower can prepay without any fee or penalty.
We’ll discuss prepayment in more detail later in the course, including prepayment fees and when they can be imposed/collected. Prepayment is a HUGE issue in commercial mortgage loans, where prepayment fees are standard (although there are substantial variations, from mortgage to mortgage, in how those fees are structured). Prepayment is also an issue in some "subprime" residential mortgage loans. But in a conventional prime mortgage loan issued on the Fannie/Freddie standard note, the borrower can prepay without penalty. This has been an IMMENSE benefit to consumers, allowing them to refinance (and lower their mortgage payments) during periods of falling interest rates.
35. The form requires that the property be properly maintained and damages repaired. How often and how likely are lenders to actually visit the borrower’s home to check for damages or proper maintenance?
Before the borrower defaults? Probably never. [ Never once in 20 years has the lender holding my mortgage called to schedule an inspection of my home to see if I was in compliance with my mortgage.]
The form is there to give the lender the ability to say that if it turns out the borrower doesn’t fulfill that obligation, and as a result the lender suffers a loss, lender has the ability to pursue the borrower for it. At common law, the lender would’ve had an action against the borrower for waste for damaging or failing to maintain the property. The provision is there to enable the lender to argue that such an action is appropriate, even if the borrower has no personal liability or recourse on the underlying debt. This can be important in states with aggressive anti-deficiency statutes. In those states, if the property sells for less than the debt, I can’t sue in contract for a deficiency judgment. But I may be able to sue in tort for damages for waste.
36. ¶ 7 says that the Borrower "shall not destroy, damage or impair the Property," shall not allow the property to "deteriorate," or shall not "commit waste." Who sets these standards?
Ultimately, because this covenant is being expressed in a mortgage contract, if there is a disagreement, interpretation of this language will be up to a court. There is substantial legal authority (prior case decisions) regarding what constitutes "waste," and that case authority would presumably be reflected in the court's determination of whether or not waste has occurred.
Likewise, courts have traditionally distinguished between "waste" or "destruction" (for which the borrower would be liable) on the one hand and "normal wear and tear" (for which the borrower would not be liable) on the other. Again, whether something was "normal wear and tear" or went beyond that to "waste" would ultimately have to be resolved by a court in the event of a disagreement.
In some states, the enforcement of these covenants (and whether something is "waste") is more important than in other states, because states take different approaches on whether a mortgage loan is subject to personal recourse (i.e., a deficiency judgment). In California, for example, a lender typically cannot get a deficiency judgment against a borrower on a purchase money mortgage loan. Thus, if the borrower defaults, the lender forecloses, and the house sells for less than the debt, the lender cannot recover a deficiency. But if the lender can prove that the reason the house sold for less was because the borrower committed waste, the lender could sue in tort for waste (even though the lender could not sue in contract for a deficiency judgment).
By contrast, in Missouri, there is no anti-deficiency legislation. In Missouri, if the borrower defaults, the lender forecloses, and the house sells for less than the debt, the lender can recover a deficiency judgment. Thus, in Missouri, it is less important for the lender to be able to sue on the maintenance covenants or to be able to sue for waste.
37. Why does the Borrower have to obtain insurance on the property? Obviously, the Borrower should protect its own investment, but is it really fair to require the Borrower to protect the lender’s investment? Is this really legal?
Yes, absolutely. The Borrower’s investment and the lender’s investment is essentially the same. The lender is financing the borrower’s acquisition of the land (at least typically so). Without the lender’s money, Borrower has no interest. And if Borrower smokes in bed, falls asleep, and burns the house down, the lender’s collateral is gone. [And how is the lender supposed to prevent the Borrower, 24/7, from doing stupid things like smoking in bed, playing with matches, plugging 25 appliances into the same outlet, etc.?]
Keep in mind that if the property is destroyed and the insurance company turns over the proceeds to the lender, the lender doesn’t get to keep them without regard to the fact that this is a LOAN transaction. The lender has to apply them to pay off the debt. If the proceeds are greater than the balance of the debt — which is hopefully the case, if the premises were adequately insured — the borrower will get the excess proceeds back. And the Freddie document allows the Borrower to require the Lender to make the proceeds available for rebuilding as long as rebuilding can be done in a way that protects the lender’s interest. So the provision is hardly unfair.
38. In ¶ 5, the language appears to permit the lender to obtain insurance for the borrower if the property isn't insured. Is this subject to any reasonableness requirement? Can the lender put in place insurance that is more expensive than what the borrower can get on its own?
¶ 5 does permit the Lender to obtain what is often called "force-placed" insurance if the Borrower fails to obtain the coverages required by ¶ 5. Again, in the abstract, this is not inherently unfair; Borrower has the opportunity to obtain suitable insurance and keep it in place by making the appropriate escrow payments each month. But if the Borrower fails to maintain coverage, the Lender should be able to "force" coverage to be put in place so that the Lender is not at risk of its collateral literally going up in smoke at any moment.
It is true that force-placed insurance is typically VERY expensive, particularly in relation to traditional coverage. There is no general "reasonableness" requirement under contract or mortgage law generally. However, there are some federal regulatory restrictions on the ability of lenders and their mortgage servicers with respect to the imposition of force-placed coverage. [To some extent, these regulations are due to outrageous conduct by servicers, such as (1) sending a request to the Borrower to provide proof of coverage, even though the servicer knows coverage is in place; (2) force-placing coverage when the Borrower fails to respond; and (3) force-placing it with a subsidiary company (related to the servicer) and/or having the force-placed insurer providing a kickback to the servicer.]
39. What kind of insurance would the lender need that the borrower would then be paying for via escrow?
Really, only property casualty insurance (under ¶ 5), PMI coverage (under ¶ 10), and perhaps flood insurance, if the property is located in a floodplain (flood damage wouldn’t customarily be covered under a regular casualty policy, as many people in New Orleans learned to their distress post-Katrina).
Likewise, if the property was sitting on the San Andreas fault or the New Madrid fault, maybe the lender would require special coverage against earthquakes (again, this is often not covered under a standard property casualty policy and requires an additional premium).
Other coverages may also be appropriate as a matter of context. For example, after 9/11, commercial mortgage lenders on office buildings and other commercial buildings in New York, Chicago, DC and other metropolitan areas began requiring "terrorism" insurance.
40. Under ¶ 5, when a Lender requires a Borrower to obtain property insurance and a loss occurs, does the insurance company pay the proceeds to the Lender or the Borrower? If the proceeds are in excess of the cost of repair, are the excess proceeds applied to the borrower's monthly mortgage payments?
We will address this subject in greater detail in several weeks' time. For the time being: (a) the Deed of Trust requires that "All insurance policies required by Lender and renewals of such policies shall be subject to Lender’s right to disapprove such policies, shall include a standard mortgage clause, and shall name Lender as mortgagee and/or as an additional loss payee." This means that the proceeds will be payable to both Lender and the Borrower, which prevents the Borrower from using the proceeds without the Borrower's consent.
In some forms, the mortgage/deed of trust will provide that Lender has the right to apply any insurance proceeds to reduce the debt and does not have to make the proceeds available to the Borrower for repair or rebuilding. In the Fannie/Freddie standard form, the Borrower does have a right, under certain conditions, to have the proceeds made available for repair/rebuilding. Again, in a couple of weeks, we'll discuss further how state courts have treated this issue, both where a mortgage is silent and where the mortgage purports to address the issue expressly.
If the Lender has the right to apply the proceeds to the debt, they are applied in a lump sum. If the proceeds are greater than the balance of the debt, then the loan is paid off and the Borrower gets the balance of the proceeds. If the proceeds are less than the amount of the debt, then the principal balance is reduced by this "prepayment," and the borrower keeps making its regular monthly payments on the note (which would then be paid off sooner as a result of the partial prepayment).
41. ¶ 16 says that the document is governed by "federal law and the law of the jurisdiction in which the Property is located." How could both federal and state law apply? Which would control? Are there provisions in the document required by federal law that could not be modified?
Generally speaking, repayment of a loan and the enforcement of a mortgage securing that loan are governed by state law, because state law has traditionally defined the parameters of real property rights. However, in some situations, there are applicable federal laws and regulations which may control or "pre-empt" state law to a certain extent. Thus, for example, the federal RESPA law does place a limit on the amount of money that the Lender may require the Borrower to pay into escrow (so as to regulate/prevent lenders from requiring excessive escrows). The federal Garn-St. Germain Act (which we'll also discuss later in the course) pre-empts state law limits on the enforceability of a due-on-sale clause (such as appears in ¶ 18), so the ability of the Lender to enforce its rights under ¶ 18 are governed by federal law.
Rather than identify the source of governing law for each and every provision, which would be cumbersome, Fannie/Freddie instead use the phrasing you see in ¶ 16. It is probably better to understand that provision as saying that the transaction is governed by state law (the jurisdiction where the Property is located) except to the extent that federal law pre-empts state law.
Nothing in ¶ 16 restrains the parties from modifying the form document. However, a modification that purported to give the Lender the right to do something that violated applicable law (e.g., to require the Borrower to escrow 5X the amount needed for annual taxes) would not be enforceable by the Lender under the federal RESPA statute. Further, to reiterate a point made previously, if the Lender modifies these documents to any extent, it can't sell that loan on the secondary market.
42. Do Lenders have any incentive to delay or avoid the Borrower's right to reinstate after acceleration?
Assuming the loan is on the Fannie/Freddie form, the answer is no. Because the Borrower clearly has the reinstatement right as a matter of contract, the Lender can't really delay or avoid it. If the Borrower tenders the correct amount, the Borrower has contractually reinstated, and further enforcement action (such as going forward with a foreclosure) would be a breach by the Lender.
I suppose that some Lenders could act strategically and try to argue that the Borrower had not tendered the correct amount so as to continue with foreclosure (hoping that the Borrower simply rolls over and does not contest the issue). But that seems like a bad idea, especially if the Borrower is tendering what the Lender knows is the correct amount.