ACKNOWLEDGMENT

I/we have read this disclosure form, and understand that [referring party] is referring me/us to purchase the
above-described settlement service(s) and may receive a financial or other benefit as the result of this referral.

...[signature]

Computerized Loan Origination (CLO)

Prior to June 7, 1996, mortgage brokers benefited from an exemption permitting them to charge fees for limited
borrower services: pre-qualifying, counseling, and matching available loan products to consumer/borrower
qualifications and needs. The CLO had to meet certain federal standards and was to be accompanied by the
delivery of an advance notice describing the intended services and fees. If the required standards were met, the
mortgage broker was able to charge a negotiated fee without direct regard to the relationship of the value of the
services provided (except as otherwise limited by California law as an agent and fiduciary). HUD has
withdrawn from CLOs the required notice and the qualified exemption for payment of compensation to
mortgage brokers.

Accordingly, the use of limited service CLOs has disappeared from the origination of federally related
mortgage loans. However, commencing a loan application through an electronic means has become
commonplace and is included in the services of loan originators when making or arranging federally related
mortgage loans. Face-to face or telephonic interviews typically follow an electronic loan application.
Regardless of the goods or facilities provided or the services rendered, the compensation of mortgage brokers
(MLBs/MLOs) (whether acting individually or in cooperation with another broker) must be reasonable related
to the value of the foregoing. Further, as agents and fiduciaries under California law (unless specific authority
exists to negotiate the commission), the general rule is that the commissions, fees, costs, and expenses must be
reasonably earned and actually incurred (12 USC Section 2601 et seq. and 24 CFR Section 3500 et seq.;
Business and Professions Code Sections 10176(a), (b), (c), (g), (i), and (l), 10177(g), (j), and (q); 10 CCR,

Chapter 6, Section 2843; Civil Code Sections 2295 et seq., 2349 et seq., and 2923.1; and Financial Code
Sections 4979.5, 4995(c) and (d) and 4995.3(c)).

RESPA Statute of Limitations

A borrower has three years from the date of occurrence to bring an action against a lender for failure to timely
disclose transfer of loan servicing and other loan servicing issues. The limit is one year from the date of
occurrence for a lender’s unauthorized payment of referral fees (kickbacks) or the forced use of a title insurance
company.

RESPA Enforcement Policy

It is the policy of the Secretary regarding RESPA enforcement matters to cooperate with Federal, State, or local
agencies having supervisory powers over creditors/lenders, mortgage brokers (MLBs/MLOs), or other persons
with responsibilities under RESPA. Federal agencies with supervisory powers over creditors/lenders may use
their powers to require compliance with RESPA. In addition, failure to comply with RESPA may be grounds
for administrative action by the Secretary under 2 CFR part 2424 concerning debarment, suspension,
ineligibility of contractors and grantees, or under the authority of the HUD Mortgagee Review Board. The
remedies described in this paragraph are cumulative and are not intended to limit any other form of
enforcement that may be legally available (24 CFR Section 3500.19).

ADDITIONAL CHARACTERISTICS OF PROMISSORY NOTES AND DEEDS OF TRUST OR MORTGAGES

In General

The parties and the property must be adequately identified in the instruments, and the instruments must be
signed by, delivered to and accepted by the appropriate parties. The parties should be named in the security
instrument in the same manner they are named in the promissory note, unless additional parties have been
added as co-signors or have provided additional or separate collateral secured by separate security instruments.

Further, in spousal circumstances where title is held in joint tenancy or as tenants in common, it is possible for
the name of one spouse who is the borrower to appear on the promissory note and the deed of trust or
mortgage, or for one borrower to appear on the promissory note and both to appear on the deed of trust or
mortgage. Needless to say, the foregoing deviations from the customary practice of the same parties being
identified in both the promissory note and deed of trust or mortgage should be reviewed by knowledgeable
legal counsel in advance of their use.

Notary acknowledgment of the security instrument is necessary for recording purposes. Subsequent to
acknowledgement, no changes may be made to the parties of the instruments without a subsequent
acknowledgement.

A valid deed of trust or mortgage must have a valid underlying debt/loan or obligation (whether present or
future), otherwise the security instrument secures nothing. Without a debt/loan or an obligation to secure, the
security instrument has no meaning and no lien attaches to the intended security property.

One security instrument can secure several debts/loans or obligations (whether present or future), and one debt
or obligation can be secured by several security instruments on several parcels of land. Further, a single security
instrument may describe several parcels of land as the security for the debt/loan or obligations the promissory
note evidenced.

Unless prohibited by law, fractional interests in the fee title to real property as well as the entire fee interest
may be hypothecated or pledged, but lenders/creditors or beneficiaries/mortgagees are generally reluctant to
lend on partial estates. No requirement exists that the trustor/mortgagor be the debtor. One person may give a
deed of trust or a mortgage to secure the debt/loan or obligations of another, or as a surety or guarantor. As
previously discussed, the debtor/trustor/mortgagor is usually the same person.

A transaction which is a “hidden security device” (a mortgage transaction disguised to appear otherwise)
established by the use of a grant deed as a “deed absolute” to secure a debt/loan or the performance of an
obligation will typically be characterized as a mortgage without power of sale subject to judicial foreclosure,
including the reinstatement, redemption, and anti-deficiency rules discussed in this Chapter (Civil Code
Sections 2925 and 2950). Such transactions are not to be structured by MLBs. Hidden security devices are for
legal counsel to consider, if at all appropriate for the fact situation.

A beneficiary/lender/mortgagee of a security instrument with power of sale will usually prefer the publicly
held, privately conducted foreclosure sale (trustee’s sale) if the real property is valuable enough to satisfy the
debt/loan and expenses of the sale. Since the power of sale eliminates subsequent to the sale the
debtor’s/trustor’s/mortgagor’s right of redemption, the trustee’s sale is generally absolute. If the security
property’s sale is expected to be insufficient to satisfy the debt/loan, the beneficiary/lender/mortgagee will
generally initiate a judicial sale and seek a deficiency judgment following such foreclosure sale when the
security instrument is a non-purchase money deed of trust or mortgage. The election of the remedy is the choice
of the lender/creditor or beneficiary/mortgagee. This election of remedy is to be made with the advice of
knowledgeable legal counsel before proceeding.

Interest-Only Promissory Notes

As previously indicated, an interest-only promissory note is characterized as a straight note in which the
monthly payments cover the accruing interest. The unpaid principal balance, which remains constant, is due and
payable on an agreed date in the form of a balloon payment. Balloon payments are discussed further in this
Chapter.

Depending upon the facts, balloon payments in loans secured by 1 to 4 dwelling units are typically required at
the end of periods as short as one to as long as seven years. Most commonly, the balloon payment will be due at
the end of a five year period. Shorter periods should be limited to bridge loans such as construction loans or
loans where a reasonable method of repayment has been established and assuming the short period for the
maturity date does not violate applicable federal or state law.

Balloon Payment Loans

In California, when a private investor/lender makes or funds a loan or when a seller extends credit to the buyer
(a “carry back”) in the form of a purchase money note and junior deed of trust or mortgage, often the monthly
payments to service the debt are either interest only or do not fully amortize the loan or extension of credit.
These transactions are typically subject to a due date, e.g., three to five years, at which time payment in full of
the principal amount owing plus any interest accrued thereon is required (the “maturity date”). This last
payment is called a balloon payment, and the amount owing is generally substantial.

Section 2924i of the Civil Code requires the holder of a balloon payment loan or forbearance with a term in
excess of one year secured by an owner-occupied dwelling of four or fewer units to give 90 to 150 days notice
in advance of the due date of the balloon payment. Seller “carry backs” are subject to a similar advance balloon
payment notice pursuant to 2966 of the Civil Code. Foreclosure of the loan or forbearance or seller “carry
back” may not commence without the required balloon payment notice being first given.

Real property loans negotiated by MLBs, junior loans under $20,000, or first loans under $30,000 (“sheltered”
loans) are subject to specific controls on broker compensation and to prohibited loan terms, as defined. For
example, loans or forbearances secured by non-owner-occupied real property with a term of less than three
years require substantially equal installment payments over the period of the loan with the final payment due at
the maturity date (the balloon payment). This means the balloon payment may not occur before the 36th month
of the loan term. During the period of the loan, no installment shall be greater than twice the amount of the
smallest installment.

If the loan or forbearance is secured by owner-occupied real property, the term of the loan must be more than
six years to include a balloon payment. Loans or forbearances for six years and less (when the security property
is owner-occupied) are subject to limitations regarding the installment payments, whether providing for interest
and principal or for interest only. No installment payment during the loan term may be in amount greater than
twice the amount of the smallest installment, i.e., no balloon payment until the final payment is to be no sooner
than the 73rd month.

The balloon payments that may occur when the loan is “sheltered” must be disclosed in accordance with
Business and Professions Code Section 10241.4. The notice is also to contain a statement whether any
refinancing, renegotiation or extension of the loan term has been agreed to by the parties, or whether the MLB
has undertaken to use his or her best efforts to obtain a future refinancing, renegotiation or extension of the loan
described in the disclosure. The outcome of such efforts may well be limited by market conditions operative at
the time and to the then credit worthiness and financial standing of the borrower.

A further discussion of the balloon payments described above are included in this Chapter in the Section
regarding Article 7 of the Business and Professions Code. The foregoing requirements do not apply to a
purchase money note given back to a seller for part payment of the purchase price, a seller “carry back”.

Piggybacks or Combo Financing

Piggyback or combo financing is a financing arrangement whereby two conventional loans, one secured by a
first deed of trust or mortgage and a second secured by a junior deed of trust or mortgage, are made by the same
creditor/lender or by two different lenders to purchase or refinance a residential security property. In a typical
scenario, the first conventional loan may provide sufficient funds up to 80% of the purchase price or appraised
value of the security property (whichever is less), and the junior loan funds up to an additional 10% for a
combined loan-to-value ratio (CLTV) of 90%. Typically, depository institutions and licensed lenders will
reduce the LTV or the CLTV for commercial security properties, i.e., other than residential property consisting
of 1 to 4 dwelling units.

Since mortgage insurance is normally only required by creditors/lenders on first conventional loans exceeding
80% LTV, piggyback financing has the advantage of avoiding the (non-tax deductible) cost of mortgage
insurance in favor of (tax deductible) interest expense on the junior deed of trust or mortgage.

Swing or Bridge Loans

In residential loan transactions, a swing or bridge loan is a temporary loan made against the equity in the
borrower’s home (which is to be sold), or against the equity in both the present and the “contemplated” home
(which is being purchased). The loan funds are used for the down payment on the contemplated residence. In
addition, swing or bridge loans are used to finance the construction of the borrower’s intended residence.

Where the security property is or is intended to become the residence of the borrower (owner-occupied), the use
of swing or bridge loans requires special consideration. For example, a bridge loan for the purposes of
applicable California law is defined as a temporary loan having a maturity of one year or less for the purpose of
acquisition or the construction of a dwelling intended to become the consumer’s (borrower’s) principal
dwelling (Financial Code Section 4970(d)). Because loans with short maturity dates are subject to extensive
regulation, these products should not be offered to private investors/lenders by MLBs without the advice of
knowledgeable legal counsel prior to proceeding with such loan transactions.

ALTERNATIVE FINANCING

In a stable economic environment (i.e., one involving low inflation and relatively constant market interest
rates), the long-term, fixed-rate conventional loan was the typical financing vehicle for the purchase of
residential real property. Uncertainty regarding future inflation and interest rates can complicate matters for

both lenders and borrowers. As people continue to build, sell and purchase homes, the terms of home
mortgages reflect economic realities and expectations including the periodic reluctance of lenders, investors,
and some borrowers to accept long-term, fixed-rate loans.

Loans that involve balloon payments, interest reset options, shared appreciation at resale, etc., have
ramifications that are not readily apparent to most people. This section discusses some of the alternatives to the
fixed-rate conventional loan that have been offered by lenders to borrowers.

The Fixed-Rate Conventional Loan

The use of alternative financing instruments (non-traditional loan products) authorized under preemptive
federal law constituted a major change in the traditional lender-borrower relationship in that the risk of changes
in the market rate of interest shifted from lenders to borrowers. However, marketplace competition, including
FHA insured or VA indemnified loans, resulted in continued availability of fully amortized, long-term, fixed-
interest rate mortgages. The Federal National Mortgage Corporation (FNMA or Fannie Mae) and the Federal
Home Loan Mortgage Corporation (FHLMC or Freddie Mac) also contributed and continue to contribute to the
availability of fixed interest rate mortgages.

Redesigned Mortgage Instruments

During the 1970’s and the early 1980’s unstable economic conditions caused Congress, California legislators,
consumers, lenders, and real estate and mortgage industry representatives to explore a whole catalog of issues
regarding the use of alternative mortgage instruments or non-traditional loan products that were being made
available to homeowners and purchasers. In 1970, legislation was passed and regulations adopted in California
authorizing the use of variable rate mortgages (VRMs). The interest rate of a VRM changes within a range as
increases or decreases in an identified published index occurs. In 1980, California legislation authorized the use
of renegotiable rate mortgages (RRMs) in which the borrower has an option to either prepay or renew the
residential loan, typically at five year intervals. Generally, renewal of such loans is subject to renegotiation of
the interest rate. Lenders were required to offer a fixed-rate mortgage as an option to the RRM.

In 1981, the California Legislature also authorized the use of adjustable rate mortgages (ARMs). These
mortgages allowed for the nominal interest rate to adjust periodically by a set margin in relationship to a
defined index. Again, lenders were required to offer fixed rate mortgages as an option.

In response to the foregoing California legislation, state depository institutions sought federal legislation to
level the playing field among state licensed and chartered and federally licensed and chartered depository
institutions. As previously mentioned, the Alternative Mortgage Lending Act was passed by Congress in 1982
to preempt state law to the contrary allowing state licensed and chartered institutions to make residential
mortgage loans pursuant to federal law. State depository institutions thereafter followed federal regulations
when express preemption of state law was included in federal law. Otherwise, state depository institutions were
obligated to follow the more stringent of the applicable state or federal law.

Basically, alternative mortgages also known as non-traditional loan products, resulted in an expansion of the
residential mortgage market. These alternative or non-traditional loan products shifted to borrowers some of
the risks inherent in market changes to enhance the inflow of funds to lenders during periods of tight money
and of high interest rates.

Adjustable Rate Mortgages (ARMs)

As mentioned, an ARM is a mortgage loan that provides for adjustment of its interest rate as market interest
rates change. Interest rates are linked to an index (typically representing short term interest rates) which
fluctuates as market interest rates change. Following an initial contract period as defined in the loan documents
and at predetermined periods (monthly, quarterly, or annually depending upon the terms of the loan); lenders
would adjust the interest rates on residential mortgage loans based upon a pre-agreed margin added to an
identified current index to arrive at the borrowers’ new interest rates for the next period. The new interest rates
would remain operative until subsequent adjustments occurred.

Major indices used in ARMs include: the Prime or Reference Rate of major commercial banks, as published in
the Wall Street Journal (Prime Rate); the London Interbank Offered Rate (LIBOR), as published in the Wall
Street Journal or by Fannie Mae; United States Treasury Securities adjusted to a constant maturity (TCM), as
published by the Federal Reserve in its Statistical Release H.15; and the 11th District Cost of Funds (COFI), as

published by the Federal Home Loan Bank of San Francisco. There are many variations in methods of
calculation for the aforementioned indices as well as other indices available for different types of ARMs. A
Home Equity Line of Credit (HELOC) is a revolving line of credit typically featuring an adjustable rate tied to
the Prime Rate of major commercial banks, as published in the Wall Street Journal.

Because ARM interest rates can increase over the term of the loan, ARM borrowers share with lenders the risk
that interest rates will increase; therefore, it is important for borrowers to not only fully understand how their
loan may react to changes in market conditions, but also to minimize their exposure by selecting loan programs
with low margins and reasonable caps or limits on interest rate changes. Selecting a less volatile index is also
important to borrowers.

Some ARM products also include an interest rate floor limiting decreases in the promissory note interest rates
regardless of the downward movement of the selected index. Typically, interest rate floors have been set at
either the start (teaser) or the initial rate. More recently, the difference between the start or teaser rates and the
initial rates has diminished.

Lenders benefit from ARMs in that they are able to more closely match the maturities of assets and liabilities
and minimize their exposure to the risk of rising interest rates. This results in lower initial rates on ARMs than
on fixed rate loans. ARMs that include negative amortization or payment options have proven to be more
troubling to borrowers as they often result in loan balances exceeding the then value of the security property
(particularly in a declining market) or in borrower payment shock.

Renegotiable Rate Mortgages (RRMs)

An RRM is a long-term mortgage (amortized up to 30 years) comprised of a series of short-term loans. The
loans are renewable after specified periods (e.g., every three to five years). Both the interest rates and the
monthly payments remain fixed during periods between renegotiation/renewal.

Any change in the interest rate, as limited by law, is based on changes in an identified index. If the borrower
declines renewal after any specified period, the remaining balance of the loan including any interest remaining
unpaid and accrued thereon becomes due and payable.

Rollover Mortgages (ROMs)

ROMs (used extensively in Canada) are a renegotiated loan wherein the interest rate (and hence, the monthly
payment) is renegotiated, typically every five years. Consequently, the mortgage rate is adjusted every five
years consistent with the then current or prevailing mortgage rates, although monthly payments are amortized
on a 25 or 30-year basis. Monthly payments are calculated in the same manner as conventional mortgage loans,
with the term decreasing in increments of five years to permit full payment at maturity date specified at loan
origination.

Reverse Mortgages (RMs)

Elderly or retired homeowners often rely on limited or fixed incomes while at the same time owning their
homes free and clear or with relatively small mortgage loan balances. For many of these homeowners the
choices are limited because of reduced fixed income during retirement years. The choices available to these
homeowners include either selling their home to access the equity as a means of supplementing their living
expenses or to consider obtaining a reverse mortgage.

The reverse mortgage loan that is available today is known as a Home Equity Conversion Mortgage (HECM),
an FHA insured product. Under a HECM reverse mortgage, the homeowner is not required to make loan
payments. Instead the homeowner has a choice of receiving monthly income/cash flow from the lender or
receiving a lump sum payment at the time the loan is originated. The amount of income/cash flow or the initial
lump sum paid to the borrower is determined through an analysis of the current and expected future value of the
security property; the current and future expected accruing interest rates to be applied to the principal
distributions made to the homeowner during the term of the reverse mortgage (based upon the selection by the
lender of one of two HECM authorized adjustable rate programs); and upon the remaining life expectancy of
the homeowner.

The analysis considers the amount of any existing mortgage loans encumbering the homeowner’s property that
must be paid in full at the time of origination of the reverse mortgage loan. This may require the selection of the

option for a lump sum payment at the time of loan origination or that the loan program include both a lump sum
payment sufficient to payoff the existing encumbrance(s) and to thereafter provide a monthly income/cash flow
to the homeowner. If the amount owing in connection with the existing mortgage loans is in excess of the
calculated maximum amount available from the selected HECM loan program, the homeowner may not be
entitled to obtain a reverse mortgage.

These homeowners are qualified for a reverse mortgage loan in a maximum amount that can be sustained by the
equity in the security property (based upon the analysis previously discussed) and not on their retirement
income, or their credit worthiness and financial standing. The homeowner’s equity must also sustain the
mortgage premiums imposed by HUD/FHA both at the time of origination and throughout the term of the
reverse mortgage loan, among other fees, costs, and expenses. The fees, costs, and expenses to originate a
reverse mortgage are typically much higher than to originate a conventional loan; therefore, it is ill-advised to
consider a reverse mortgage for a short period. The selection of a reverse mortgage loan by a homeowner
requires a long-term commitment to occupy the security property.

The FHA insurance coverage protects homeowners by insuring the monthly income/cash flow will continue
even if the lender becomes insolvent or subject to a regulatory enforcement action. The insurance coverage also
protects the lender and the homeowner in the event the amount owing at the time of the maturity of the reverse
mortgage loan exceeds the then market value of the security property. The difference is subject to a claim
against the insurance coverage by the reverse mortgage lender thus protecting the estate of the homeowner from
any shortfall in principal balance and accrued interest that might otherwise be due.

HECM reverse mortgages are due and payable when then last qualified borrower permanently leaves the
property or until a specified event, such as death of the homeowner or a sale of the security property. In effect,
a reverse mortgage enables the homeowner to draw on the equity of their home by increasing their loan balance
each month. No cash payment of interest is involved, as the increase in the loan balance each month represents
the cash advanced, plus interest on the outstanding principal balance.

Shared Appreciation Mortgages (SAMs)

SAMs give the lender the right to an agreed percentage of the appreciation in the market value of the security
property in exchange for an initial below market interest rate. These loans are usually unavailable in markets
where real property is not appreciating in value.

Graduated Payment Mortgages (GPMs)

GPMs provide for partially deferred payments of principal at the start of the loan term. There are a variety of
plans. Usually, after the first five years of the term, the principal and interest payments increase substantially to
pay off the loan during the remainder of the term (e.g., 25 years). This loan may be appropriate for borrowers
who expect salary or income increases in future years. A GPM may involve negative amortization (i.e.,
increases in principal) in the early years of the loan, although some GPM products do not provide for negative
amortization. If negative amortization is included, the early sale of the home could require the borrower repay
more than the original principal amount of the loan. This could be a significant problem if the property has not
increased or has even declined in market value.

In Summary

Alternative mortgages also known as non-traditional loan products are not suitable for everyone. It is very
important that those who recommend such products, or who contemplate using them personally, have a good
understanding of the potential risks and drawbacks as well as the benefits. A temporary solution to a financing
problem may turn out to be a long-term detriment to the borrower and/or lender. When the party recommending
such products is an MLB/MLO, the understanding of and the explanation regarding the use of alternative
mortgages or non-traditional loan products occurs within the context of the fiduciary duties owed to the
intended borrower.

Real estate licensees, including MLBs/MLOs should use caution when advocating the use of innovative or
creative financing techniques and products in residential loan transactions. These licensees (as agents and
fiduciaries) should be prepared to explain the benefits and risks to their clients throughout the anticipated term
of the residential mortgage loan when using alternative mortgages or non-traditional loan products. Alternative
mortgages or non-traditional loan products are not something that licensees and their principals should learn

together through trial and error. Innovative or creative financing techniques and products generally are to be
avoided without the advice of knowledgeable legal counsel.

APPENDIX G-1: INITIAL ESCROW ACCOUNT DISCLOSURE STATEMENT – FORMAT

[Servicer’s name, address, and toll-free number]

BACKGROUND

Finance is the lifeblood of the real estate industry. Developers, contractors, real estate brokers (REBs) and
mortgage loan brokers (MLBs) should each understand how real estate is financed.

Traditional sources of loan funds are the financial depository institutions (depository institutions), including
savings and loan associations, savings banks, commercial banks, thrift and loans and credit unions. Other non-
institutional sources characterized as “non-banks” include mortgage bankers, finance lenders, private
individuals and entities, pension funds, mortgage trusts, investment trusts, and hedge funds. Insurance
companies are neither depository institutions nor non-banks. These entities collect premiums from
policyholders/the insured and invest some of the premium dollars in interests in real property, including equities
and mortgage loans.

Brief Overview

Over the past 15 to 20 years, enacted California legislation that characterized certain non-depository institutions
or non-banks as institutional and supervised lenders for limited, defined purposes. These include mortgage
bankers (licensed under the Residential Mortgage Lending Act), finance lenders (licensed under the California
Finance Lender Law), pension funds in excess of $15,000,000 in assets, mortgage trusts, investment trusts, and
hedge funds. The expansion of these non-depository institutions or non-banks and their growing share of the
residential mortgage market resulted in the development of a secondary market through securitization of
mortgage loans in the form of mortgage backed securities. Mortgage backed securities are qualified by
registration for intrastate and by coordination for interstate issuance of public offerings. Depending upon the
fact situation, these securities may also be qualified by exemption as private placements in accordance with
applicable federal and state law.

The secondary mortgage market (investors purchasing real estate loans originated by other lenders through
mortgage backed securities) surpassed loan sources which dominated real estate lending prior to the 1990’s.
The significant financial collapse and consolidation of the savings and loan and savings bank industry that
occurred at the end of the 1980’s and in the early 1990’s contributed to this change. At the beginning of 1980’s,
there were approximately 4,022 savings and loans and savings banks in the United States. As of December 31,
2009, approximately 1,158 remain, of which 756 are supervised by the Office of Thrift Supervision (OTS) and
402 are supervised by the Federal Deposit Insurance Corporation (FDIC). During the same period, commercial
banks reduced in number from approximately 15,000 to 6,739, of which the Office of the Comptroller of the
Currency (OCC) supervises 4,461 and the Federal Reserve Bank (the Fed or FRB) supervises 839.

The FDIC issued a public report at the end of the first quarter of 2010 that indicated 775 banks or more than
10% of remaining U.S. banks were placed on a list of “problem” depository institutions. These problem
institutions had a significant portion of non-performing commercial loans on their balance sheets. Non-
performing loans are considered to be loans that are at least 3 months past due. According to the FDIC report,
the number of non-performing commercial loans continued to increase for the 16th consecutive quarter. The
number of problem banks/depository institutions listed by the FDIC increased from 262 at the end of 2008 to
702 at the end of 2009 and to 775 at the end of the first quarter of 2010.

In addition to savings and loans, savings banks, and commercial banks, credit unions have been and remain a
significant source of residential financing. In recent years, credit unions have been merging, resulting in some
having hundreds of millions of dollars in assets. Currently, approximately 7,244 credit unions control $205
billion in assets, $181 billion in deposits, and $120 billion in loans to their members. Commercial banks control
$4.4 trillion in assets, $3.1 trillion in deposits, and $2.7 trillion in loans.

Life and health insurance companies also invest substantial resources in loans secured by real property. The
Insurance Information Institute reports that, as a percentage of total investments, the life and health insurance
industry continues to invest in mortgage loans from 9.85 to 10.87% of their total assets. As of the end of 2008,
this industry reportedly held $327.4 billion in real estate loans. While life and health insurance companies
historically invested in residential loans, during the last approximate 30 years the mortgage loans held by this

industry have been other than residential, i.e., income producing properties including apartments, office
buildings, shopping centers, malls, strip and freestanding commercial retail, industrial and the like.

Since the 1980’s, mortgage loan brokers (MLBs) have become a substantial source of residential mortgage loan
origination. The industry-wide use of MLBs to “originate” residential mortgage loans expanded until the
mortgage melt down of 2007 and 2008. Depending upon markets, MLBs “originated” from 50 to 70% of
residential mortgage loans, i.e., loans secured by 1 to 4 dwelling units.

The term “originate” has historically meant to fund or make the loan and did not include the function of
“arranging” a loan on behalf of another or others. Since the late 1980’s, mortgage lenders, state legislatures,
Congress and various federal and state governmental agencies and departments have redefined the term
“originate” to include third parties who arrange loans for lenders to fund and make. These third party
“originators” are commonly known as MLBs. Recently, the term “originate” has been extended to employees
who act as loan representatives of depository institutions and of licensed lenders. MLBs and lender
representatives who solicit and negotiate loans to be secured by 1 to 4 residential units have been re-
characterized as Mortgage Loan Originators (MLOs) in the federal Secure and Fair Enforcement for Mortgage
Licensing Act of 2008 (the SAFE Act). The Safe Act is briefly explained later in this Chapter.

California MLBs also make and arrange loans relying on funds from private individuals/entities, known as
private investors/lenders. Traditionally, these private investors/lenders funded loans secured by 1 to 4
residential units. The majority of these loans were based upon the “equity” in residential properties held by
borrowers rather than to finance the purchase of such properties. Beginning with the early 1990’s, depository
institutions and licensed lenders (non-banks) expanded their loan products to include the quality of loans that
previously had been almost an exclusive market for private investors/lenders making loans through MLBs. This
almost exclusive market consisted of mortgage loans that relied in large part on the equity in the security
property and to a lesser extent on the credit worthiness and financial standing of the borrower.

Private investors/lenders and the MLBs through whom these residential mortgage loans were funded could not
effectively compete with the expanded residential loan products that were being offered to the borrowing public
by depository institutions and non-banks. However, the historic secondary market would not purchase most of
these expanded residential loan products (alternative mortgages or non-traditional loan products). To create the
liquidity necessary to continue to fund these expanded residential loan products, a new secondary market was
established relying on the issuance of the aforementioned mortgage backed securities.

The residential mortgage loans funded by the historic depository institutions and the more recently constructed
non-bank lenders were then packaged, securitized, and sold to foreign and domestic investors in risk/yield
based “traunches” through Wall Street investment banks and broker-dealers. These historic depository
institutions and more recently constructed non-banks also sold these loan products to each other.

The Wall Street Investment Banks and broker-dealers created a parallel loan “origination” and delivery system
outside of the direct regulatory oversight of the Fed and the various federal agencies having supervisory
jurisdiction over depository institutions, e.g., FDIC, OCC, and OTS, among others. These federal agencies were
responsible for ensuring the safety and soundness of the depository institutions. The new and alternative
“origination” delivery system relied primarily on MLBs as third party “originators” of residential mortgage
loans, which were often funded through credit facilities made available by mortgage bankers, finance lenders,
or hedge funds.

Before Deregulation

Partially because of the unstable market forces prevailing over the last 30 to 35 years, depository institutions
such as savings and loan associations, savings banks, commercial banks, credit unions, and thrift and loans
experienced reductions in profitability. Largely unregulated non-depository institutions or non-banks drew
savings deposits away from regulated depository institutions by paying investors higher rates of interest on
financial instruments created for this purpose (e.g., uninsured money market funds, commercial paper, and
hedge funds).

During the late 1970’s, many depository institutions were holding low-interest loan portfolios that steadily
declined in value. At the same time, they were unable to make enough higher-interest rate loans to achieve
acceptable profit levels. This happened in part because of the decline in personal savings, appreciating property

values, and increasing interest rates paid to depositors. It was during this period the concept of brokered
deposits was first established. Wall Street broker-dealers were delivering deposits from their investor clients to
depository institutions looking for those that would pay the highest interest rates. High deposit rates resulted in
high mortgage loan interest rates. Many potential home buyers could not qualify for higher-rate mortgage loans
and/or were unable to make required down payments.

Across the country, forced postponements of home ownership occurred except for transactions involving
transferable (assumable) loans and seller-assisted financing. Subdividers, developers, and builders reduced new
home production. By the end of 1980, the prime interest rate imposed by commercial banks reached 21.5%. On
September 14, 1981, the interest rate for FHA and VA single-family insured or indemnified home loans
reached 17.5%. Tight money, stringent credit underwriting, and high interest rates made mortgage money
scarce and expensive. Potential private and government sector borrowers were forced to bid for available loan
funds.

Deregulation that Followed

The foregoing mortgage market led to a period of deregulation, the process whereby regulatory restraints upon
the financial services industry were reduced or removed. Deregulation extended to California law, and federal
legislation was pursued to level the playing field between federally licensed and chartered depository
institutions and California licensed and chartered depository institutions. This legislative deregulation included,
among others, the federal Depository Institutions Deregulation and Monetary Control Act of 1980, the
Depository Institutions Act of 1982 (also known as the Garn - St. Germain Act), and the Alternative Mortgage
Lending Act of 1982.

Re-regulation

Re-regulation occurred at the end of the 1980’s as a result of substantial losses in the savings and loan and
savings bank industry. Re-regulation began with the federal Financial Institutions Reform, Recovery and
Enforcement Act of 1989 (FIRREA). This federal re-regulation continued with a significant number of
amendments to both the Real Estate Settlement Procedures Act (RESPA) and the Consumer Credit Act, also
known as the Truth-In-Lending Act (TILA).

FIRREA was designed to “bail out” the savings and loan and savings bank industry as the Federal Savings and
Loan Insurance Corporation (FSLIC) did not have sufficient reserves to accomplish this objective. FIRREA
directly regulated federal depository institutions, and these regulations affected state licensed and chartered
depository institutions. The supervision by federal regulators over savings and loans, savings banks and
commercial banks increased during the 1990’s to include, among other changes, enhanced capital reserve ratios
required for loan losses. In addition, the OTS was structured as an office within the Fed or the FRB, replacing
the Federal Home Loan Bank Board (FHLBB) that had supervised savings and loans and savings banks since
the 1930’s. At the same time, the FSLIC was restructured from a separate entity to the Saving Associations
Insurance Fund (SAIF) as a subset of the FDIC.

More Deregulation

Following the restructuring of the savings and loan and savings bank industry in the early 1990’s and the
enhanced federal regulatory supervision that followed, Congress returned to deregulation. An example is the
federal Financial Institutions Regulatory Relief Act (FIRRA), also known as the Paper Reduction Act of 1996.
Included as part of FIRRA was the termination of SAIF, with its function of insuring deposits held by savings
and loans and savings banks being transferred to the Bankers Insurance Fund (BIF). BIF also operated under
the FDIC.

In 2006, the Federal Deposit Insurance Act became law. This Reform Act merged BIF and the deposit
insurance function of savings and loans, savings banks, and commercial banks into a fund called the Deposit
Insurance Fund (DIF). This change was made effective March 31, 2006. The Reform Act also established
capital reserve ranges from 1.15 to 1.50% within which the FDIC directors were allowed to set reserves for
member institutions, i.e., the Designated Reserve Ratio (DRR).

With this deregulation, the differences once separating the loan products, services, and the purposes of savings
and loans, savings banks, and commercial banks were reduced or eliminated. Further, the distinctions in
premiums paid to DIF by the various depository institutions were restructured. Savings institutions competed

with commercial banks for business and profits with few governmental restrictions. Some experts in the
financial world believed that depository institutions surviving this competition would become larger, more
diverse, and more efficient than the depository institutions prior to the 1990’s.

The process of diversification and integration of the financial services industry accelerated by the repeal of the
Glass-Steagall Act as part of the federal Gramm-Leach-Bliley Act of 1999. The repeal of the Glass-Steagall Act
allowed savings and loans, savings banks, and commercial banks to invest funds and integrate investment
activities with investment bankers and insurance carriers, including engaging in the issuance of mortgage-
backed securities and in the structuring and issuing of unregulated financial instruments referred to as
derivatives.

Derivatives have been defined as agreements or contracts that are not based on a real, or a concomitant
exchange, i.e., nothing tangible is currently exchanged such as money or a product. For example, a person goes
to a department store and exchanges money for merchandise. The money is currency and the merchandise is a
commodity. The exchange is concomitant and complete. Each party receives something tangible. If the
purchaser had asked the store to hold the merchandise to be delivered at a later date when future payment is
made at a predetermined price standard (based upon the movement in the retail price of the product) and the
store agrees, then a form of derivative has been created.

Derivatives are agreements derived from proposed future exchanges rather than current and concomitant
exchanges of assets, obligations, or liabilities. In financial terms, a derivative is a financial instrument between
two parties representing an agreement based on the value of an identified and underlying asset linked to the
future price movement of the asset rather than its presumed current value. Some commonplace derivatives, such
as swaps, futures, and options have a theoretical face value that can be calculated based on formulas. These
derivatives can be traded on open markets before their expiration date as if they were assets.

California Law

Consolidation of the licensing of lenders other than depository institutions has occurred in California. As of
July 1, 1995, the Finance Lender Law established a single license, the California Finance Lender (CFL) which
replaced three licenses including personal property brokers, consumer finance lenders, and commercial finance
lenders. These three licenses were merged into the CFL license.

Effective January 1, 1996, the California Legislature created a new license category for mortgage bankers either
originating or servicing residential loans in this state. These licensees are known as residential mortgage lenders
(RMLs), each of which is licensed under the Residential Mortgage Lending Act (RMLA). CFLs and RMLs are
licensed and regulated by the Department of Corporations (DOC).

Some mortgage bankers remain licensed as real estate brokers (REBs) and continue to operate their non-
residential commercial loan business (loans secured by other than 1 to 4 dwelling units) under the regulation of
the Department of Real Estate (DRE). RMLs are not to use an REB license to make, arrange or to service
residential loans.

During 1996, the California Legislature consolidated regulation of depository institutions into a Department of
Financial Institutions (DFI). This department replaced the Department of Banking and the Department of
Savings and Loans and acquired from the DOC’s regulatory oversight the state-chartered thrift and loans
(industrial loan companies) and the credit unions.

California industrial loan companies have also experienced significant restructuring. These institutions were
legislatively required to switch from a California-based insurance fund to the FDIC. With this switch came
more regulatory oversight, including stricter loan underwriting guidelines. Reported diminished profits
followed this restructuring and the result was the merger of many of these institutions into larger institutions
that were able to profitably function within the regulatory climate and competitive market of the 1990’s through
the middle of 2007.

Restructuring of the Residential Loan Market

Deregulation and the proliferation of alternative mortgage instruments or non-traditional loan products were
each responsible for the restructuring of the housing finance system. These alternative mortgage instruments or
non-traditional loan products were responsible for redefining the underwriting guidelines and the standards for

borrower qualifications applied by depository institutions and by non-banks (including licensed lenders). The
purpose was to facilitate the expansion of homeownership as a stated public policy and also as a means of
pursuing the objectives of the federal Community Reinvestment Act.

As always, the most important issue facing both mortgage lenders and borrowers is the availability and
affordability of mortgage funds. As legislators, regulators, lenders, brokers (including MLBs) and consumer
interests addressed complex risks, challenges and opportunities, more changes occurred in the lending process.
For example, electronic loan originations became readily acceptable to depository institutions and non-banks as
well as to the secondary market.

The foregoing changes increased involvement of licensed lenders and brokers, including RMLs, CFLs, and
MLBs in residential mortgage loan originations. Since the mortgage meltdown of 2007 (to be discussed later in
this Chapter), what remains to be seen is how much consolidation will occur among these licensees, and if not
consolidation, how many of these licensees will become subsidiaries of or affiliates horizontally associated with
depository institutions. The result of these business relationships will require acknowledgement and disclosure
of Affiliated Business Arrangements (ABAs) to be discussed later in this Chapter.

Extensive federal and state re-regulation of lenders and mortgage brokers making and arranging residential
mortgage loans (including the SAFE Act) will likely reduce the ability for small independent licensed firms to
survive. Accordingly, many of these firms will be forced to merge or, as previously mentioned, may become
subsidiaries or affiliates of depository institutions or their holding companies.

Acquisition of state licensed firms may also be considered by federally licensed and chartered savings and
loans, savings banks, and commercial banks following a decision of the U.S. Supreme Court issued in April
2007. The decision is Watters, Commissioner, Michigan Office of Insurance and Financial Services v.
Wachovia Bank, N.A. et al., No. 05–1342 (argued November 29, 2006, decided April 17, 2007). The U. S.
Supreme Court held that subsidiaries of federally licensed and chartered depository institutions or their holding
companies did not require licensing under state law. This decision abrogated in part the opinion of the
California Attorney General, 84-903, which was issued in October 1985 and had concluded that entities,
whether subsidiaries or affiliates, could not rely on exemption from state licensure that extends to the parent or
to the employees of the parent entity. The remaining opinions of the Attorney General remain operative.

Essentially, the Attorney General’s opinions require separate licensing of entities that fund or make loans,
purchase promissory notes, or service loans/promissory notes held by the entities. The U. S. Supreme Court
decision will likely facilitate the acquisition of a number of RMLs, CFLs, and MLBs by federally licensed and
chartered depository institutions.

DEEDS OF TRUST OR MORTGAGES

Security Interest

“Security interest” is a term designating the interests of the lender/creditor in the property of the
borrower/debtor. Certain assets of the borrower/debtor are set aside so that the lender/creditor can reach or sell
them if the borrower/debtor defaults on his or her debt or obligations. The document that describes the rights
and duties of the lender and the borrower is called a security instrument. Deeds of trust and mortgages are
security instruments.

In General

The deed of trust is the security instrument most frequently used in California real estate loan transactions.
Early distinctions between the legal and economic effects of the deed of trust and mortgage have diminished
considerably. In the early 1930’s, the California Supreme Court held in the case, Bank of Italy Nat'l Trust and
Savings Ass'n v. Bentley, 217 Cal. 644, 657 (1933), that deeds of trusts and mortgages were functional
equivalents. Also, Civil Code Section 2920 was amended in 1986 to provide “…mortgage also means any
security device or instrument…that confers a power of sale affecting real property…to be exercised after breach
of the obligation so secured…”. Now, both security instruments may include a power of sale through which a
named or substituted trustee may conduct a trustee’s sale as part of the non-judicial foreclosure procedural law
(Civil Code Section 2924 et seq.).

Unless indicated otherwise, references to “mortgage”, “mortgagor”, or “mortgagee” in this discussion include
“deed of trust”, “trustor”, “beneficiary”, “lender”, or “lender/creditor” and vice versa. Further, references to
“debtor” or “borrower” also may mean “trustor” or “mortgagor”. Further, the terms creditor/lender and
borrower/debtor as used in this Chapter also describe the person or entity funding or making a loan and the
person or entity that obtains the loan. These terms are sometimes used interchangeably with other terms
describing the same parties and other times used distinguishably when so defined.

Differences Between Deeds of Trust and Mortgages

The historical differences between deeds of trust and mortgages have been largely eliminated. What remains
distinguishable are the names of the parties and the terms used to extinguish the deed of trust as compared to
the mortgage as a lien against the security property when the debt or loan is paid. The deed of trust is
extinguished by a deed of reconveyance while the mortgage is extinguished by a certificate of
discharge/satisfaction of indebtedness.

The parties to a mortgage remain identified as the mortgagor (borrower) and the mortgagee (lender or
beneficiary). Even here the terms mortgagor/mortgagee are often used to describe the borrower and the
beneficiary as in the deed of trust. For example, federal government agencies and enterprises interchange the
use of mortgagor and mortgagee with the terms borrower/trustor, and the terms lender/beneficiary/mortgagee
with the terms creditor/lender.

When the mortgage instrument is constructed without power of sale, it may only be foreclosed judicially. When
judicial foreclosure is the only available foreclosure remedy; the statute of limitations, the pursuit of
deficiencies (money claims), and the redemption rights would be distinguishable from a deed of trust that is
foreclosed through a power of sale as a function of the procedural law authorizing the named or substituted
trustee to conduct such sales. However, when the deed of trust or mortgage each includes a power of sale,
distinctions regarding the statute of limitations, deficiencies, and redemption rights no longer exist.

When a power of sale is included in a deed of trust or mortgage, each security instrument is subject to the same
anti-deficiency limitations and to the same reinstatement and redemption rights (if a non-judicial foreclosure is
the selected remedy). Should judicial foreclosure be the selected remedy, the same rules are generally
applicable to both deeds of trusts or mortgages.

The Civil Code was amended in 2006 to make uniform the statute of limitations when a deed of trust or
mortgage contains the power of sale. If the final maturity date or the last date fixed for the payment of the
debt/loan or performance of the obligations is ascertainable from the recorded evidence of indebtedness, an
action for foreclosure may be commenced within 10 years from that date, whether the security
device/instrument for the debt/loan or obligations is a deed of trust or mortgage. If the recorded evidence of
indebtedness does not fix the maturity date or the last date for the payment of the debt/loan or performance of
the obligations, then an action to foreclose may commence within 60 years after the recording of the security
device/instrument. It is important to note that the California Legislature and the Law Revision Commission in
the context of this legislation have deemed deeds of trust and mortgages to be functional equivalents (Civil
Code Section 882.020).

Junior Deeds of Trust or Mortgages

It is often necessary to obtain junior financing (a loan secured by a deed of trust or mortgage recorded after the
recordation of or made subordinate to the deed of trust or mortgage securing the senior financing) to complete a
transaction where the amount of a first conventional loan (senior financing) plus the trustor’s/mortgagor’s down
payment are not sufficient to pay the purchase price.

It should be noted junior financing may not be employed when the security property is subject to a first
conventional loan made by a financial institution or licensed lender at the time of purchase without the approval
of the foregoing. When the senior financing is FHA insured or is a VA indemnified loan made at the time of the
purchase of the security property, junior financing is most often prohibited. Even to further encumber a security
property with junior financing where the senior financing is held by a financial institution or a licensed lender
(or when the loan is FHA insured or VA indemnified), may require prior approval from the financial institution,
licensed lender, or applicable government agency because the existence of due on further encumbrance clauses
or similar provisions.

Packaged or Mixed Collateral Deeds of Trust or Mortgages

A package or mixed collateral deed of trust or mortgage involves a loan on real property that is secured by
more than just the land and improvements thereon. It may include fixtures (appliances, carpeting, drapes, and
air conditioning units) as well as other items of business or household personal property. As a cautionary note,
MLBs are not licensed to make or arrange loans to be funded by private investors/lenders secured by business
or household personal property. This restriction does not apply to depository institutions or certain licensed
lenders, i.e., the California Finance Lender (CFL).

In California, the license that specifically authorizes making and arranging loans secured by business or
household personal properties are issued under the Finance Lender Law to CFLs. In loan transactions where
business personal property represents an essential part of the security for the real property loan, MLBs should
seek the prior advice of knowledgeable legal counsel prior to proceeding.

Blanket Deeds of Trust or Mortgages

A blanket deed of trust or mortgage is a loan which covers more than just one parcel of property. Usually, the
loan contains a “release clause” providing for release of a particular parcel upon the repayment of a specified
portion of the loan. Typical use of blanket security instruments is in connection with subdivisions of homes
built on speculation.

Initially, one blanket deed of trust covers the entire subdivision or the particularly defined and authorized unit
or phase of the subdivision. Releases from the blanket encumbrances may not occur until the
developer/subdivider/builder has complied with the requirements imposed pursuant to the Subdivision Map Act
and, if a common interest development (as defined), with the requirements of the Subdivided Lands Law. The
Subdivision Map Act is found in the Government Code commencing with Section 66411. This law delegates
primary responsibility of regulating the development of residential subdivisions to local government (cities and
counties). Each condition imposed by local government as a prerequisite to issuing the required entitlements
and authorizing the development of a residential subdivision must be met or satisfied in an acceptable manner
prior to releasing from the blanket financing any individual lot or parcel within the subdivision, or the
authorized unit or phase thereof.

The Subdivided Lands Law is found in the Business and Professions Code commencing with Section 11000.
The regulatory and enforcement oversight of this law is the responsibility of the DRE. Prior to releasing any lot
or parcel within a subdivision from the blanket financing, compliance with the requirements of the Subdivided
Lands Law must occur, including the issuance of the Public Report, or in accordance with an applicable
exemption from such required issuance.

It is unlawful to sell, offer to sell, lease or offer to lease, finance or offer to finance any lot or parcel of real
property or commence construction of any building for sale or lease (except for model homes), or to allow any
occupancy of a lot or parcel within the subdivision until a final map has been recorded in full compliance with
the Subdivision Map Act. It is also unlawful to sell or offer to sell, lease or offer to lease, or to finance any lot
or parcel in a subdivision subject to the Subdivided Lands Law without compliance with this law (including
notice to the Real Estate Commissioner of the provisions of such financing). Further, the issuance of a Public
Report or an Amended Public Report by the DRE must first occur prior to offering any lot or parcel for sale or
for lease unless an applicable exemption exists for such required issuance (Business and Professions Code
Section 11000 et seq.).

The manner in which blanket financing/encumbrances are handled in common interest developments is also
subject to the Subdivided Lands Law. The statutory penalties for violating these provisions may result in fines,
in jail or prison terms, or both not to mention discipline of the real estate licensee who may be acting in an
agent or in a principal capacity (or both) in such transactions (Business and Professions Code Sections 11013 et
seq. and 11023).

Open-End Deeds of Trust or Mortgages

An open-end deed of trust or mortgage involves a loan arrangement whereby additional amounts of money may
be lent in the future (an advance) without affecting the priority of the security instrument. In California, the law
provides that additional advances retain the priority established by the recorded deed of trust or mortgage, if the
advances qualify as obligatory as opposed to optional (Civil Code Sections 2882 and 2884).

Construction loan advances made pursuant to construction loan agreements and evidenced by a construction
promissory notes and deeds of trust or mortgages are obligatory. For example, a supervised institutional or
licensed lender operating under government regulation and with sufficient net worth and reserves may well be
able to establish that the draws or voucher payments made during the construction period will retain the priority
of the recorded documents and instruments, including the construction loan agreements and deeds of trust or
mortgages. If properly documented, the same standards should apply to HELOCs.

MLBs should exercise caution when structuring land acquisition and development, vertical construction loans,
or HELOCs to adequately address the obligatory or optional advance issue and to establish under what fact
situation such loans may be partially funded or funded in stages by private investors/lenders. Partially funded
loans when relying on fractionalized note interests to be held by private investors/lenders pose significant
problems, including the loss of priority in connection with mechanic’s liens occurring during the staged funding
and the possible result of a “Ponzi” scheme (even if inadvertent). The question of advance fees also is at issue
when such loans are partially or staged funded. Partial or staged funding of construction or rehabilitation loans
are expressly prohibited in transactions subject to Business and Profession Code Section 10238(h)(4), the
“multi-lender” statutory “quasi-private placement” exemption from qualification under the Corporate Securities
Law of 1968.

Wrap-Around Deeds of Trust or Mortgages (Over-Riding or All-Inclusive Trust Deeds or AITDs)

A word of caution is required before discussing this type of financing. Prior to using this security instrument, it
is essential that an analysis of the existing financing (typically a conventional loan) be undertaken to learn
whether the deed of trust or mortgage includes due-on-sale or due on further encumbrance clauses. Most loans
made by depository institutions or licensed lenders, including FHA insured or VA indemnified loans, contain in
their loan documents (promissory notes and security instruments), acceleration provisions that either include or
substantively describe due-on-sale or due on encumbrance clauses/provisions. These clauses preclude the
transfer of the security property to a new owner or the further encumbrance of the property by the owner
holding title without the existing lender’s prior approval.

Practitioners should be aware that the full implementation of the Federal Deposit Institutions Act of 1982
(Garn-St. Germain Act) has resulted in federal preemption of state law that restricted the right of lenders to
accelerate the maturity date of loans secured by real property (regardless of the maturity date set forth in the
loan documents) in the event the borrower either transferred the title to or further encumbered the security
property, as defined. This includes AITDs and real property sales contracts.

When the security property is an owner-occupied residence, certain exemptions from the exercise of this right
were included in the Garn-St. Germain Act. This preemption has limited the ability to lawfully use AITDs and
real property sales contracts. Implementing an AITD and a real property sales contract in violation of a due-on-
sale or due on further encumbrance clause may result in an allegation of fraud upon the existing creditor/lender
and/or professional negligence, including a breach of fiduciary duty. Accordingly, the advice of knowledgeable
legal counsel is recommended to ensure the transaction is being conducted lawfully and each party is receiving
what they intended and for which they bargained.

During periods of credit shortages and/or “tight-money,” it is may be impossible for some potential buyers to
qualify for conventional loans and for other borrowers to refinance existing loans secured by commercial real
estate (as defined) held for the production of income or for investment. Often the purpose for refinancing is to
raise additional capital or to improve the rate and terms of the financing. The opportunity to refinance may be
severely limited. For example, the existing loan may be “locked” precluding prepayment for a prescribed
period. Further, the existing loan may not be locked but may include a substantial prepayment penalty or
include a yield maintenance agreement that imposes substantial costs for the owner of the property at the time
of refinance or prepayment of the existing loan. In addition, loan-to-value ratios established by depository
institutions and licensed lenders may limit the ability to refinance. In such circumstances (among others), these
owners and their agents may elect to use an AITD as a means of further encumbering or selling the security
property.

An AITD, like a junior deed of trust or mortgage, should not disturb the existing loan, yet the debtor is able to
borrow an additional amount against the security property to obtain cash or to permit the sale of the property.
After the AITD has been arranged, the new lender typically assumes payment of the existing loan while
funding a new loan in an increased principal amount at a higher interest rate. The increased principal amount of
the AITD includes the unpaid principal balance of the existing loan plus the loan funds advanced (or the AITD
reflects the amount of the purchase price being “carried back” by the owner as the seller of the security
property).

The borrower makes payment on the AITD to the new creditor/lender that in turn makes payment to the holder
of the existing loan, which remains the senior encumbrance against the security property. Although the AITD
“wraps around” the existing loan, it is in effect a junior encumbrance that secures the repayment of the
debt/loan representing the difference between the unpaid balance of the existing loan and the principal loan
amount secured by the AITD. This method has also been used to finance a sale of real estate where the
purchaser has only a small down payment. In the case of a seller “carry back”, the AITD evidences the time
differential payment of the purchase price. The buyer/borrower executes an AITD to the seller who will collect
a larger loan payment from buyer/borrower, and the seller will continue to make payments on the existing loan.
The interest rate spread between the amount required under the AITD and the nominal rate on the underlying
promissory note evidencing the debt/loan results in an expected profit for the creditor/lender.

Pledged Savings Account Deeds of Trust or Mortgages

Under the pledged savings account loan, also known as the flexible loan insurance program mortgage, or FLIP,
part of the borrower’s down payment is used to fund a pledged savings account. The savings account is
maintained as cash collateral for the creditor/lender and a source of supplementary payments for the borrower
during the first (usually two) years of the loan. Interest on the account is typically paid to the borrower.

Pledged savings account loans are used by depository institutions as additional collateral to reduce otherwise
required equity or down payment for residential as well as commercial loans. Pledged savings accounts may
also appear in construction loans made by depository institutions as additional collateral to cover performance
of obligations that may include the payment of interest during construction.

EFFECTS OF SECURED TRANSACTIONS

As previously indicated in this Chapter, the terms “debtor”, “borrower”, “trustor”, and “mortgagor” may be
used together, separately, or in some combination. Unless specifically noted, they are interchangeable terms
describing the person or entity who has borrowed money, the repayment of which is secured by real property.
Further, the terms “creditor”, “lender”, “beneficiary”, or “mortgagee” may be used together, separately, or in
some combination. Unless specifically noted, they are interchangeable and are intended to describe the person
or entity that has loaned money, the repayment of which is secured by real property.

Having subjected property to the lien of a deed of trust or mortgage, the debtor/borrower/trustor/mortgagor
should be aware of some of the effects of these security instruments. Among the more important effects are:

1. Assignment of the debt by the creditor;

2. Transfer of the property by the borrower;

3. Acceleration due to breaches and default (including due-on-sale and due on further encumbrance);

4. Offset/Estoppels Statements and Certificates;

5. Lien priorities; and,

6. Purchase Money vs. Non-Purchase Money Deeds of Trust or Mortgages.

Assignment of Debt by the Creditor

The assignment of a debt secured by a mortgage carries with it the security. An attempted assignment of the
mortgage without the note transfers nothing to the assignee, but a transfer of the note without the mortgage
gives the assignee the right to the security (Civil Code Section 2936).

An assignment of a deed of trust or mortgage may be recorded and recordation gives constructive notice to all
persons (Civil Code Section 2934). After the promissory note has been transferred (assigned or endorsed) and
the assignment of the deed of trust or mortgage has been recorded, the debtor is not protected if he continues
making payment to the original lender/creditor. Failing to record the assignment would prevent constructive
notice being transmitted to all persons regardless of notice of transfer of loan servicing. Recent amendments to
federal and state law require notice to the debtor/trustor/mortgagor of any transfer of servicing agent (Civil
Code Section 2937 and 24 CFR Section 3500.21).

Business and Professions Code Sections 10233.2, 10234, 10234.5 and 10 CCR, Chapter 6, Section 2841.5
require every licensee negotiating a loan secured by a deed of trust or mortgage, or where the promissory note
or interests therein are being sold or assigned, to cause the deed of trust or mortgage or the assignment thereof
to be recorded. When delivering these instruments to the lender or assignee (including private
investors/lenders), the licensee is to in writing recommend that the deed of trust or mortgage or the assignment
thereof be immediately recorded, if the licensee has not already recorded such instruments on behalf of the
lender or assignee thereof.

Should the licensee be acting as an MLB and be servicing the loan secured by real property, the MLB may
retain the original promissory note and deed of trust or mortgage but perfect delivery to the lender and/or the
assignee or assignees thereof by recording the required instruments in the office of the County recorder in
which the security property is located. A conformed copy of the promissory note and deed of trust or mortgage
should be delivered by the MLB to the lender (or to each of the private investors/lenders). The ability of the
MLB acting as a servicing agent under a written agreement with the lender (including private investors/lenders)
or assignees thereof to retain the promissory notes and security instruments is authorized in applicable law
(Business and Professions Code Sections 10233.2, 10234, and 10234.5).

Transfer of the Security Property by Borrowers

When encumbered real property is transferred, the buyer either obtains new financing (and the existing loan is
paid off), buys the property “subject to” the existing loan, or “assumes” the loan. Buyers may not take title to
the security property “subject to” and existing loan when the deed of trust or mortgage securing the loan
includes a due-on-sale clause. Taking title “subject to” the existing loan may result in no personal liability to
the buyer; however, the advice of knowledgeable legal counsel should be obtained prior to proceeding with
such transactions.

Despite the transfer to the buyer of the security property, the seller will (except in purchase money mortgage
fact situations) remain personally liable to the lender for the loan repayment. Even in purchase money fact
situations, the seller may remain liable to the lender to the extent of collateral actions that may be pursued by
the lender, including actions for fraud. Further, the credit worthiness and financial standing of the seller
remains at issue if the buyer fails to timely perform each of the obligations set forth in the promissory note or
mortgage. The purchase money exception limits the availability of pursuing a money claim that results from a
deficiency judgment. The lender would be required to look only to a sale of the security property to recover the
amount of the debt/loan.

If the loan terms do not include a due-on-sale clause and as long as the buyer makes the loan payments in a
timely manner and holds, keeps, and performs each and every obligation set forth in the promissory note and
deed of trust or mortgage (e.g., cultivates, irrigates, fumigates, and otherwise keeps and maintains the security
property in good and tenable condition), no problem should occur for the original maker of the loan and
trustor/mortgagor. If the buyer defaults and the loan is not a purchase money loan, the lender can look to the
seller/original maker for payment, even years after the transfer was made. The seller may also suffer a loss of

credit status due to the purchaser’s failure to timely make the payments or perform each of the obligations
required of the maker.

Under a loan assumption, the buyer becomes the principal debtor and the seller either may remain liable to the
lender as a continuing maker, or may become liable to the lender as surety for any deficiency resulting after the
sale of the property. The safest arrangement for the seller is to ask the lender for a substitution of liability,
releasing the seller of all liability in consideration for assumption of the debt/loan and of each and every
obligation thereof by the buyer. In such circumstances, the buyer must qualify as though they were the maker of
the loan.

Acceleration Due to Breaches and Defaults

Deeds of trust and mortgages generally contain clauses giving the lender the right to declare the full amount of
debt/loan due and payable upon defined breaches and default, including the failure to timely pay debt service,
property taxes when due, or the happening of a certain event such as failure to maintain the security property or
to proceed with an unauthorized transfer or further encumbrance of the security property, i.e., due–on-sale and
due on further encumbrance clauses.

“Due-on-sale” and due on further encumbrance clauses, are forms of an acceleration clause. These clauses give
the lender the right or option to insist the loan be paid off or renegotiated when the title to the security property
is transferred or further encumbered. When loan funds are available at acceptable interest rates, buyers
ordinarily obtain new financing and the seller pays off the existing loan as part of the terms of the purchase and
sale transaction. In times of scarce money, escalating interest rates, enhanced loan underwriting standards, or
declining property values; buyers may prefer (as previously discussed) to assume or take “subject to” the
existing mortgage. Lenders generally do not want to be “locked” into long-term, lower-than-market-rate loans.
Often, lenders will argue that they must not only watch the value of their existing loans decline, but also are
forced to pay higher interest rates to depositors who otherwise would withdraw funds and seek higher returns in
other investments.

The issue of a lender’s right to automatically enforce a “due-on-sale” provision upon transfer of the mortgaged
property has been resolved in favor of the lender, as a result of the 1982 United States Supreme Court decision,
Fidelity Federal Savings and Loan Association v. de la Cuesta (1982 458 US 141), and the 1982 federal
legislation to which this Chapter has previously referred, the Federal Deposit Institutions Act of 1982 (also
known as the Garn- St. Germain Act). These amendments to the law provide for specified exemptions when the
security property is a single family owner-occupied residence. Of course, loan documents containing no due-
on-sale clause are not affected by the operative changes in applicable law.

Brief Overview of Due-On-Sale and Due On Further Encumbrance Clauses

The California Supreme Court ruled in Wellenkamp v. Bank of America (1978) 21 Cal. 3d 943, that a state-
chartered institutional lender could not automatically enforce a due-on-sale provision in its loan documents to
accelerate payment of a loan when residential property securing the loan is sold by the borrower. Under this
ruling an institutional lender had to demonstrate that enforcement was necessary to protect against impairment
of its security or the risk of default (character and credit considerations).

In its opinion, the court reviewed prior decisions, particularly La Sala v. American Savings and Loan
Association (1971) 5 Cal. 3d 864, and Tucker v. Lassen Savings and Loan Association (1974) 12 Cal. 3d 629.
In La Sala, further encumbering of real property through a second loan in the form of a junior deed of trust or
mortgage was found to be insufficient justification for acceleration of the maturity date. In Tucker, sale of the
property under a real property sales contract (installment contract) was held to be insufficient justification.

A flurry of California court cases followed Wellenkamp addressing issues it left unresolved, such as the
applicability of Wellenkamp to private lenders, commercial as well as residential property, and federal
regulations preempting state laws on due-on-sale and due on further encumbrance provisions. The Wellenkamp
rule was found applicable to California real property and real property secured transactions.

However, federally-chartered banks and savings and loan associations successfully asserted that the validity
and automatic exercise of due-on-sale or due on further encumbrance provisions is applicable to them
notwithstanding state law to the contrary. As previously mentioned, this contention was upheld by the United
States Supreme Court in Fidelity Federal Savings and Loan Association v. De La Cuesta (1982) 458 US 141.

On October 15, 1982, the Federal Depository Institutions Act of 1982 (the Garn-St. Germain Act) became
effective. As mentioned previously with certain limited exceptions, the law makes due-on-sale or due on further
encumbrance provisions in real property secured loans automatically enforceable by all types of lenders,
including non-institutional private investors/lenders.

These amendments to federal law preempted state laws and judicial decisions which restrict enforceability of
due-on-sale or due on further encumbrance provisions in promissory notes and security instruments. In
addition, FHA and VA have since implemented rules and regulations restricting the transferability of the loans
they insure or indemnify.

Enforceability

The following concerns the automatic enforceability of due-on-sale and due on further encumbrance provisions
in loan instruments:

1. Federally-chartered savings and loan associations may automatically enforce due-on-sale and due on
further encumbrance clauses in promissory notes and deeds of trust that they originated while federally
chartered;

2. With certain exceptions of limited application, all loans originated after October 15, 1982 may be
accelerated, upon transfer of the property securing the loan, if the security instrument includes a due-
on-sale clause; and,

3. As of October 15, 1985 with very few exceptions, loan transfers or further encumbrances of the
security property without the consent of the existing lender are no longer possible in California.

Other Exceptions

Where the security is the owner-occupied residence of the borrower, notable exceptions to automatic
enforceability of due-on-sale or due on further encumbrance clauses enumerated under the law include, among
others, the following:

1. Creation of a junior deed of trust or mortgage (liens) on the security property which are not related to a
transfer of the rights of occupancy;

2. Transfer of the property by one joint tenant to another joint tenant;

3. Transfer to a relative or descendent of a borrower resulting from the death of the borrower; and,

4. Transfer into a revocable inter-vivos trust of which the borrower is the settlor and beneficiary, if it
does not relate to a transfer of rights of occupancy of the security property.

Special Provision

As previously discussed in this Chapter, a clause in any deed of trust or mortgage that provides for acceleration
of the due/maturity date upon sale, conveyance, alienation, lease, succession, assignment or other transfer of
property (containing four or fewer residential units) subject to a deed of trust or mortgage is invalid unless the
clause is printed, in its entirety, in both the security instrument and the promissory note or other document
evidencing the debt/loan and the obligations (Civil Code Section 2924.5).

Caution Regarding Due-On-Sale and Due On Further Encumbrance

Proposed loan transfers, whether as the result of assumptions or taking title “subject-to”, must be very carefully
considered in light of the Supreme Court ruling allowing the nation’s federal lenders to automatically enforce
due-on-sale provisions in their loans and the effects of the Garn-St. Germain or Federal Depository Institutions
Act of 1982. This federal law limited, and in California by 1985 eliminated, except in certain fact situations
(regarding single- family owneroccupied security properties), automatic transfers of loans or further
encumbrances of the security property secured by real property with due-on-sale or due on further encumbrance
clauses within the security instruments. Covert transfers, no matter how structured, are not an acceptable

practice and are to be avoided by real estate licensees. Again, the advice of legal counsel is recommended
before proceeding with transfers of the security property while leaving an existing loan in place.

Offset/Estoppel Statements and Certificates

In transactions involving an assignment of an existing mortgage or deed of trust or mortgage to an investor, an
offset statement is customarily obtained for the benefit of the investor. The information included in the offset
statement (often referred to an estoppel certificate) is typically the unpaid balance of the promissory note, the
date to which interest is paid, the interest rate, the payment amount and due date, the maturity date of loan, the
existence of due-on-sale or due on further encumbrance clauses, as well as other forms of acceleration clauses
that are of interest to an assignee or endorsee, and whether the property owner has any claims which do not
appear in the promissory notes and security instruments being purchased by the investor. The offset/estoppel
statement/certificate is in addition to the beneficiary statement of current loan status from the lender. Together
the offset/estoppel and beneficiary statements/certificates confirm to the person/investor purchasing the existing
loan the nature of the obligations of the property owner (trustor/mortgagor) that will inure to the benefit of the
new holder of the deed of trust or mortgage (assignee).

Lien Priorities

Ordinarily, different liens or encumbrances upon the same security property have priority according to the time
of their recordation. Notice is an important element in the determination of priority. Notice may be actual or it
may be constructive from recordation, thus giving notice of the lien or encumbrance to subsequent buyers and
encumbrancers for value (including junior lien holders such as deeds of trust or mortgages). Actual notice will
be imparted through an investigation of the occupancy of the security property, including other manners of
receiving specific notice of the liens or encumbrances in question. For example, an occupant of an intended
security property under a lease with an option right, pursuant to a land contract of sale, or in accordance with an
executory purchase and sale agreement, would impart actual notice of the equitable interest in the title that
arises from any one of the foregoing documents/instruments and the equitable interest would be prior to any
subsequently recorded deed of trust or mortgage.

County and municipal property taxes and authorized assessments are “super liens” and retain priority over
deeds of trust and mortgages no matter when recorded. Where there are special assessments affecting the
security property, such assessments impart notice to all persons when recorded. These assessments, whether
bonds or otherwise, are subordinate to all fixed assessment liens previously imposed on the property. These
special assessments would retain priority over all fixed assessment liens that are subsequently recorded against
the same property.

Generally, special assessments are coequal to and independent of the lien for general property taxes, except as
otherwise provided for by applicable law. Special and ad valorem assessments have the same priority as
property taxes, including each installment due as required by the terms of the foregoing. They each retain super
lien status over deeds of trusts or mortgages and other liens and encumbrances no matter when recorded
(Government Code Section 53930 et seq.)

Purchase Money vs. Non-Purchase Money Deeds of Trust or Mortgages

Purchase money mortgages are described in California law to include deeds of trust or mortgages. Two distinct
definitions of purchase money debt exist under applicable law. One definition applies to the issue of priority
over all other liens created against and brought with the buyer to the property, subject to the operation of the
recording laws when the deed of trust or mortgage is given for the price of the security real property. In such
event, the liens created against the purchaser are junior or subordinate to the purchase money deed of trust or
mortgage. This rule protects even third persons who furnished money, but only when it is loaned for the express
purpose of acquiring the security property (Civil Code Section 2898).

For purposes of establishing whether a deficiency judgment may be obtained against the debtor/borrower, the
deed of trust or mortgage must be given to the seller/vendor to secure the payment of the balance of the
purchase price of the security real property. When given to a third party lender to secure repayment of a
debt/loan or obligation, the proceeds of the debt/loan must have been used to acquire the security property and
the borrower must intend to occupy entirely or in part as his/her residence. The security property must consist
of 1 to 4 dwelling units. Third party financing of the purchase of 1 to 4 dwelling units for the purpose of
investment or the production of income does not qualify the deed of trust or mortgage as purchase money.

When the loan is secured by a purchase money deed of trust or mortgage, as defined, and the borrower fails to
pay the debt/loan according to its terms, the lender/creditor/beneficiary can generally look only to the security
property or to the proceeds of sale from the property for payment.

This limitation applies whether the security property is sold through judicial or a non-judicial foreclosure. The
inability to obtain a deficiency judgment may not preclude the lender/creditor/beneficiary from proceeding
against the borrower under a collateral action theory, including an action for fraud (Code of Civil Procedure
Sections 580b, 580d, and 726 et seq.; and Financial Code Section 7460).

Under current applicable law, refinancing the owner-occupied security property alters the character of the
security instrument from a purchase money to a non-purchase money deed of trust or mortgage. Further, if the
security property for the loan is other than 1 to 4 dwelling units (e.g., commercial, income producing property,
or land) and the lender is a third party (the extender of credit was other than the seller/vendor), the deed of trust
or mortgage is characterized as a non-purchase money security instrument.

With a non-purchase money deed of trust or mortgage, the lender/creditor/beneficiary may generally proceed
through the security property and obtain a money judgment for the difference between the amount received at a
judicial foreclosure sale and the total amount of debt/loan owing (including authorized fees, costs, and
expenses). The court may order a fair value hearing to ensure the property is sold at the foreclosure sale in an
amount consistent with its appraised value or as expressly ordered by the court (Code of Civil Procedure
Section 580a).

FEDERAL AND STATE COMPLIANCE AND REPORTING REQUIRMENTS

Equal Credit Opportunity Act (ECOA)

Authority and scope

The authority and scope of ECOA is set forth in the regulation issued by the Board of Governors of the Federal
Reserve System pursuant to title VII (Equal Credit Opportunity Act) of the Consumer Credit Protection Act, as
amended (15 USC Section 1601 et seq.). ECOA applies to all persons who are creditors, as defined in 12 CFR
Section 202.2(l) of the applicable regulations. Certain exemptions are operative; however, they generally do not
extend to creditors/lenders of residential mortgage loans. Information collection requirements imposed upon
creditors/lenders contained in the foregoing regulation have been approved by the Office of Management and
Budget under the provisions of 44 USC Section 3501 et seq. and have been assigned OMB No. 7100-0201.

Purpose

The purpose of ECOA is to promote the availability of credit to all creditworthy applicants without regard to
race, color, religion, national origin, sex, marital status, or age (provided the applicant has the capacity to
contract); whether all or part of the applicant's income is derived from a public assistance program; or that the
applicant has in good faith exercised any right under the Consumer Credit Protection Act. ECOA prohibits
creditors/lenders practices that discriminate on the basis of any of these factors. The use of the term consumer
may not necessarily exclude certain commercial loan applications from being subject to ECOA.

This law requires creditors/lenders to notify applicants of actions taken on their applications (including credit
denials); to report credit histories in the names of both spouses on an account; to retain records of credit
applications; and to collect information about the applicant's race and other personal characteristics in
applications for dwelling-related loans (generally, residential mortgage loans occupied as the primary residence
of the consumer/borrower); and to provide applicants with copies of appraisal reports prepared and used in
connection with credit transactions.

Federal and State Licensed and Chartered Creditors/Lenders are Subject to ECOA in Mortgage
Transactions

Among the requirements imposed by ECOA when an action is taken by such creditors/lenders after an
application has been received from a consumer/borrower is to provide a prescribed notice informing the
applicant of the reasons for the denial or altering of the credit terms requested. The notice is to be issued within
30 days of the decision. The reasons may include the credit worthiness and financial standing of the
consumer/borrower, the value of the security property, the incompleteness or lack of necessary information
required to complete the loan application, or that the file remains open and no credit decision has been made,
among others. The specific notice requirements are included in Regulation B of ECOA.

Regulation B also addresses the issue of spousal and multiple signatures on the loan documentation. For
example, requiring a signature simply because the individual is married to the applicant, amounts to substantive
discrimination when the transaction is subject to ECOA. The Official Staff Commentary contains the advice
that submission of a joint financial statement is meant to presume that the application is for joint credit. The
FRB strongly recommends that a creditor/lender clearly document the use of additional signatures. It is also
recommended that mortgage loan originators (MLOs) whether employed by the creditor/lender or performing
as an independent agent and fiduciary of the consumer/borrower, keep log sheets of the substance of
conversations with the applicant(s) about the loan application. Creditors/lenders are advised not to presume the
consumer/borrower will transfer title to the security property as a means to escape the reach of collectors.

Another clarification has been included within the revised ECOA regulations requiring creditors/lenders when
considering separately the income of each applicant or combining the income of both applicants to apply the
same methods for all applications, regardless of the relationship of the applicants to each other. Record
retention is required for a period of 25 months from the date of initial solicitation for extensions of credit.
Records to be kept include the solicitation criteria and any lists maintained in connection therewith. Further,
records of any complaints received from consumers/borrower must also be maintained by creditors/lenders.

Subsequent to the establishment of a secondary market for alternative mortgages or non-traditional loan
products, consumer advocates have raised questions about when an applicant is in fact an applicant and have
asked the FRB to take action to protect consumers prior to the submission of a loan application. The question is
whether ECOA and the regulations thereof protect consumers who have not yet applied for credit. In response,
the FRB has added requirements for record keeping to allow examiners to evaluate the design and demographic
impact of solicitations, including the information used to select targets for such solicitations, of any consumer
complaints received, and of any evidence of unequal treatment.

The definition of creditor has been clarified to include, when multiple parties are involved in a single credit
application, anyone involved in making the credit decision or in setting the terms of the credit. Such persons are
creditors for the purposes of ECOA. This means that an MLB/MLO who negotiated the terms with a
consumer/borrower is an ECOA creditor by virtue of having set terms of credit.

Third Parties Subject to the Requirements for Creditors under ECOA

Under Regulation B, the term “creditor” includes any person “who in the ordinary course of business” regularly
delivers loan applications to creditors/lenders, or selects or offers to select creditors/lenders to whom requests
for credit may be made.” This definition does not apply to the term “creditor” pursuant to TILA which
specifically excludes third parties who are arrangers of extensions of credit. Official Staff Commentary 2(1)-2
provides guidance to mortgage brokers (MLBs/MLOs), i.e., “For certain purposes, the term ‘creditor’ includes
persons such as real estate brokers who do not participate in credit decisions but who regularly refer applicants
to creditors or select or offer to select creditors to whom credit requests can be made. These persons must
comply with Section 202.4, the general rule prohibiting discrimination, and with Section 202.5(a) on
discouraging applications.” MLBs/MLOs are subject to the general prohibitions against discrimination in

mortgage loan transactions and are not to engage in any unlawful conduct that would discourage any persons
applying for a mortgage loan (Business and Professions Code Section 10177(l)(1) and (2), among others).

Adverse Action Issues. The Official Staff Commentary to Regulation B also provides guidance regarding the
giving of notices of adverse action when the loan application of a consumer/borrower is delivered by third
parties such as MLBs/MLOs to creditors/lenders. When loan applications are submitted by MLBs/MLOs on
behalf of consumers/borrowers to more than one creditor/lender and the loan transaction proceeds with one of
the creditors/lenders, the remaining creditors/lenders who received the loan applications are under no duty to
provide a notice of adverse action to the consumer/borrower.

A notice of adverse action under ECOA (if applicable) would be issued by the creditor/lender whose proposed
loan transaction was initially accepted by the consumer/borrower. Should the consumer/borrower elect not to
proceed with any of the creditors/lenders receiving concurrent loan applications, each creditor/lender who took
an adverse action are well advised although may not be required to either provide the consumer/borrower
directly or through the MLB/MLO (who accepted and delivered the loan application) with the required notice
of adverse action.

A notice of adverse action given by an MLB/MLO must disclose the identity of each creditor/lender on whose
behalf the notice is being given. The FRB requires notices of adverse action given by third parties to distinguish
the reasons for the decline of credit or altering of the credit terms by each creditor/lender to which the specific
reasons apply. The Official Staff Commentary provides guidance on how notices of adverse action are to be
given by MLBs/MLOs as third parties.

Guidance to creditors/lenders is provided regarding the content of such notices when the loan application is
delivered by a third party. Applications submitted through a third party are subject to the following:

1. Third-party notice – delivery by creditor. The notification of adverse action may be given by
one of the creditors to whom an application was submitted through the third-party.…

2. Third-party notice – enforcement agency. If a single adverse action notice is being provided
to an applicant on behalf of several creditors and they are under the jurisdiction of different federal
enforcement agencies, the notice need not name each agency; disclosure of any one of them will
suffice.

3. Third-party notice – liability. When a notice is to be provided through a third party, a creditor
is not liable for an act or omission of the third party that constitutes a violation of the regulation if the
creditor accurately and in a timely manner provided the third party with the information necessary for
the notification and maintains reasonable procedures adopted to prevent such violations.”

The foregoing guidance is published in Comment 9(g) to Section 202.9 of Regulation B. When delegation to an
MLB/MLO as a third party occurs for the purpose of giving the notice of adverse action on behalf of the
creditor/lender, the broker must be specifically authorized by the creditor/lender. In such circumstances, the
creditor/lender (particularly when applying California law) may well be liable for compliance violations
resulting from any deficiencies in the adverse notice or for any other violations of Regulation B engaged in by
the authorized MLB/MLO. The issue presented is whether the MLB/MLO when authorized becomes the agent
of the creditor/lender for the purpose of issuing the notice of adverse action.

ECOA and State Law Requirements for Real Estate Brokers (MLBs/MLOs)

Real estate brokers (MLBs/MLOs) may have primary responsibility for providing the notice of adverse action.
The MLB/MLO may be authorized to engage in certain legitimate prescreening functions, relying on
qualification standards supplied or required by the creditor/lender. Should the MLB/MLO make the
determination the loan application is not to be delivered to the creditor/lender as the consumer/borrower does
not meet the qualification standards imposed; the broker has taken an adverse action on the application and
would be responsible for providing the notice of adverse action.

Pursuant to California law, MLBs/MLOs must provide a notice to the consumer/borrower of any adverse action
and whether the adverse action is based in whole or part on any information contained in the consumer credit
report received and used by such licensees (regardless of the role of these brokers in the loan transaction). The
notice of adverse action required under California law is based upon the use of a consumer credit report and not

on the predicate of receiving a loan application. However, it is generally accepted that compliance with the
notice requirements under Regulation B of ECOA will comply with California law provided MLBs/MLOs issue
the notice of adverse action based upon the use of a consumer credit report rather than on the receipt of the loan
application (Civil Code Section 1785.20).

Home Mortgage Disclosure Act (HMDA)

Background and Application

The Home Mortgage Disclosure Act (HMDA) was adopted by Congress in 1975 (12 USC Section 2801 et
seq.). HMDA was authorized and implemented by the FRB and became effective in 1976. It is commonly
known as Regulation C, which was significantly amended in 2004. HMDA and the implementing Regulation C
applies to federally insured banks, savings and loans, savings banks, credit unions as well as “for profit”
mortgage lending institutions (licensed lenders and non-banks other than depository institutions). These
mortgage lending institutions are subject to reporting under HMDA when home purchase loans originated equal
or exceed 10% of the lending institution’s loan origination volume, or if the purchase money loans originated
equaled at least $25 million, or if the lending institution had either $10 million in assets or originated at least
100 home purchase loans, including refinances of home purchase loans.

Collection and Disclosure of Information

HMDA requires that creditors/lenders (as defined above) collect and publically disclose information about
housing related loans, including characteristics about the applicants and consumers/borrowers. The original
purpose of HMDA was to provide the citizens/residents and public officials of the United States with sufficient
information to determine whether such creditors/lenders are serving the housing credit needs of the
communities and neighborhoods in which they are located, to assist public officials and private investors in
distributing funds in areas that may need investment, and to assist in identifying possible discriminatory lending
patterns and enforcing fair lending laws. These obligations are also included in the Community Reinvestment
Act (CRA).

Covered Loans

Covered loans include home purchase loans, home improvement loans and refinances secured by a dwelling.
“Dwelling means any residential structure, whether or not attached to real property. It includes vacation or
second homes and rental properties; multifamily as well as 1 to 4 family structures; individual condominium
and cooperative units; and manufactured and mobile homes. It excludes recreational vehicles such as boats and
campers, and transitory residences such as hotels, hospitals, and college dormitories” (FFIEC publication, “A
Guide to HMDA Reporting, Getting It Right!”).

Reporting Requirements

HMDA reporting is limited to property on which a dwelling is located and does not apply to loans on
unimproved land, construction only loans and other temporary financing, purchased loans or interests in
mortgage backed securities, servicing rights, loans acquired as part of a merger or acquisition; and the
acquisition of a partial interest in a home purchase, home improvement, or a refinancing loan; prequalification
requests, or “assumptions” that do not involve a written agreement between the creditor/lender and the new
borrower (generally described as a “subject to” transfer). As aforementioned, the federal agency, FFIEC, has
published “A Guide to HMDA Reporting, Getting It Right!” which is available on the FFIEC’s website
(http://www.ffiec.gov/hmda/guide.htm). This publication describes in detail the scope, purpose and how to
properly report as required by HMDA.

The Holden Act

Background and Purpose

Following the enactment of HMDA under federal law, California adopted “The Holden Act” to impose similar
requirements upon creditors/lenders that either are state licensed or chartered depository institutions or licensed
under California law (Health and Safety Code Section 35810 et seq.). To the extent that this state law includes
subject matter addressed under HMDA or under the Federal Fair Housing Act (42 USC Section 3601 et seq.),
the federal law is intended to apply and would prevail, unless the state law is more restrictive.

The purpose of the Holden Act is to ensure, among other objectives, no financial depository institution
discriminates in the availability of financial assistance for the purpose of purchasing, rehabilitating, improving,
or refinancing housing accommodations (whether in whole or in part) due to the conditions, characteristics, or

trends in the neighborhood or geographic area surrounding the housing accommodations. An exemption is
provided when the financial depository institution can demonstrate the consideration of the foregoing
conditions in a particular case is required to avoid an unsafe and unsound business practice (Health and Safety
Code Section 35810(a)).

Discrimination Standards

The foregoing discriminatory standards are also applied by this law when considering Government Code
Sections 12926, 12926.1, 12955, and 12955.2, including with reference to familial status (the relationships that
may exist among the occupants, as well as the issue of age). However, California law recognizes the limited
exemption from the familial status standard applicable to older persons (senior citizens), as defined in
Government Code Section 12955.9. Further, Civil Code Sections are controlling relating to certain housing for
senior citizens when applying the familial status issue (Civil Code Sections 51.2, 51.3, 51.4, 51.10, 51.11,
799.5, and 1360). The housing exemptions for senior citizens from otherwise applying the non-discriminatory
familial status issue includes housing accommodations specifically designed for use by older persons (whether
as rental housing or as housing within common interest developments (CIDs)). The statutes regarding familial
status are intended to ensure no discrimination occurs regardless of the relationships or age that may exist
among the occupants of the housing accommodations (Health and Safety Code Section 35811).

The Holden Act also precludes discrimination by depository institutions and licensed lenders (creditors/lenders)
regarding the racial, ethnic, religious, or national origin composition of a neighborhood or a geographic area
surrounding the housing accommodations (or whether such composition is undergoing change or is expected to
undergo change). Further, in appraising of housing accommodations for the purpose of providing financial
assistance, depository institutions and licensed lenders are not to use practices that are inconsistent with the
prohibitions regarding discrimination concerning the composition or the expected future composition of a
neighborhood or geographic area. However, the aforementioned creditors/lenders are not precluded when
directing the appraisal of intended security properties from considering conditions of the housing
accommodations that constitute a threat to the health or safety of the occupant or that which may apply in the
appraisal process when estimating the fair market value of such properties (Health and Safety Code Sections
35812 and 35813).

Compliance and Reporting Obligations

The Secretary or the Secretary’s designee of Business Transportation and Housing Agency (BT & H) is
charged with the responsibility of monitoring and investigating the lending patterns and practices of the
depository institutions and licensed lenders to ensure compliance with the provisions of this law. Annual
reports to the California Legislature by the Secretary are required on the activities of supervising regulatory
agencies and departments in ensuring compliance and reporting from all persons/entities that are in the business
of originating residential mortgage loans in California, including (among others) insurers, mortgage bankers,
investment bankers, credit unions, and MLBs/MLOs that are engaged in the making of such mortgage loans.

These regulations are to include reports as required and deemed necessary by the Secretary to the appropriate
supervising regulatory agencies or departments. The reports are intended to be substantially consistent with the
reporting standards established under HMDA. The Secretary’s regulations are intended to also address the
reporting requirements imposed upon those creditors/lenders whose assets or residential mortgage loan volumes
are insufficient to meet the federal reporting requirements (Health and Safety Code Sections 35815 and 35816).

The Fair and Accurate Transaction Act (FACT) – “The Red Flag Rules”

Background and Application

The FACT Act was passed in 2003 and is an extension of the Gramm-Leach-Bliley Act (GLB Act). The
citation for the FACT Act is Public Law 108–159, December 4, 2003. Sections of the FACT Act have become
effective over a period of time and regulations are promulgated by different federal agencies for distinguishable
purposes. The last two Sections of the FACT Act are known as the “Red Flag Rules” and the “Address
Discrepancy Policy”. These Sections became effective August 1, 2009.

Regulations

The Federal Trade Commission (FTC) and the National Credit Union Association (NCUA) issued regulations
to implement the “Red Flag Rules” and the “Address Discrepancy Policy”, which regulations affect depository
institutions and “creditors” (as defined) with “covered accounts” (15 USC Sections 1681a(q)(3)(4), 1681c(h),

1681m(e), and 1691a(e), and 16 CFR Part 681). Included within the definitions of the foregoing are financial
depository institutions, i.e., state or federally licensed or chartered banks, savings associations, savings banks,
mutual savings banks, and credit unions; and any other persons/entities that hold a “transaction account”
belonging to a customer or client/principal depending upon the fact situation.

“Creditor” Defined

For the purposes of the aforementioned statutes and regulations, the term “creditor” is any person/entity that
regularly extends, renews, or continues credit; any person/entity that regularly arranges for the extension,
renewal, or continuation of credit; or any assignee of an original “creditor” who is involved in the decision to
extend, renew, or continue credit. “Creditors” under this law (who are other than depository institutions)
include mortgage bankers, finance companies, automobile dealers, mortgage brokers (MLBs/MLOs), real estate
brokers involved in defined activities in relationship to property sales, utility companies, telecommunication
companies, and non-profit entities that defer payment for goods and services (among others).

While depository institutions are primarily regulated by the FRB and other related federal banking regulatory
agencies (including the NCUA), most “creditors” come under the jurisdiction of the FTC. This would include,
as aforementioned, MLBs/MLOs. As defined for application of the “Red Flag Rules” under the FACT Act, the
term “creditor” is not intended to apply to the definition of “creditor” (often referred to as creditor/lender) for
the purposes of extending credit or making loans to consumers/borrowers pursuant to TILA. The term creditor
for this purpose is the lender in the loan transaction required to complete and deliver the disclosures and notices
of rights and to otherwise comply with TILA and Regulation Z (15 USC 1601, Subsection 103(f), and 12 CFR
Section 226.2(a)(17)).

Covered Accounts

Under the FACT Act and related federal law and implementing regulations, a “covered account” is an account
used primarily for personal, family, or household purposes, and which involves multiple payments or
transactions. “Covered accounts” include credit card accounts, mortgage loans, automobile loans, margin
accounts, cell phone accounts, utility accounts, checking accounts, and savings accounts, among others. The
term “covered account” is also intended to apply to an account for which there is a foreseeable risk of identity
theft, e.g., such as small businesses or sole proprietor accounts.

Transaction Accounts

The term “transaction account” is defined pursuant to the aforesaid regulations to mean a deposit or other
account from which the owner makes payments or transfers (i.e., checking accounts, negotiable order of
withdrawal accounts, savings deposits subject to automatic transfers, and shared draft accounts). This term
would also apply to accounts held in behalf of clients/beneficiaries such as escrows or impounds for the future
payment of property taxes and insurance premiums; and trust accounts for advance fees, earnest money
deposits, loan servicing, or funds from property management activities, among others.

Loan servicing trust accounts in connection with transactions involving residential mortgage loans are
presumably included within the definition of “covered accounts” as the funds held and disbursed are used
primarily for personal, family, or household purposes, and the loan servicing involves multiple payments or
transactions. Commercial loan servicing accounts maintained on behalf of private investors/lenders raise
questions regarding this issue. For example, are the funds of the private investors/lenders used for or in any way
applied to personal, family, or household purposes? This is a factual matter to be determined with the
assistance of professionals including knowledgeable legal counsel and a CPA.

Policies and Procedures

Depository institutions and “creditors” under the “Red Flag Rules” are to establish policies and procedures (or a
written program) that identifies and detects the relevant warning signs of identity theft, such as unusual account
activity, fraud alerts on consumer reports, attempted use of suspicious account application documents, or
unauthorized access to the data or records maintained regarding the account(s). The policies and procedures (or
the written program) should describe appropriate responses to prevent and mitigate the conduct or activities
identified by the warning signs (the “Red Flags”).

The objectives when designing a program to comply with the “Red Flag Rules” are to 1.) Detect identity theft
(“Red Flags”); 2.) Prevent future identity theft; 3.) Mitigate identity theft; and 4.) Update the program

periodically, as necessary. Since the transaction files of MLBs/MLOs are to be maintained a minimum of three
years (and for certain purposes, longer periods), the policies and procedures (or the written program) to
accomplish the foregoing objectives of detecting, preventing, mitigating, and updating the program is to apply
to and for the protection of the information contained within these files.

“Red Flag Rules”

The “Red Flag Rules” are intended to be flexible to provide depository institutions and “creditors” with the
opportunity to design and implement a program that is appropriate for the size and complexity of each, as well
as to consider the nature of their financial operations. The “Red Flag Rules” fall into five categories:

1. Alerts, notifications, or warnings from a consumer reporting agency;

2. Suspicious documents;

3. Suspicious personal identifying information, including a suspicious address;

4. Unusual use of or suspicious activities relating to a “covered account”; and,

5. Notices from customers/clients, victims of identity theft, law enforcement authorities, or other
businesses about possible identity theft in connection with “covered accounts”.

Address Discrepancy Policy

Depository institutions and “creditors” are required to adopt an “Address Discrepancy Policy”. The purpose of
such a policy is to establish procedures to identify and respond to discrepancies noted in the information
received from customers/clients regarding their past and present addresses. For example, the credit report
reveals a different address of the customer/client than the loan application; the address for tax information
returns is distinguishable from the address where payments or disbursements to the consumer/client are to be
made; or when the consumer/borrower is requesting a loan on an owner-occupied security property and the
applicant’s current reported address in third party verifications are different than the security property; among
others. Not only are policies and procedures required to identify these discrepancies (“Red Flags”), but
guidance for staff members is necessary to assist in resolving these discrepancies before proceeding any further
with the financial services requested.

How to Comply

The starting point for developing a program is the Guidelines issued for the Red Flags Rule are available at
www.ftc.gov/os/fedreg/2007/november/071109redflags.pdf . The guidelines are found on pages 63773 and
63744 of the document. It is also recommended that practitioners contact knowledgeable legal counsel to
prepare a Red Flag manual incorporating the policies and procedures to be applied in each fact situation,
including the elements and issues discussed in this section. The program must provide for appropriate
responses to the Red Flags identified to prevent and mitigate identity theft, including monitoring an account,
closing an account, not opening an account (or declining to proceed with the loan application), contacting the
customer/client when detecting a Red Flag, or any combination of the foregoing. In certain events, such as a
recent data breach or a phishing fraud that targeted the depository institution or “creditor” may require specific
preventative actions.

Administering the Program

No matter how good the policies and procedures (written program) looks on paper, the true test is how it works.
The program must describe how it is to be administered, including the approval of the management of the
business organization and how the program will be maintained and kept current. According to the Red Flag
Rule, the program requires approval by the board of directors of the business organization, and if the firm
operates without a board, then by a senior employee whose responsibility it is to administer the program. The
board or designated employee must approve any changes made to the program.

Further, the program should include staff training as appropriate and provide a means for the manager to
monitor the work of service providers, including third parties. Evidence of compliance with the Red Flags Rule
by independent service providers who are third parties with whom the business organization does business
should be included as an element of the program. The program is to describe how oversight is accomplished
and it must be kept relevant and current.

Penalties for Non-Compliance

Although there are no criminal penalties for failure to comply with the Red Flags Rule, depository institutions
or “creditors” that violate the rule are liable for a civil penalties of $1,000 per occurrence, a fine of $2,500 per
occurrence, plus actual damages.

California depository institutions and “creditors” (as well as any “business” as defined) should not overlook
applicable state law and the civil penalties imposed for the failure to securely maintain and to destroy in a
timely and lawful manner the customer/client records that include personal information (as defined). Disposal
of such records under California law requires shredding, erasing, or otherwise modifying the personal
information in these records to make the information unreadable, or to be undecipherable by any means (Civil
Code Section 1798.80 et seq.). In addition, actions for identity theft may be brought under California law
against any person or entity by victims of identity theft. Civil and criminal sanctions are available under this
law (Civil Code Section 1798.92 et seq.).

The Fair Credit Reporting Act (FCRA)

Background

The Fair Credit Reporting Act of 1971 and subsequent amendments guarantees consumers rights as they relate
to credit information, including a prospective consumer/borrower’s right to know about their own credit. State
and federal laws require the mortgage broker (MLB/MLO) to provide specific disclosures to the consumer who
is applying for credit secured by real property (15 USC Section 1681 et seq. and Civil Code Section 1785.14 et
seq.).

Disclosure of credit scores

FCRA Section 609(g) was added by the FACT Act and requires the disclosure of an applicant’s credit score.
The Act applies to persons making or arranging loans whenever a credit score is used in conjunction with an
application for the loan that will be secured by a 1 to 4 unit residential real property, whether the credit is
closed end or open ended. Further, it applies regardless of the outcome of the credit decision. Therefore,
disclosures are to be made whether the application is approved, denied, withdrawn or closed for
incompleteness. This law does not apply to credit applications for loans secured by mobile homes.

A credit score is defined by the Act as a numerical value or a categorization derived from a statistical tool or
modeling system used by a person who makes or arranges a loan to predict the likelihood of certain credit
behaviors, including default; also referred to as a “risk predictor” or “risk score”. This definition appears to
include credit scores maintained by credit repositories including bureaus that do not take into account the
characteristics of the subject transaction. This definition may extend to depository institutions and other
creditors who undertook to develop their own credit score methodology.

The three most commonly used in California are Experian’s Fair Isaac Corporation score, the FICO Score;
TransUnion’s Empirica Score; and Equifax’s Beacon Score. It does not include any mortgage score or rating of
an automated underwriting system that considers factors in addition to credit information such as the loan-to-
value ratio, the applicant’s assets or other elements of the underwriting process or decision. Fannie Mae’s
Desktop Underwriter and Freddie Mac’s Loan Prospector are excluded, since they take into account the
proposed down payment, loan-to-value ratio and other loan specific data.

The disclosure of an applicant’s credit information must be delivered “as soon as reasonably practicable.” The
contents of the notice under federal law are defined in Section 609 (g)(1)(A). Initially, this law requires that “a
copy of the information identified… that was obtained from a consumer credit reporting agency” and a required
statutory notice be provided to the consumer/borrower. Subsequently, this law requires that six items of
information need to be given as follows:

1. A statement that the information and credit scoring model may be different than the credit score used
by the lender;

2. The current credit score;

3. The range of possible credit scores;

4. The key factors, up to four, that adversely affected the consumer’s credit score in the model used (i.e.,
key factors mean all relevant elements or reasons adversely affecting the credit score for the particular

individual, listed in order of their importance and based on their effect on the credit score; and if the
key factors include the number of inquiries made with respect to the consumer report, this factor must
be disclosed without regard to the four factor limit);

5. The date the credit score was created; and,

6. The name of the person or entity that provided the credit score or credit file from which the score was
created.

The statutory notice required in Section 609 (g)(1)(D) further requires the name, address and telephone number
of each credit repository/bureau providing a credit score that was used plus the statutory text. Later in Section
609 (g)(1)(E)(ii) it provides that this law does not require any person to disclose any information other than a
credit score and the key factors.

The disclosure of credit scores applies to each individual for whom a credit score was used; therefore, each
applicant is to be provided with the statutory required notice and the information set forth above.

Depending upon the fact situation, creditors/lenders and MLBs/MLOs acting under California law must also
provide the consumer/borrower with a notice regarding the use of "Credit Scores" and of information
prescribed by state statute, including the key factors that adversely affect the consumer/borrower's credit score
in the model used. Further, the information provided is to include how to contact the three credit repositories to
correct any inaccuracy in the consumer/borrower's credit report. The three repositories are Experian,
TransUnion, and Equifax (Civil Code Sections 1785.14, 1785.15, 1785.15.1, 1785.15.2, 1785.16, and
1785.17).

Credit Disputes

If an applicant believes there is a mistake in his/her credit report and wishes to dispute or correct the mistake,
the applicant can contact the credit repository that developed the report. Under FCRA, the repository must
complete an investigation of the disputed items within 30 days and provide a written notice of the results of the
investigation within 5 days of completion, and to provide a copy of the credit report (if it has changed) based on
data developed from the dispute. The FTC is responsible for enforcing FCRA.

The Home Valuation Code of Conduct (HVCC)

Background

The Home Valuation Code of Conduct (the Code) is the result of a joint agreement among Fannie Mae, Freddie
Mac, the Federal Housing Finance Agency (FHFA), and the New York State Attorney General. The Code is
intended to enhance the independence and accuracy of the appraisal process and to provide added protections
for homebuyers, lenders, investors in mortgage loans, and to generally support the housing market. While the
Code arises from an agreement, depository institutions are subject to the impact on the agreement of regulations
concerning third party relationships promulgated in OCC regulations 12 CFR Sections 5.34, 5.36, and 5.39
describing the permissibility of the activities to be conducted. Further, affiliated relationships that may result
from the joint agreement are subject to the rules applicable to such relationships (Sections 23A and 23B of the
Federal Reserve Act, 12 USC 371c and c(1)).

Delivery of Single Family Mortgages to Fannie Mae and Freddie Mac

Effective May 1, 2009, Fannie Mae and Freddie Mac no longer purchase residential mortgages from Sellers
that have not adopted the Code with respect to single-family mortgages (other than government insured or
indemnified loans) delivered to Fannie Mae or Freddie Mac. Also, effective for single-family mortgages with
loan application dates on or after May 1, 2009, Fannie Mae and Freddie Mac seller/servicers must represent and
warrant that the appraisal report is obtained in a manner consistent with the Code.

The sale of mortgage loans that are excluded from the foregoing representation and warranty include FHA and
VA insured or indemnified mortgage loans; Section 184 Native American Mortgages; and Section 502
Guaranteed Rural Housing Mortgages.

Fannie Mae and Freddie Mac have jointly established the Uniform Mortgage Data Program (UMDP) under the
direction of the FHFA to provide common requirements for appraisal and loan delivery data, including a
Uniform Appraisal Dataset that standardizes key appraisal data elements to enhance data quality and promote
consistency; and a Uniform Collateral Data Portal (UCDP) for the electronic collection of appraisal data.

Non-compliance with the Code

Complaints about non-compliance with the Code may be submitted electronically or through the mail using the
complaint submission form. The complaint submission form must be completely filled out to be accepted and
reviewed. Anonymous or incomplete complaints will not be reviewed. Instructions are provided on the
complaint types that are eligible for submission to Fannie Mae or Freddie Mac.

Taking Precautions

There are many factors that led to the inflated property values experienced a few short years ago, which
substantially contributed to the market conditions that are being experienced at the time of this writing. One of
those factors involved real estate appraisers who were not objective in their appraisal work, but rather were
unduly influenced to arrive at specified values by those who hired them. Appraisers were influenced in a
variety of ways, ranging from subtle to overt, but the net effect was uncontrolled market appreciation that could
not be sustained.

To address the problem of the improper influence of real estate appraisers, Civil Code Section 1090.5, was
enacted and became effective October 5, 2007. It provides in part that “No person with an interest in a real
estate transaction involving an appraisal shall improperly influence or attempt to improperly influence, through
coercion, extortion, or bribery, the development, reporting, result, or review of a real estate appraisal sought in
connection with a mortgage loan.” To further restrain undue influence upon appraisers, the law also provides
that if a person who violates the law is licensed under any state licensing law, and the violation occurs within
the course and scope of the person’s duties as a licensee, the violation shall be deemed a violation of that state
licensing law.

To help real estate licensees avoid any potential impropriety, the DRE (working in conjunction with the Office
of Real Estate Appraisers, the Department of Corporations, and the Department of Financial Institutions)
developed the following list of practices which may constitute evidence of a violation of California law and
should be avoided when engaging the services of a licensed real estate appraiser.

1. Withholding or threatening to withhold timely payment or partial payment for a completed appraisal
report, regardless of whether a sale or financing transaction closes;

2. Withholding or threatening to withhold future business from an appraiser, or demoting or terminating
or threatening to demote or terminate an appraiser;

3. Expressly or impliedly promising future business, promotions, or increased compensation for an
appraiser;

4. Conditioning the ordering of an appraisal report or the payment of an appraisal fee or salary or bonus
on the opinion, conclusion, or valuation to be reached, or on a preliminary value estimate requested
from an appraiser;

5. Requesting that an appraiser provide an estimated, predetermined, or desired valuation in an appraisal
report prior to the completion of the appraisal report, or requesting that an appraiser provide estimated
values or comparable sales at any time prior to the appraiser’s completion of an appraisal report;

6. Providing to an appraiser an anticipated, estimated, encouraged, or desired value for a subject property
or a proposed or target amount to be loaned to the borrower, except that a copy of the sales contract
for purchase transactions may be provided;

7. Requesting the removal of language related to observed physical, functional or economic
obsolescence, or adverse property conditions noted in an appraisal report;

8. Providing to an appraiser, appraisal company, appraisal management company, or any entity or person
related to the appraiser, appraisal company, or appraisal management company, stock or other
financial or non-financial benefits;

9. Allowing the removal of an appraiser from a list of qualified appraisers, or the addition of an appraiser
to an exclusionary list of disapproved appraisers used by any entity, without prior written notice to
such appraiser, which notice shall include written evidence of the appraiser’s illegal conduct, a
violation of the Uniform Standards of Professional Appraisal Practice (USPAP) or state licensing

standards, substandard performance, improper or unprofessional behavior or other substantive reason
for removal;

10. Ordering, obtaining, using, or paying for a second or subsequent appraisal or automated valuation
model (AVM) in connection with a mortgage financing transaction unless: (i) there is a reasonable
basis to believe that the initial appraisal was flawed or tainted and such basis is clearly and
appropriately noted in the loan file, or (ii) such appraisal or AVM is done pursuant to written, pre-
established bona fide pre- or post-funding appraisal review or quality control process or underwriting
guidelines, and so long as the lender adheres to a policy of selecting the most reliable appraisal, rather
than the appraisal that states the highest value; or,

11. Any other act or practice that impairs or attempts to impair an appraiser’s independence, objectivity, or
impartiality or violates law or regulation, including, but not limited to, the Truth in Lending Act
(TILA) and Regulation Z, or USPAP.

It should be noted that neither Civil Code Section 1090.5, nor any other California code section, prohibits a
person with an interest in a real estate transaction from asking an appraiser to do any of the following: (1)
consider additional, appropriate property information; (2) provide further detail, substantiation, or explanation
for the appraiser’s value conclusion; and/or (3) correct objective factual errors in an appraisal report.

While the above list is illustrative of acts that may be evidence of violations of the prohibitions against undue
influence contained in Civil Code section 1090.5, it is not exhaustive. It is, however, intended to alert real estate
licensees of practices that could potentially lead to disciplinary action. In this regard, real estate licensees are
admonished to exercise caution when working with real estate appraisers and avoid actions that could be
considered improper influence.”

The USA Patriot Act

Background

An applicant is to be identified to determine if there exists an association with terrorism, narcotics trafficking
and/or money laundering. This is accomplished by utilizing the lists published by the Office of Foreign Asset
Control. The information regarding the persons or nation-states that identify with such an association is known
as the U.S. Treasury Department’s Specially Designated Nationals (SDN) and Blocked Persons list. This list
also includes nation-states that have been placed on non-favored nation status. If the applicant is either
specifically named or is from one of the nation-states appearing on the list, the financial institution (depository
institution) or licensed creditor/lender, including MLB/MLO, cannot proceed with a loan application or with
other financial services. The website for the list is www.ustreas.gov/offices/enforcement/ofac/sdn/.

The Office of Foreign Assets Control (OFAC) administers a series of laws that impose economic sanctions
against hostile targets to further U.S. foreign policy and national security objectives. The list identifies “pariah”
countries, as well as certain groups, such as narcotics traffickers and terrorists, who threaten the security,
economy, and safety of the United States and its citizens. Management of sanctions is entrusted to the Secretary
of the Treasury. While OFAC is responsible for promulgating, developing, and administering the sanctions for
the Secretary under eight basic statutes, all of the bank regulatory agencies cooperate in ensuring financial
institution compliance with the regulations implementing the USA Patriot Act.

Compliance

“U.S. persons” or “persons subject to the jurisdiction of the United States”, depending on the sanctions
program, must comply with OFAC regulations. This law is expected to include licensed creditors/lenders and
MLBs/MLOs that have been characterized as financial institutions for other purposes under federal law, e.g.
FACT. Commercial banks, whether large or small, are subject to these terms and are responsible for complying
with OFAC regulations.

While depository institutions are routinely examined to ensure they maintain policies and procedures in place
for complying with the requirements of OFAC, licensed creditors/lenders (other than depository institutions), as
well as MLBs/MLOs are primarily left to their own practices to establish compliance with this issue. These
creditors/lenders and brokers need to establish internal policies and procedures (including obtaining the lists
available from the previously identified website) to ensure that loan applications and other financial services are
not extended to SDN and Blocked Persons.

For example, establishing new accounts (such as fiduciary, discount, or other securities or brokerage
transaction accounts), pursuing certain loan brokerage activities, developing new loan customers/clients,
proceeding with wire transfers, and engaging in other bank or financial transactions should not occur until the
identity of a potentially Blocked Person are compared to OFAC’s listings. MLBs/MLOs should be subject to
more limited compliance with this law than would depository institutions, depending upon the activities
pursued by these brokers. Real estate brokers (MLBs) who receive capital/funds from private investors/lenders
should research their liability under this law, as these brokers will likely be subject to broader application of the
USA Patriot Act than brokers who package loans to be delivered to depository institutions or licensed
creditors/lenders.

Reporting Procedures and Requirements

Whenever a bank blocks or rejects a prohibited transaction, that bank must report its action to OFAC within 10
days, describing the action taken, including a copy of the payment order or other relevant documentation. In
addition to this periodic report, all holders of blocked property must file a comprehensive annual report of
blocked property (form TDF 90-22.50) by September 30 each year. Reportedly, no procedures have yet to be
developed to monitor licensed creditors/lenders or MLBs/MLOs in connection with this issue. Nonetheless, the
importance of establishing a compliance program and developing internal audit procedures should be obvious.

Specially Designated Nationals and Blocked Persons

Individuals and entities which are owned or controlled by, or acting for or on behalf of, the governments of
target countries or are associated with international narcotics trafficking or terrorism are listed on the Treasury
Department’s Specially Designated Nationals (SDN) and Blocked Persons list. The purpose of maintaining this
list in current status is to inform persons subject to the jurisdiction of the United States they are prohibited from
dealing with those identified and they must block all property within their possession or control in which these
blocked individuals and entities have an interest.

An Overview of Current OFAC Profiles for Blocking Transactions

Commercial banks (and it is believed the following extends to all persons/entities subject to this law) must
block transactions involving the following:

1. Individuals appearing on OFAC’s SDN list;

2. Cuban and North Korean citizens, except U.S. residents, wherever located;

3. Individuals, regardless of citizenship, currently residing in Cuba or North Korea;

4. Entities on OFAC’s SDN list;

5. Companies and Commercial Enterprises located in North Korea and Cuba; and,

6. Governmental entities and officials of Libya, Iraq, North Korea, Cuba, Sudan, Serbia, and the Federal
Republic of Yugoslavia, including those entities and individuals appearing on OFAC’s list of SDNs
and Blocked Persons. All banks in Libya, Iraq, and Serbia are government-controlled banks.

Objectives and Screening

The most fundamental objective of OFAC compliance procedures is to provide enough information to key staff
members in relevant operations to recognize and stop, or “interdict,” suspected transactions for further review
before processing. An effective internal communication network is critical to OFAC regulatory compliance.
Compliance training programs should be initiated by all persons/entities subject to this law.

Such training initiatives can range from mentioning regulations in staff meetings and incorporating compliance
requirements into operating manuals including policies and procedures, and joining with other affected persons
or entities (including trade associations) to sponsor seminars. Relevant operational areas of every affected
person or entity should receive, at a minimum, a listing of sanctioned countries and continuously updated SDN
list (Public Law 106-56-October 26, 2001).

The Flood Disaster Protection Act (FDPA)

Background

The Flood Disaster Protection Act (FDPA) was adopted to provide adequate amounts of federally subsidized
flood insurance to owners of improved real property located in a designated flood hazard area of communities
that participate in the National Flood Insurance Program (NFIP). The purpose of this program is to provide an
alternative to the federal disaster relief funds normally required in flooded areas. The NFIP is administered by
the Federal Emergency Management Agency (FEMA) The federal banking agencies adopted uniform
interagency flood regulations effective October 1, 1996. Further information can be found in the Interagency
Questions and Answers Regarding Flood Insurance at www.occ.treas.gov/handbook/compliance.htm.

Both consumer and commercial loans to be secured by improved real property or with a mobile home (located
or to be located in an identified special flood hazard area) are loans designated for consideration of flood
insurance coverage. The Act also applies to increases in, extensions or renewals of such loans. Federally
regulated lending institutions are prohibited from making, increasing, renewing or extending such loans, unless
the property securing the loan is covered by sufficient flood insurance.

“The FDPA imposes five basic requirements on a creditor/lender:

1. Prior to making, increasing or renewing or extending a loan, the lender must determine whether the
property is located in an area designated by FEMA as a special flood hazard zone rated “A” or “V”;

2. If the property is located in a special flood hazard area (SFHA), the lender must determine whether the
property is located in a community participating in the NFIP and then provide special notices to the
borrower, loan servicer, and flood insurer;

3. If the community participates in the NFIP, the lender may not close the loan without proof that
sufficient flood insurance is in place (if the community does not participate in the NFIP and flood
insurance is unavailable from FEMA, lenders may wish to obtain flood insurance coverage from a
private insurer to protect the collateral);

4. If the lender ever determines that flood insurance has lapsed or become insufficient in amount, the
lender must force place the insurance required; and,

5. Certain notices about flood insurance coverage are required at various points during the life of the
loan.”

The statutes imposing the above requirements are found in 42 USC 4001-4129, which include the National
Flood Insurance Act of 1968 (1968 Act); the Flood Disaster Protection Act of 1973 (FDPA); and Title V of the
Riegle Community Development and Regulatory Improvement Act of 1994.

Compliance

Regulators of this law include FRB, NCUA, FDIC, the OCC, OTS, and the Farm Credit Administration (FCA),
collectively the agencies, issued a joint rule to implement the National Insurance Reform Act (the OCC’s
implementing regulation is cited as 12 CFR 22). The agencies have adopted, “Interagency Questions and
Answers Regarding Flood Insurance”, published in the Comptroller of the Currency Administrator of National
Banks Comptroller’s Handbook, May 1999. The questions and answers serve as guidance to comply with the
regulations.

The Federal Financial Institutions Examination Council (FFIEC) has published statements in the Federal
Register regarding notice and request for comments on loans in areas having special flood hazards, including
interagency questions and answers regarding flood insurance. The publication by the FFIEC is cited as Council
(FFIEC) 62 FR 39523 (July 23, 1997).

Eligibility for the purchase of flood insurance extends to communities that agree to adopt ordinances to mitigate
the impact of future flooding, such as conditioning the issuance of building permits for new residential
construction upon the requirement that the structure be built so that the lowest floor is above the flood elevation
level.

There are 14 Flood hazard areas defined. If the property is located within an “A” and “V” rated FIRM zones
(A, A1-30, AE, A99, AH, AR, V1-30, VE, V and VO) insurance is required. Insurance is available but not
required for the remaining zones. If the improved property or mobile home is located or will be located in a
flood hazard area but not in an area of special flood hazard, B, X, C or D zones, flood insurance is not required
but may be obtained.

The flood insurance regulations apply to federally regulated depository institutions and loan servicers acting on
behalf of such institutions. The loan servicer’s obligations to comply with the NFIP are governed by the loan
servicing agreement.

“A ‘loan servicer’ means the party responsible for:

1. Receiving any scheduled periodic payments from a borrower on a loan including amounts for taxes,
insurance premiums and other charges with respect to the property securing the loan; and,

2. Making payments of principal and interest and any other payments from the amounts received from
the borrower under the loan.

The flood regulations apply to any loan made by a regulated lender secured in whole or in part by real property
improved with vertical structures or with a mobile home. The term mobile home does not include a recreational
vehicle. Loans secured by vacant land are not subject to flood insurance. Commercial, business agricultural and
residential loans are subject to flood insurance.

The Agencies have created the term “designated loan” and defines that term to mean a loan secured by a
building or mobile home that is located or to be located in a special flood hazard area in which flood insurance
is available under the Act.

When a loan is made to construct improvements upon the property that is located in a special flood hazard area,
flood insurance coverage must be maintained throughout the construction. Where a building and its contents
both secure a loan, and the building is located in a special flood hazard area, flood insurance coverage is
required for the building and any contents stored in that building. Exemptions to the flood insurance
requirements generally include loans that have an original principal balance of $5,000 or less and a term of one
year or less.

FNMA and FHLMC have imposed requirements that loans sold to these entities have adequate flood insurance
coverage. To promote consistent treatment for lenders, the OTS and the FDIC have adopted the position of the
OCC and FRB that a loan purchase does not require that a determination be made whether the security property
is located in a special flood hazard area. Although commercial banks may purchase mortgage loans where flood
insurance was not obtained, these depository institutions must review their loan portfolio to measure the
operative risk and exposure in the absence of flood insurance coverage. This may require the depository
institution to purchase the flood insurance coverage as a means of reducing portfolio risk.

FNMA outlines the basic flood insurance requirements for mortgagees sold on the secondary market in their
most recent Fannie Mae Servicing Guide (Servicing Guide) that can be found online at www.efanniemae.com.
FHLMC’s flood insurance guidelines are contained in Volumes 1 and 2 of its single family Seller/Servicer
guide that can also be accessed on their website at www.freddiemac.com. The NCUA directs federal credit
unions to not purchase member loans without determining whether such loans secured by improved real
property have adequate flood insurance coverage.

Lenders are required to document their flood hazard determinations on the Department of Homeland
Security/Federal Emergency Management Agency Standard Flood Hazard Determination Form (SFHDF)
O.M.B. No. 1660-0040. The current form has an expiration date of December 31, 2011. The form is made
available on FEMA’s website, www.fema.gov.

A notice to the borrower is required whenever a lender makes, increases, extends, or renews a loan secured by a
building or a mobile home located in a SFHA. The notice is also to inform the borrower whether flood

insurance coverage is available under the NFIP. The notice must be in writing and includes required contents.
The flood regulations contain a model notice form that the lender may use at its option.

When flood insurance coverage is required, a lender must ensure that adequate flood insurance coverage is in
place by the time the loan closes. Applicable regulations include the methods for determining the amount of
coverage.

“In general it must be at least equal to the lesser of:

7. The outstanding principal balance of the designated loan;

8. The maximum amount available under NFIP for the particular type of property; and,

9. The value of the improvements (overall value of the property less the value of the land).”

Lenders may require more insurance than required by the applicable regulations to ensure repayment of the
loan; however, the coverage may not be more than the replacement cost of the improvements. The amount of
building coverage limits and contents coverage limits currently in effect are published in the questions and
answers that may be found on the FEMA website. California law prohibits requiring hazard insurance in an
amount in excess of the replacement value of the improvements on the real property (Civil Code Section
2955.5).

FEDERAL AND STATE DISCLOSURES AND NOTICE OF RIGHTS

Article 7 - The Borrower

The Real Estate Law has long required the licensing of one who solicits or negotiates mortgage loans for
another or others for compensation (or expectation of compensation) evidenced by promissory notes secured by
deeds of trust or mortgages (either directly or collaterally) by/though liens on real property. The statutory
scheme found in Article 7 of the Business and Professions Code, commencing with Section 10240, was enacted
to curb a variety of abuses carried on by some participants in the mortgage brokerage industry. These abuses
included exorbitant commissions; inflated costs and expenses; short term loans with large balloon payments;
and misrepresentations or concealments of material facts. Article 7 is referred to by the industry, the Courts, the
Regulators, the public and others as the Real Property Loan Law, the Mortgage Loan Brokers’ Law, or the
Necessitous Borrowers’ Act (Business and Professions Code Section 10240 et seq. and 10CCR, Chapter 6,
2840 et seq.).

Non-licensed Assistants

A real estate broker (MLB) who engages in mortgage loan activities or in the purchase, sale, or assignment of
promissory notes may, under specified conditions, employ non-licensed assistants. Business and Professions
Code Section 10133.1(c)(1) and (c)(2) was added in 2000 to provide for an exemption from licensure of
persons who are employees of real estate brokers (MLBs/MLOs) when such persons are performing activities
under the supervision of the MLBs, as defined. The exemption allows a non-licensed employee to assist the
MLBs/MLOs in certain residential mortgage loan transactions (as defined) provided such employees do not
participate in any negotiations among the principals of such transactions (10 CCR, Chapter 8, Section 2841).
Beginning January 1, 2011 loan processors and underwriters must be employees of the real estate broker
(MLB/MLO) or be separately licensed as mortgage loan originators if providing services as independent
contractors.

Real estate brokers (MLBs) must exercise reasonable supervision and control over the non-licensed employees’
activities at an office or branch office licensed to each employing broker. In December of 2000, the activities
and conditions for employment of unlicensed assistants were included in the Commissioner’s Regulations (10
CCR, Chapter 6, Section 2841). This regulation implemented the exemption authorized by Business and
Professions Code Section 10133.1(c)(1) and (c)(2) and mirrors the “Guidelines For Unlicensed Assistants” that
were published by the DRE in the Winter of 1993. The aforementioned Guidelines were issued as a safe harbor

on which real estate licensees may rely when applying the clerical exemption included in applicable law
(Business and Professions Code Section 10133.2).

Accordingly, MLBs employing unlicensed assistants in loan transactions, as defined, that are not subject to
Section 2841 of the Regulations would apply the “Guidelines For Unlicensed Assistants” to establish the
parameters of the activities authorized for such persons under the supervision of these real estate brokers.

Application of Article 7

Certain Sections of Article 7 apply to every real estate broker (MLB) who engages in loan transactions, as
defined. Except for Business and Professions Code Section 10240, this Article applies to dwellings defined to
mean a single dwelling unit in a condominium or cooperative, or a parcel of real property containing 1 to 4
residential units which are owned by a signatory to the deed of trust or mortgage secured thereby that was made
or arranged by an MLB (Business and Professions Code Sections 10240.1 and 10240.2). The provisions of this
Article apply to loans secured directly or collaterally by a first trust deed, the principal of which is less than
thirty thousand dollars, or to a loan secured directly or collaterally by a subordinate lien, the principal of which
is less than twenty thousand dollars.

The remaining provisions of Article 7 apply only to first or senior deeds of trust or mortgages, the original
principal balance of which are $30,000 or more; or to junior deeds of trust of mortgages, the principal balance
of which are $20,000 or more. When the first or senior deeds of trust or mortgages are securing an original
principal balance up to $30,000 or the junior deeds of trust or mortgages are securing an original principal
balance of up to $20,000, these transactions are commonly referred to as “Sheltered Loans”.

Article 7 applies to loans made or negotiated by real estate brokers (MLBs) acting within the meaning of
subdivision (d) of Section 10131 and subdivision (b) of Section 10240 of the Business and Professions Code.
Subdivision (b) of Section 10240 includes loan transactions in which a broker (MLB) solicits a borrower with
express or implied representations that the MLB will obtain and arrange a loan as an agent, but in fact makes
the loan with the broker’s own funds or funds the broker/MLB controls. In such fact situations, the broker may
not discharge the agency and fiduciary relationship established with the borrower, even though the MLB is
acting as well as a principal (and as the agent and fiduciary of private investors/lenders funding the loan) when
making the loan with funds the broker (MLB) owns or controls (Business and Professions Code Sections
10131(d) and (e), 10131.1, 10131.3, 10177(q), 10230 et seq., 10237 et seq., and 10240(b), and 10 CCR,
Chapter 6, Section 2840 et seq. and 2846; Civil Code Sections 2295 et seq., 2349 et seq., and 2923.1; and
Corporations Code Sections 25019, 25100(e) and 25206, and 10 CCR, Chapter 3, Sections 260.115 and
260.204.1; among others).

Mortgage Loan Disclosure Statement

The MLDS is at the heart of Article 7. This statement’s purpose is to provide a prospective borrower with
information concerning the important features or the material facts of an intended loan transaction, including
the fees, costs, and expenses to obtain the financing. A real estate broker (MLB) soliciting or negotiating a loan
transaction, as defined, on behalf of another or others (for compensation or in the expectation of compensation)
or when making the loan with funds owned or controlled by the MLB, which loan is evidenced by a promissory
note and a deed of trust or mortgage (secured either directly or collaterally by/through a lien on real property);
must present and deliver a completed MLDS to the prospective borrower within 3 business days of receipt of a
completed written loan application or before the borrower becomes obligated to take or accept the loan
(whichever is earlier).

MLBs either directly or through a salesperson or broker associate employed by the broker are required to obtain
the signature of the borrower(s) on the MLDS prior to the time that the borrower becomes obligated to
complete the loan transaction. The licensee must certify in the MLDS that the loan transaction complies with
Article 7, as applicable (Business and Professions Code Section 10240 et seq. and 10 CCR, Chapter 6, Sections
2840, 2842.5, 2843 and if lending 2844).

The information that must be included in the MLDS is set forth in the Real Estate Law (Business and
Professions Code Section 10241 et seq. and 10 CCR, Chapter 6, Section 2840 et seq.). Unless the MLDS is in
the form prescribed for use in the Commissioner’s regulations, the form of MLDS must be specifically
approved by the Commissioner prior to its use (10 CCR, Chapter 6, Section 2840 et seq.). The Commissioner

has established approved forms in Regulations 2840 and 2842. Mortgage Loan Disclosure Forms can be
obtained at any DRE office or on the DRE Web site at http://www.dre.ca.gov/frm_mlb.html. Other mortgage
lending and brokerage forms published by the DRE are available through the same web page.

In 2008, the DRE promulgated Commissioner’s Regulation 2842 and adopted the Mortgage Loan Disclosure
Form, RE 885 for the disclosure of terms on non-traditional and subprime mortgage products. This form must
be used when offering any loan that is defined as a “non-traditional mortgage product” in Regulation 2842, or
as defined throughout this chapter as an alternative mortgage(s) or non-traditional loan product(s). Further, the
Real Estate Commissioner promulgated at the same time Regulation 2844 describing the standards to which
MLBs/MLOs are subject when making a loan from funds owned or controlled by the broker that qualifies as a
“non-traditional mortgage product” (Business and Professions Code Sections 10131.1, 10240(b), and 10241(j),
and 10 CCR, Chapter 6, Section 2844).

In addition to the MLDS, real estate brokers (MLBs/MLOs) are required under the Real Estate Settlement
Procedures Act (RESPA) to complete and deliver a Good Faith Estimate (GFE) to the consumer/borrower. The
GFE is more fully discussed in the following section of this Chapter.

Broker Owned or Broker Controlled Funds

Both forms of the MLDS provide for disclosure that the broker (MLB) anticipate that the loan will be made
with broker-controlled funds (including funds that the broker owns). The phrase “broker-controlled funds”
means funds owned by the broker, by the broker’s spouse, child, parent, grandparent, brother, sister, father-in-
law, mother-in-law, brother-in-law or sister-in-law, or by any entity in which the broker alone or together with
any of the above relatives has an ownership interest, among others (Business and Professions Code Sections
10131.1, 10240(b), and 10241(j), and 10 CCR, Chapter 6, Section 2844). The definition of the broker’s own
funds or funds that the broker (MLB) controls should not be determined without consideration of the applicable
sections of the Corporate Securities Law of 1968 and the Corporations Commissioner’s Regulations pertaining
thereto.

Alternate Disclosures - Applicable Federal Law

When the real estate broker (MLB/MLO) is the creditor/lender, the broker may rely on federal disclosures and
the notices of rights required in federally regulated residential mortgage loan transactions, i.e., the disclosures
and the notices of rights required pursuant to the Real Estate Settlement Procedures Act (RESPA) and to the
Truth-In-Lending Act (TILA). A predicate to reliance exclusively on the foregoing federal disclosures and
notices of rights is the original principal amount of the loan must exceed the “Sheltered Loan” limits as set forth
in California law (12 USC 2601 et seq. and 24 CFR Parts 3500 et seq., Regulation X; 15 USC 1601 et seq. and
12 CFR Section 226 et seq., Regulation Z; and Business and Professions Code Sections 10240(c) and 10245).

A further and an important predicate is the qualifying MLBs/MLOs must be the creditor/lender and may not be
performing exclusively as the agent and fiduciary of the consumer/borrower (see the federal cases cited below
in the section entitled, “Disclosures – Case Law”). Qualifying MLBs/MLOs would not be required to complete
and deliver the MLDS in accordance with state law, if the “good faith estimate” that satisfies the requirements
of RESPA includes the broker’s real estate license number and a clear and conspicuous statement that the
“Good Faith Estimate” does not constitute a loan commitment.

Further, if the residential mortgage loan contains a provision for a balloon payment, the notice and disclosure
required under applicable California law must be included. Alternatively, the qualifying MLB/MLO may rely
on the balloon payment notice and disclosure required for the subject residential mortgage loan by Fannie Mae
or Freddie Mac, or the MLB/MLO may use a disclosure determined by the Real Estate Commissioner to satisfy
the requirements of TILA (12 CFR Section 226 et seq. and 24 CFR Parts 3500 et seq.; and Business and
Professions Code Section 10241(h)).

The prospective consumer/borrower must also be provided with the applicable disclosures required by TILA
and must acknowledge receipt of the RESPA “good faith estimate” and TILA required disclosures and notices
of rights prior to becoming obligated to the residential mortgage loan transaction. The broker (MLB/MLO)
must maintain copies of the disclosures and the signed acknowledgement for three years pursuant to applicable
law (Business and Professions Code Sections 10148 and 10240(c)).

Disclosures - Case Law

The federal District Court and the Court of Appeals for the 3rd Circuit have held that the disclosures and
notices of rights required pursuant to TILA (including Regulation Z thereof) must be made by the
creditor/lender and not by a third party agent. However, these holdings do not appear to extend to an agent that
is functioning in the place and stead of the creditor/lender through an express
management/administration/operations agreement (including the loan servicing relationship), i.e., in an
investment contract relationship with private investors/lenders funding and making the residential mortgage
loan as the creditors for TILA purposes. Further, these holdings should not apply to the exclusive authorized
agent and loan correspondent for the depository institution or licensed creditor/lender funding and making the
loan as the creditor for TILA purposes. The agent in this circumstance is also acting in the place and stead of
the creditor/lender.

The Court in the three separate reported case citations issued in the 3rd Circuit regarding this issue did not alter
the holding applicable to this discussion, i.e., the TILA required disclosures and notices of rights must be
completed and given to the consumer/borrower by the creditor/lender and not by a third-party agent, as defined.
The MLB/MLO making the residential mortgage loan relying on funds the broker controls or on the broker’s
own funds (as defined) would be the creditor/lender for TILA purposes.

Further, when the MLB/MLO is performing in an investment contract relationship, or is the exclusive
authorized agent and loan correspondent for a depository institution or a licensed creditor/lender may also
qualify as the creditor/lender pursuant to TILA. The status of creditor/lender (or performing in the role of
creditor/lender as described above) is an essential predicate to reliance on the alternative federal disclosures and
the notices of rights discussed in the previous section, “Alternate Disclosures - Applicable Federal Law”. This
means an MLB/MLO who is acting as the exclusive agent of the consumer/borrower is not entitled to complete
and deliver TILA disclosures and notices of rights. (Vallies v. Sky Bank, 432 F. 3d 493 – 2006; Vallies v. Sky
Bank, 583 F. Supp. 2d 687 – 2008; and Vallies v. Sky Bank, 591 F. 3d 152 – 2009).

In Realty Projects, Inc. v. Smith (1973 32 C.A. 3d 204), the court held that the statutory obligation of a licensee
to act fairly and honestly demanded that the licensee inform prospective borrowers of the differences between
commissions and other charges for loans in amounts subject to the Real Property Loan Law as against loans not
covered by that law. While the Court referred to the respondent/licensee as the agent of the prospective
borrower, the Court did not rely upon an agency theory in reaching its decision regarding this disclosure duty.
Rather, this duty was declared to stem simply from the respondent’s status as a licensee.

However in the case of Wyatt v. Union Mortgage Co. (1979 24 C.A. 3d 773), the Court held that a mortgage
loan broker’s (MLB’s) duty to disclose information about late charges and the effective interest rate of a loan
was based upon a fiduciary relationship between the broker (MLB) and the prospective borrower, i.e., part of
the fiduciary duties owed to the consumer/borrower (Civil Code Sections 2295 et seq., 2349 et seq., and 2923.1
and Financial Code Sections 4979.5, 4995(c) and (d), and 4995.3). It should be noted that Civil Code Section
2923.1 and Financial Code Sections 4979.5, 4995(c) and (d), and 4995.3 were each codified subsequent to the
reported decision in Wyatt v. Union Mortgage Co.

Commissions and Other Charges

Article 7 limits the amount that may be charged as commission or fees and as “costs and expenses” for
arranging or making a loan. Again, these limitations do not apply to a first or senior loan of $30,000 or more or
a junior loan of $20,000 or more (residential mortgage loans other than “Sheltered Loans”). The maximum
commissions for loans subject to Article 7 are:

1. First or senior loans:

a. 5 percent of the principal of a loan of less than 3 years;

b. 10 percent of the principal of a loan of 3 years or more;

2. Second or other junior loans:

a. 5 percent of the principal of a loan of less than 2 years;

b. 10 percent of the principal of a loan of at least 2 years but less than 3 years; and,

c. 15 percent of the principal of a loan of 3 years or more.

Costs and expenses of making or arranging a loan subject to Article 7, including appraisal fees, escrow fees,
notary and credit investigation fees (but excluding actual title charges and recording fees) charged to or
imposed upon a consumer/borrower cannot exceed 5 percent of the original principal balance/amount of the
loan or $390, whichever is greater, to a maximum of $700. The amount charged cannot exceed the actual costs
and expenses paid, incurred or reasonably earned. Fees, costs, and expenses imposed by the MLB/MLO must
be reasonably earned and actually incurred. No charge can exceed the amount customarily charged for the same
or comparable service in the community where the service is rendered (Business and Professions Code Section
10242 and 10 CCR, Chapter 6, Section 2843).

Balloon Payments

For the purposes of Article 7, a balloon payment is defined as an installment payment that is greater than twice
the amount of the smallest installment payment required by the terms of the promissory note (Business and
Professions Code Sections 10244 and 10244.1).

Generally, no mortgage loan subject to Article 7 that qualifies as a “Sheltered Loan” may have a balloon
payment, if the term of the loan is less than 3 years. However, if the real property securing the loan is an
owner-occupied dwelling, a balloon payment is not permissible if the term of the loan is 6 years or less
(Business and Professions Code Section 10244 and 10244.1). As in the case of the 3-year balloon payment
provision, this restriction does not apply to a promissory note given back to the seller (“carry back”) by the
purchaser of the dwelling on account of the purchase price (Civil Code Section 2956 et seq.). Notwithstanding
the foregoing, should the residential mortgage loan qualify as a “High-Cost Loan”, applicable California law
otherwise limits the use of balloon payments when the term of the loan is less than 5 years (Financial Code
Section 4973(b)(1)).

The MLDS includes a required notice regarding balloon payments. This notice must be in 10 point bold
typeface/font (using capital or upper case letters) and it must contain the precise language required by statute
(Business and Professions Code Sections 10241 and 10241.4). Business and Professions Code Section 10241.4
requires an expanded disclosure should provisions have been made, or will be sought, for either extension,
refinancing or renegotiation of a residential mortgage loan (as defined) subject to Article 7 when the loan
includes a balloon payment.

Other Restrictions

Other restrictions on mortgage loans subject to Article 7 include:

1. An MLB is prohibited from charging or negotiating any loan servicing or loan collection fees to be
paid by the borrower;

2. A consumer/borrower may not be required to purchase credit life or credit disability insurance as a
condition of obtaining a loan;

3. An MLB/MLO may collect only one premium for credit life or credit disability insurance provided
through duly licensed insurance agents, and only one consumer/borrower whose earnings are
reasonably relied upon by the creditor/lender for repayment of the loan may be insured;

4. Regardless of the amount of the loan, charges for late payments of an installment are limited to 10
percent (or $5, whichever is greater) of the principal and interest part of the installment or periodic
payment, and if a payment is paid or tendered within ten days of a payment due date, no late charge
may be imposed for the payment tendered;

5. No charge may be assessed for a prepayment penalty fee in connection with a prepayment of the
principal amount owning made more than seven years from the date of the loan, and if the prepayment

occurs within the first seven years of the origination of the loan, the prepayment penalty may not
exceed for any prepayment of principal (during any 12-month period) a fee in excess of six months’
advance interest on the amounts prepaid that are greater than 20 percent of the then remaining unpaid
principal balance; and,

6. The term of an exclusive right granted to the MLB/MLO by the consumer/borrower to secure
financing cannot exceed 45 days.

The late payment charges may not be imposed more than once for each late payment of an installment due and
no late charge may be imposed upon any installment which is paid or tendered in full within 10 days after its
scheduled due date (even though an earlier maturing installment or a late charge on an early installment may
not have been paid in full). A late charge in the authorized amount of 10% (of the monthly or periodic
installment of principal and interest) may not be imposed for the failure to timely pay a balloon payment, as
defined. Rather, the authorized late-payment charge for a balloon payment is limited to the late charge
imposable for a single monthly installment of principal and interest multiplied by the number of months
occurring from the date that the balloon payment was due to the date such payment was paid or tendered plus
one such monthly late charge.

The prepayment penalty provisions of Article 7 are trumped by the prepayment penalty fees controlled by the
provisions of the “High-Cost Loan” or “Covered Loan” and the “Higher-Cost/Priced Mortgage Loan” laws
subsequently enacted (if the loan transaction is subject to these laws). The prepayment penalty fees under the
“High-Cost Loan” or “Covered Loan” law are controlled by Financial Code Section 4973(2)(C) and such fees
under the “Higher-Cost/Priced Mortgage Loan” law are controlled by Financial Code Section 4995.1. While the
foregoing late charges and prepayment penalty fees established in Article 7 were intended for single family,
owner-occupied dwellings, these provisions apply to any loans negotiated by MLBs (Business and Professions
Code Sections 10241.1, 10242.5, 10242.6, 10248, and 10248.1).

Commissioner’s Regulations

As previously cited in this section, regarding Article 7, real estate licensees should be familiar with
Commissioner’s Regulations 2840, 2841, 2841.5, 2842, 2842.5, 2843, and 2844.

REAL ESTATE SETTLEMENT PROCEDURES ACT (RESPA) REGULATION X

Background

The U. S. Congress enacted the Real Estate Settlement Procedures Act (RESPA) in 1974 to provide certain
consumers/borrowers with early information about the fees, costs, and expenses involved in real estate
transactions that include federally related mortgage loans. RESPA also protects consumers/borrowers from
hidden kickbacks and other abusive practices. In residential transactions involving federally related mortgage
loans, RESPA requires consumers/borrowers who are refinancing, further encumbering, or purchasing (as the
buyers) the intended security property to receive information regarding settlement or closing costs and prepaid
expenses (estimates of fees, costs, expenses and “points” to be incurred).

The term “points” as applied in the financial services industry includes loan origination fees; discounts to adjust
investor yields or to assist in accomplishing a “rebate” sufficient to pay the required fees, costs, and expenses to
settle or close the loan transaction; and to pay the commissions imposed by mortgage brokers (MLBs/MLOs)
for services rendered to arrange mortgage loans. In this Chapter, the consumer/borrower is the person applying
for a loan and to whom the disclosures and notices of rights are to be delivered.

Federally Related Mortgage Loans

Generally, federally related mortgage loans include loans the proceeds of which are for the purpose of
purchasing, refinancing, or further encumbering real property improved with 1 to 4 residential units. The
residential real property may be owner occupied or non-owner occupied, and the deed or trust or mortgage
securing the repayment of the loan may be recorded senior or junior in priority (12 USC Section 2601 et seq.
and 24 CFR Section 3500 et seq.).

The specific definition of the term, “federally related mortgage loan”, as set forth in RESPA is any loan (other
than temporary financing such as a construction or bridge loan) which:

“(A) is secured by a first or subordinate lien on residential real property (including individual units of
condominiums and cooperatives) designed principally for the occupancy of from one to four families, including
any such secured loan, the proceeds of which are used to prepay or pay off an existing loan secured by the same
property; and

(B) (i) is made in whole or in part by any lender the deposits or accounts of which are insured by any agency of
the Federal Government, or is made in whole or in part by any lender which is regulated by any agency of the
Federal Government; or

(ii) is made in whole or in part, or insured, guaranteed, supplemented, or assisted in any way, by the Secretary
or any other officer or agency of the Federal Government or under or in connection with a housing or urban
development program administered by the Secretary or a housing or related program administered by any other
such officer or agency; or

(iii) is intended to be sold by the originating lender to the Federal National Mortgage Association, the
Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, or a financial
institution from which it is to be purchased by the Federal Home Loan Mortgage Corporation; or

(iv) is made in whole or in part by any “creditor”, as defined in section 103(f) of the Consumer Credit
Protection Act (15 USC Section 1602 (f)), who makes or invests in residential real estate loans aggregating
more than $1,000,000 per year, except that

for the purpose of this Act, the term “creditor” does not include any agency or instrumentality of any State” (12
USC Section 2602 (1)(B)).

Exemptions from RESPA

RESPA applies to federally related mortgage loans (as defined) except for loans secured by real property
consisting of 25 acres or more, vacant land, or for a loan that is primarily for business, commercial, or
agricultural purposes. Loan transactions for temporary or short-term purposes (defined as construction or bridge
loans) are exempt from the application of RESPA. The temporary financing exemption from RESPA relies
upon the definition for such financing included within the regulations promulgated under TILA (12 CFR
Section 226.3(a)(1)).

The definition for temporary financing applied under California law is similar to the federal definition with a
noted exception that state law imposes, i.e., such loans must have a maturity of one year or less. Further, bridge
loans when applied under California law are for the express purpose of financing the acquisition or construction
of a dwelling intended to be the consumer’s/borrower’s principal residence (Financial Code Section 4970(d)).

Further, RESPA does not apply to loan “assumptions” (transfers of the title to the security property) without at
the same time transferring the liability of the initial maker of the mortgage loan through an assumption
agreement executed by the transferee and the creditor/lender. Such transfers occur “subject to” the existing
mortgage loan and may well be in violation of due–on-sale clauses included within the loan documents. RESPA
also does not apply to contemplated conversions of existing loans from one amortization to another or from
adjustable to a fixed interest rate residential mortgage loan. Secondary market transactions where the
originating creditor/lender sells, endorses or assigns the mortgage loan as an “asset in being” (an asset existing
as part of a loan portfolio) to the ultimate investor(s) are also exempt from RESPA (24 CFR Section 3500.5(a)
and (b)).

Definitions of “Creditor” and of “Lender”

The Consumer Credit Protection Act, commonly referred to as the Truth-In-Lending Act (TILA), applies to
qualifying “creditors” (15 USC Section 1601 et seq. and 12 CFR Section 226 et seq.). Accordingly, federal law
applies two distinguishable definitions to the persons or entities that fund and make loans, i.e., “creditors” and
“lenders”. RESPA defines the persons or entities that fund or make loans as “lenders”.

Pursuant to TILA, the term ''creditor'' refers to a person (or entity) that “(1) regularly extends, whether in
connection with loans, in sales of property or services, or otherwise extends consumer credit which is payable

by an agreement in more than four installments or for which the payment of a finance charge is or may be
required, and (2) is the person to whom the debt arising from the consumer credit transaction is initially payable
on the face of the evidence of indebtedness or, if there is no such evidence of indebtedness, by agreement…”
(15 USC Section 1601(f) and 12CFR Section 226.2(a)(17)). The conjunctive “and” requires both the extension
of credit (funding and making the loan) and being identified as the initial payee on the face of the evidence of
indebtedness or the agreement.

Further, a person or entity regularly extends consumer credit, “… only if it extended credit (other than credit
subject to the requirements of 226.32) more than 25 times (or more than 5 times for transactions secured by a
dwelling) in the preceding calendar year. If a person did not meet these numerical standards in the preceding
calendar year, the numerical standards are to be applied to the current calendar year. A person regularly extends
consumer credit if, in any 12-month period, the person originates more than one credit extension that is subject
to the requirements of 226.32 or one or more such credit extensions through a mortgage broker” (15 USC
Section 1601(f) and 12 CFR 226.2(a)(17)). The TILA definition of “creditor” has been adopted for RESPA
purposes (12 USC Section 2602).

The term “lender” is defined in applicable federal law as persons and entities that regularly make loans and that
appear on the promissory note and other evidence of indebtedness as the initial payee. Under federal law, the
term “creditor” applies to persons and entities that complete and deliver certain disclosures and notices of rights
to consumers/borrowers when making residential mortgage loans. The term “creditor” also applies under
federal law to persons or entities that make residential mortgage loans that are subject to various federal
mandates, including the completion of demographic and geographic reports, and that otherwise require
compliance with consumer/borrower protection objectives. The result of the foregoing is a “two-pronged”
definition for those persons and entities engaged in the funding and making of residential mortgage loans, i.e.,
“lenders” and “creditors”.

RESPA Amendments

Significant changes to RESPA were published November 17, 2008. The new regulations became effective over
a period of several months, commencing January 16, 2009, and concluding as of January 1, 2010. These
changes include (among other technical changes) amending the contents of the booklet, “Shopping for Your
Home Loan, HUD’s Settlement Cost Booklet”; revisions to the Good Faith Estimate; modifying the HUD-1 and
HUD-1A Settlement/Closing Statements; restructuring the Servicing Disclosure Statement; and altering the
requirements for the Initial Escrow (Impound) Account Statement. Each of the foregoing amendments,
revisions, modifications, alterations, or restructuring is discussed in this Section.

Special Information Booklet

There are six disclosure requirements under RESPA. The first is to provide mortgage loan applicants
(consumers/borrowers) with a special information booklet. This booklet entitled, “Shopping for Your Home
Loan, HUD’s Settlement Cost Booklet”, revised in December 2009, is available on the HUD website at
www.hud.gov. The booklet is to be delivered to a person from whom the creditor/lender receives or for whom a
written application is prepared in connection with a federally related mortgage loan. The special information
booklet may be translated into languages other than English when appropriate or as required by applicable law.

When Required

The special information booklet is to be received by the applicant (consumer/borrower) at the earliest possible
time; however, the booklet is not required when the applicant is applying for a reverse mortgage. In open-end
credit transactions, such as home equity lines of credit (HELOCs), the special information booklet may be
replaced with the booklet published by HUD entitled, “When Your Home is on the Line, What You Should
Know about Equity Lines of Credit”.

Multiple Applicants

When two or more persons (consumers/borrowers) apply together for a loan, the creditor/lender is in
compliance if one consumer/borrower receives a copy of the booklet. The creditor/lender may deliver the
booklet to the applicant or mail it to the applicant (consumer/borrower) no later than three business days after
the application is received or prepared. If the applicant uses a mortgage broker (MLB/MLO), the mortgage
broker is to provide the special information booklet relieving the creditor/lender from the responsibility to do
so. Further, if the creditor/lender denies the application for credit of the consumer/borrower before the end of

the three-business-day period, then the creditor/lender need not provide the booklet (12 USC Section 2604 and
24 CFR Section 3500.6(c) and (d)).

Time of Delivery

Disclosures required under RESPA are generally to be completed and delivered within a defined number of
business days. For RESPA purposes, a business day is defined as a day on which the offices of the person or
business entity (creditor/lender or mortgage broker (MLB/MLO)) are open to the public for carrying on
substantially all of the entity’s business functions (24 CFR Section 3500.2(b)). Notwithstanding the foregoing,
Sundays and federal holidays are excluded from the definition of a business day.

Good Faith Estimate

Content, Form, and Delivery

The second required disclosure under RESPA is the Good Faith Estimate (GFE). The GFE is to be completed
and delivered to the applicant (consumer/borrower) and it includes an estimate of settlement charges or closing
costs and prepaid expenses as well as the prospective material loan terms. RESPA requires that a GFE
disclosing the fees, costs, and expenses and the material loan terms be completed and delivered to the
consumer/borrower no later than three business days after preparing the loan application or receiving
information sufficient to complete an application, whether received by the creditor/lender or the mortgage
broker (MLB/MLO) (24 CFR Section 3500.7).

The creditor/lender or the mortgage broker (MLB/MLO) is to provide the GFE to the loan applicant
(consumer/borrower) by hand delivery; by placing it in the mail; or, if the applicant agrees, by fax, e-mail, or
other electronic means. When the residential mortgage loan is being delivered to the creditor/lender by a
mortgage broker (MLB/MLO), it is the obligation of the creditor/lender funding the mortgage loan to verify the
GFE was delivered to the consumer/borrower within the three business days as described in this paragraph. If
the GFE was timely delivered by the mortgage broker (MLB/MLO), then the creditor/lender need not complete
and deliver the GFE. A GFE is not required on home equity lines of credit (HELOCs), or regarding loan
applications denied by the creditor/lender or withdrawn by the applicant (consumer/borrower) within the
statutory three days. (24 CFR Section 3500.7(a)(3)(i)(ii)).

Tolerances for Amounts Included on the GFE

Neither the creditor/lender nor the mortgage broker (MLB/MLO) may charge, as a condition for providing a
GFE, any fee for an appraisal, inspection, or other similar settlement services. The creditor/lender or the
mortgage broker (MLB/MLO) may, at its/their option, charge a fee limited to the cost of a credit report. No
additional fees may be charged by the creditor/lender or the mortgage broker (MLB/MLO) until after the
applicant (consumer/borrower) has received the GFE (24 CFR Sections 3500.7 (a)(4) and (b)(4)). The GFE is
deemed received by the consumer/borrower within three calendar days subsequent to the mailing, excluding
Sundays and legal holidays specified in applicable federal law (5 USC Section 6103(a) and 24 CFR Section
3500.7 (a)(4) and (b)(4)).

The loan application includes an estimate of the then market value of the intended security property as
represented by the applicant (consumer/borrower) or as may be reflected in a purchase and sale agreement (if
the loan is to finance the purchase of the intended security property). The creditor/lender or the mortgage
broker (MLB/MLO) are advised to research comparable sales and/or listings in the neighborhood where the
intended security property is located through on line vendor services, MLS’, or through information available
from title companies. The purpose of the foregoing is to apply reasonableness tests as the appropriate standard
when considering the applicant’s estimate of market value or that the proposed sales price of the intended
security property bears a relationship to recent comparable sales in that neighborhood.

Limitations on Collection of Fees

The creditor/lender or the mortgage broker (MLB/MLO) may at any time collect from the loan applicant
(consumer/borrower) information in addition to the contents of the application (as described and defined), when
the creditor/lender is prohibited from requiring such information as a condition for providing a GFE. An
example is the applicant (consumer/borrower) may not be required to submit supplemental documentation to
verify the information provided on the loan application (24 CFR Section 3500.7 (a)(5) and (b)(5)). However,
the creditor/lender may obtain verification from third parties in support of the information included in the
application provided no fees, costs, and expenses are imposed on the applicant (consumer/borrower) other than

a credit report fee in advance of providing a GFE. As previously mentioned, the foregoing includes (among
others) the fee for an appraisal report (24 CFR Section 3500.7 (a)(4) and (b)(4)).

Binding on Loan Originator

It is paramount the GFE contains accurate information. While the GFE is not a commitment to lend by the
creditor/lender, the creditor/lender and the mortgage broker (MLB/MLO), as loan originators, are each bound
within the tolerances established when completing and delivering the GFE to the consumer/borrower. Some of
the fees, costs, and expenses disclosed are subject to zero tolerances and others are subject to the 10 percent
tolerance cap on the amounts disclosed in the GFE. Should the loan originator provide a new or revised GFE to
the consumer/borrower prior to settlement or the close of the loan escrow, documentation must be included
supporting the reasons for the revisions.

The estimate of the charges (fees, costs, and expenses) for settlement services and the loan terms must remain
available for at least 10 business days from when the GFE is initially delivered to the consumer/borrower. The
loan originator may elect to maintain the GFE and the estimated charges and loan terms for longer than 10 days.
Should the loan originator extend the period of availability of the GFE, certain estimated charges or loan terms
are not subject to the tolerance requirements. These are the interest rate; the charges and loan terms dependent
upon the interest rate (which include the charges for credit to reimburse the fees, costs, and expenses through
adjustments in the interest rate chosen); the adjusted origination charges, if any; and the daily or per diem
interest (24 CFR Section 3500.7(c)).

If a consumer/borrower does not express an intent to continue with a loan application within 10 business days
after the GFE is delivered or during the extended period of availability offered by the loan originator, the
creditor/lender or mortgage broker (MLB/MLO) is no longer bound to the initial GFE (24 CFR Section 3700.5
(f)(4)).

Retention of Documents and Disclosures

Loan originators must retain copies of GFEs and documentation of the reasons in support of a new or revised
GFE for a minimum of three years after settlement or loan closing (24 CFR Section 3500.7(f)). Mortgage loan
brokers (MLBs/MLOs) are required under state law to retain the entire loan file for at least three years
subsequent to loan closing or the last action taken, whichever is later (Business and Professions Code Section
10148).

Changed Circumstances

Change in circumstances includes those requested by the consumer/borrower; those affecting the
consumer’s/borrower’s eligibility and/or the ability to qualify for the specific loan terms disclosed; those
affecting the anticipated or represented market value of the intended security real property; or those affecting
increased costs of settlement services that exceed the tolerances for those charges arising from the foregoing
changed circumstances. Should changed circumstances apply, the loan originator should provide a revised GFE
to the consumer/borrower. If a revised GFE is delivered to the consumer/borrower, the loan originator must do
so within three business days after receiving information to establish the changed circumstances (24 CFR
Section 3500.7(f)(1), (2) and (3)).

Distinctions between Federal and State Law

Application of this federal law is not as strict as state law when considering the fiduciary duties owed by the
mortgage broker (MLB/MLO), a category of loan originator distinguishable from those who are
creditors/lenders or employees/agents of creditors/lenders. As the agent and fiduciary of the consumer/borrower
where the contemplated loan is being delivered to a depository institution or a licensed lender (the
creditor/lender), the change in circumstances (regardless of cause or reason) must be disclosed by the mortgage
broker (MLB/MLO) to the consumer/borrower (Business and Professions Code Section 10240 et seq.; and 10
CCR, Chapter 6, Section 2840 et seq.; Civil Code Sections 2295 et seq. and 2923.1; and Financial Code
Sections 4979.5, 4995(c) and (d) and 4995.3(c)).

The MLB/MLO is required under California law to complete and deliver to the consumer/borrower a Mortgage
Loan Disclosure Statement (MLDS) together with the GFE in a federally related loan transaction, as defined.
California law requires the material loan terms, including the estimated fees, costs, and expenses to be
disclosed, in writing, as well as any change in the foregoing through the use of the MLDS (and through a

revised GFE to avoid any conflicts between the two required disclosure statements). This means the material
loan terms and the estimated fees, costs and expenses and any changes are to be in writing and evidence of such
disclosures is to be maintained in the loan file. The purpose is to ensure no misrepresentation occurs and that no
false promises have been made to the consumer/borrower by the mortgage loan broker (MLB/MLO) (Business
and Professions Code Sections 10176(a), (b) and (c), 10177(d), (g) and (j), 10240 et seq., and 10 CCR, Chapter
6, Section 2840 et seq.; Civil Code Sections 2295 et seq. and 2923.1; and Financial Code Sections 4979.5,
4995(c) and (d) and 4995.3(c)).

Generally, state laws that are inconsistent with RESPA are preempted to the extent of the inconsistency.
However, the regulations promulgated pursuant to RESPA are not intended to “…annul, alter, affect, or exempt
persons subject to their provisions from complying with the law of any state with respect to settlement
practices, except to the extent of the inconsistency” (24 CFR Section 3500.13). The requirement under
California law to obtain the signature of the loan applicant (consumer/borrower) on the MLDS and to include
the GFE for this purpose (prior to becoming obligated to the loan transaction) represents an added
responsibility of the MLB/MLO that is not an “inconsistency” subject to the preemption (Business and
Professions Code Section 10240 and 10 CCR, Chapter 6, Section 2842.5).

Comparison of GFE with HUD-1 or HUD-1A

As aforementioned, charges disclosed on the GFE are compared for accuracy prior to drawing of the loan
documents (including instruments, disclosures, notices of rights and escrow instructions) and when funding the
loan. The settlement or loan closing statement (HUD-1 or HUD-1A) must be reviewed in advance of settlement
or loan closing to ensure no unauthorized changes have occurred to the fees, costs, and expenses. As
previously mentioned, once the GFE is completed and delivered to the consumer/borrower, certain charges are
subject to a zero tolerance. Charges that cannot change include the origination fee (whether imposed by the
creditor/lender or the mortgage broker (MLB/MLO)), the credit or charge (“points”) for the specific interest
rate chosen after the interest rate is “locked”, and transfer taxes (24 CFR Section 3500.7(e)).

A 10 percent tolerance is applied to the sum of the prices for services where either the creditor/lender or the
mortgage broker (MLB/MLO) requires the use of a particular provider, or the consumer/borrower uses a
provider selected or identified by the loan originator (24 CFR Sections 3500.2 and 3500.7(e)). The charges
required by the service providers selected by the loan originator (creditor/lender or the MLB/MLO); the fees
imposed for title services including title insurance coverage (lender’s and owner’s title insurance coverage);
and the charges for other required services subject to shopping (when the consumer/borrower selects providers
identified by the loan originator) cannot increase by more than 10 percent at settlement or loan closing.
Government recording charges are also subject to a 10 percent cap, i.e., they cannot exceed the amount
disclosed in the GFE by more than 10 percent.

However, the services for which the consumer/borrower selects a provider (other than a provider identified by
the loan originator) are not subject to any tolerance cap and, at settlement or loan closing, would not be
included in the sum of the charges on which the 10 percent tolerance is based. Charges of third party service
providers can change in addition to those where a service provider chosen by the consumer/borrower is used.
Other charges that can change include the initial deposit for an escrow (impound) account, daily or per diem
interest charges, and premiums for property insurance coverage (24 CFR Section 3500.7(e)).

While the regulations do not refer to property taxes, the amount of such taxes may change through pro-rations,
and the amount of reserves required when establishing an escrow (impound) account may also be subject to
change (depending upon the date of settlement or loan closing). California creditors/lenders and mortgage
brokers (MLBs/MLOs) should be aware that if the proceeds of the loan are to facilitate the purchase of
residential real property, future property taxes may be increased by supplemental tax assessments resulting from
the purchase price paid for the security property.

Interest Rate Locks and Loan Commitments

The term “interest rate lock commitment” was defined in the Mortgage Bankers Association Presentation to
Bank Regulatory Agency Representatives made on February 20, 2004. This presentation included a definition
which in part states, “An interest rate lock commitment represents a lender’s agreement to make money
available to a borrower within a specified time period at a specified rate for a specified tenor…”. When
“locking” the interest rate in residential loan transactions, the consumer/borrower may elect to “lock” typically

for periods of 15, 30, 45 or 60 days. Generally, the lock period selected is from 45 to 60 days. Shorter periods
are often selected when pre-approval of the loan has been extended by a creditor/lender and in those
circumstances when a purchase transaction must close within a short defined period.

“Pre-approve” vs. “Pre-qualify”

Interest rate locks with a commitment to make a loan to a consumer/borrower at a specified rate and terms for
an identified period (based upon “pre-approval” subject to specified conditions) is an offer from the intended
creditor/lender that may not be made by a mortgage loan broker (MLB/MLO). It is a misrepresentation and a
false promise for a MLB/MLO to communicate a “lock” in the rate and terms of a mortgage loan without
identifying the source of the “lock of rate and loan terms”. The MLB/MLO is obligated to disclose the material
facts relevant to the consumer’s/borrower’s decision to rely upon the “lock”, including the identity of the
intended creditor/lender (Business and Professions Code Sections 10176 (a),(b), (c), (k) and (l)).

Creditors/lenders may “pre-approve” the loan application of a consumer/borrower whereas mortgage brokers
(MLBs/MLOs) may “pre-qualify” but may not “pre-approve.” It is a misrepresentation for a mortgage broker
(MLB/MLO) to pre-approve or to issue a “lock” and/or “commitment”, unless the MLB/MLO is the
creditor/lender or the authorized agent for the creditor/lender for such purposes (Business and Professions Code
Sections 10176(a),(b),(c) and (k) and 10177 (g) and (j)). It is also unlawful for an MLB/MLO to delay the
closing of a mortgage loan to increase fees, costs, or expenses (charges) payable by the consumer/borrower
(Business and Professions Code Sections 10176(l) and 10177 (g) and (j)).

Revised GFEs

If the interest rate has not been “locked” or a “locked interest rate” has expired; the charge for the interest rate
chosen, the adjusted origination charges, the daily or per diem interest, and the loan terms related to the interest
rate lock may change. If the consumer/borrower later requests a “locked interest rate”, a revised GFE must be
completed and delivered showing the altered interest rate and dependent charges and loan terms. All other
charges and loan terms must remain the same as on the original/initial GFE, except as otherwise provided in the
event of changes in circumstances (24 CFR Section 3500.7 (f)(5)).

In the event the contemplated loan transaction is to finance a new home purchase and the anticipated settlement
or loan closing is to occur more than 60 calendar days from the time the initial GFE is completed and delivered,
the loan originator must separately disclose in a clear and conspicuous manner that a revised GFE may be
issued to the consumer/borrower. Should a separate disclosure occur in anticipation of a revised GFE, the
subsequent disclosure must comply with the required tolerances established by the original/initial GFE, except
as to the changed circumstances previously discussed (24 CFR Section 3700.5(f)(6)).

Violations of Section 5 of RESPA Regarding GFEs

Should any charges at settlement or loan closing exceed the fees, costs, and expenses listed on the GFE by more
than the permitted tolerances, the loan originator is to cure the tolerance violation by reimbursing the
consumer/borrower the excess amounts. The required reimbursement are the amounts by which the tolerances
were exceeded at settlement or loan closing, and the reimbursement is to be made either at loan closing or
within 30 calendar days thereafter. If the loan originator delivers or places the reimbursement in the U. S. Mail
within 30 calendar days after settlement or loan closing, the consumer/borrower is presumed to have timely
received the reimbursement.

It may prove to be difficult for a loan originator who is a mortgage broker (MLB/MLO) to cure tolerance
violations beyond the scope of the mortgage broker’s authority and capacity. Many MLBs/MLOs are pursuing
a practice of establishing the amount of the estimated fees, costs, and expenses, and the specific material loan
terms through creditors/lenders; with settlement agents, title insurers, title companies or public escrows in
advance of issuing the original/initial GFEs (24 CFR Section 3500.7(i)).

Apparently, a HUD omission has occurred regarding enforcement of Section 5 of RESPA. As of this writing,
no sanctions or penalties exist for violations of Section 5 other than timely curing any breach of the tolerance
limits or conforming the transactional terms to the material loan terms disclosed in the GFE. HUD indicates it
plans to seek authority from the U. S. Congress to impose civil monetary penalties and injunctive and equitable
relief for such RESPA violations. In the meantime, it is likely banking and other regulators will enforce the new
GFE requirements under their regulations. Federal regulators are likely to examine the fees, costs, and expenses

and material loan terms disclosed in the GFE and compare these disclosures to the HUD-1 or HUD-1A and to
the loan documents to learn whether compliance with Section 5 has occurred.

Available Instructions

HUD has prepared instructions to assist loan originators in completing and delivering the GFE that are
available on the HUD website at http://edocket.access.gpo.gov/cfr_2009/aprqtr/24cfr3500AppC.htm.

HUD-1 or HUD-1A

Required Use

The third disclosure required by RESPA in a federally related loan transaction is either the HUD-1 or HUD-1A.
Generally, the HUD-1 is to be used when the security property is being purchased and sold and the HUD-1A
when the purpose of the loan is to refinance or further encumber the intended security property (24 CFR
Section 3500.8 (a), (b), and (c)).

Form HUD-1 is required in every settlement or closing statement involving a federally related mortgage loan in
which there is a borrower (buyer) and a seller. In preparing regulations to implement RESPA, HUD has
focused on the borrower even in sales transactions. The borrower and the buyer are generally the same person
in such transactions. As previously mentioned, the HUD-1 is the appropriate form when the proceeds of the
loan are used to purchase the security property, i.e., a residential property improved by 1 to 4 dwelling units.
Creditors/lenders may use the HUD-1 in other transactions such as refinancing loans or loans secured by
subordinate liens by simply using the borrower’s side of the form. A single HUD-1 may be distributed to
multiple borrowers in the same transaction.

Form HUD-1A may be used as the settlement or loan closing statement for loans refinancing or further
encumbering the equity of the intended security property, or in other one-party transactions that do not involve
transfers of title. Creditors/lenders are not required to use either the HUD-1 or HUD-1A for open-end home
equity lines of credit (HELOCs), as long as the applicable provisions of Regulation Z are followed.

Comparison with GFEs

The settlement agent (or the escrow holder) is required to use the HUD-1 or HUD-1A settlement statement in
every settlement/escrow involving a federally related mortgage loan. In most cases, in transactions that involve
an escrow holder or settlement agent (for example, title insurance companies, underwritten title companies,
public escrows, or an attorney acting as a settlement agent), the creditor/lender historically did not have direct
statutory responsibility for the accuracy of the HUD-1 or HUD-1A (24 CFR Section 3500.8 (a), (b), and (c)).

However, the imposition of tolerance caps and related issues such as changes in circumstances place a burden
on creditors/lenders and mortgage brokers (MLBs/MLOs) to ensure the HUD-1 or HUD-1A is consistent with
the settlement charges or closing costs and prepaid expenses as disclosed in the GFE. This burden to ensure
consistency and to protect the consumer/borrower also extends to the material loan terms disclosed in the GFE
as well as in the disclosures required under Regulation Z of TILA.

Definition of Settlement Agent or Escrow Holder

The federal definition of “settlement agent” includes the creditor/lender if no one is designated by the parties in
the transaction to be a neutral settlement agent or escrow holder. In California, to function as a settlement agent
or escrow holder the person or entity requires licensing under the Public Escrow Law or an exemption from
licensing pursuant to this law (Financial Code Sections 17003, 17004 and 17006). The persons or entities that
may function as settlement agents or escrow holders without being licensed under the Public Escrow Law
include title insurance companies, underwritten title companies, banks, savings and loan associations, savings
banks, trust companies, or other licensed insurance carriers that are doing business under applicable laws of the
state of California or of the United States. Title insurance companies or underwritten title companies are
required to make an offer to issue a title policy as a predicate to conducting an escrow under this exemption.

In addition, persons licensed to practice law in California who are in a bona fide relationship with a principal to
a real property or a real property secured transaction may act as the settlement agent or escrow holder through
an exemption from the Public Escrow Law, provided the attorney is not actively engaged in business as an
escrow agent. Real estate brokers are also exempt from licensure under the Public Escrow Law when acting as
an escrow holder, provided the broker is either an agent or party to the real property or real property secured

transaction performing an act requiring a real estate license Financial Code Section 17006(a)(1) through (4),
and (b)).

Unlike most other settlement agents or escrow holders, brokers acting as an escrow holder in a real property or
a real property secured transaction are not functioning as a neutral escrow agent (Business and Professions
Code Section 10145 and Financial Code 17006). Further, mortgage bankers acting under the Residential
Mortgage Lending Act (RMLA) or finance lenders acting under the Finance Lender Law (CFLs) may not act in
California as settlement agents or escrow holders.

Obligation for Loan Originator to Review HUD-1 or HUD-1A

When the settlement agent or escrow holder is someone other than the creditor/lender, the creditor/lender
should obtain a copy of the HUD-1 or HUD-1A issued to the consumer/borrower from the settlement agent or
escrow holder. The purpose is to ensure the settlement agent or escrow holder has complied with the
instructions of the creditor/lender, including confirming that the amounts imposed as fees, costs, and expenses
are within the applicable tolerances of the estimates disclosed in the GFE. The creditor/lender is also to review
the HUD-1 or HUD-1a to ensure the material loan terms disclosed remain unchanged and to accomplish record
keeping obligations.

Similar obligations are imposed upon mortgage brokers (MLBs/MLOs) with the added burden of ensuring that
conformed copies of the deeds of trust or mortgages have been delivered to the creditor/lender or investor and
to the consumer/borrower as required under applicable law (Business and Professions Code Section 10234.5).
MLBs/MLOs must also confirm that the consumer/borrower received a copy of the final HUD-1 or HUD-1A
Settlement Statement.

Contents of HUD-1/HUD-1A

The HUD-1 settlement statement is a three-page document which has been redesigned to provide the
consumer/borrower with the ability to compare the estimates of settlement or closing costs and pre-paid
expenses given in the GFE to the actual charges shown on the HUD-1. Further, the HUD-1 includes a third
page that was added at the time of this writing to allow the consumer/borrower to determine if the actual
charges or closing costs and pre-paid expenses have exceeded the required tolerances and whether a
restatement of the same material terms of the loan as set forth in the GFE has occurred.

The GFE for comparison purposes is the last GFE (and when the loan originator is a MLB/MLO, the last
MLDS) that was completed and delivered to the consumer/borrower in accordance with applicable federal and
state law. The consumer/borrower should receive a final GFE including settlement or closing costs and prepaid
expenses that are actually being imposed as well as disclosing the material loan terms actually occurring in the
transaction (24 CFR Section 3500.8 (b) and (c) and Business and Professions Code Section 10240 et seq.).

As previously mentioned, the HUD-1A form applies in residential mortgage loan transactions where the
purpose of the loan is to accomplish the refinance or the further encumbrance of the intended security property.
The HUD1-A is a two-page statement that includes much the same information as the HUD-1, except no
information is included for a seller of real property (since no sales transaction is occurring). Again, the
information to be included must be sufficient to allow a consumer/borrower to compare the settlement charges
or closing costs and prepaid expenses to the fees, costs, and expenses and to the material loan terms as
disclosed in the GFE (24 CFR Section 3500.8 (a), (b) and (c)).

Advance Review by Consumer/Borrower

One-day in advance of the anticipated settlement or close of the loan escrow, the settlement agent or escrow
holder must permit the consumer/borrower to inspect the proposed HUD-1 or HUD-1A settlement statement as
completed, including all items known to the settlement agent or escrow holder at the time of inspection. The
one-day prior inspection of the proposed HUD-1 or HUD-1A is to occur during the business day immediately
preceding the date on which the contemplated transaction is to be settled or closed. The only items that may be
eliminated from the proposed HUD-1 or HUD-1A settlement statement for this advance inspection are those in
a sales transaction exclusively concerning the seller (24 CFR Section 3500.10 (a)).

Waiver of Right to Advance Review

The consumer/borrower may waive the right to inspect in advance the proposed HUD-1 or HUD-1A settlement
statement. Such waiver must be in a writing executed by the consumer/borrower. In such event, the settlement

agent or escrow holder is to deliver a completed HUD-1 or HUD-1A to the consumer/borrower as soon as
practical after the settlement or the close of the escrow (24 CFR Section 3500.10 (b) and (c)). When mailing the
HUD-1 or HUD-1A settlement statement, it is to be placed in the U.S. Mail addressed to the
consumers/borrowers at the address included within the loan application. A distinguishable address may be
used if authorized in writing and executed by the consumer/borrower (24 CFR Section 3500.11).

Neither the settlement agent nor the escrow holder or any other person (whether the creditor/lender, mortgage
broker, or a third party service provider) may impose a fee or charge to prepare and deliver the HUD-1 or the
HUD-1A settlement statement. This fee or charge prohibition applies to any disclosures or notices of rights
required under RESPA or pursuant to TILA (12 USC Section 2601 et seq. and 15 USC Section 1601 et seq.).

Servicing Disclosure Statement

When the Servicing Disclosure Statement is Required

The fourth disclosure required by RESPA in a federally related loan transaction is the Servicing Disclosure
Statement. When an application for a federally related mortgage loan is submitted or within 3 business days
after submission of the application, the creditor/lender or mortgage broker (MLB/MLO) who anticipates using
“table funding” or the dealer who anticipates a first lien dealer loan is to provide a Servicing Disclosure
Statement to each loan applicant (consumer/borrower) (24 CFR Section 3500.21 (a), (b), (c), and (d)).

Definition of Mortgage Servicing Loan/Federally Related Mortgage Loan

In the regulations promulgated to implement RESPA, the phrase “mortgage servicing loan” is interchangeable
with and is meant to mean a “federally related mortgage loan” (24 CFR Section 3500.2). The objective of
providing a Servicing Disclosure Statement is to inform the applicant (consumer/borrower) whether loan
servicing of the mortgage servicing loan/federally related mortgage loan may, will, or will not be transferred by
the identified loan originator.

As previously discussed, the term loan originator has been redefined in recent amendments to RESPA to
include for certain purposes creditors/lenders and mortgage brokers (MLBs/MLOs). A creditor/lender or a
mortgage broker in those jurisdictions where “table funding” is acceptable and who anticipates such a
transaction are each subject to the obligation of issuing a Servicing Disclosure Statement at the time of an
application for a federally related mortgage loan, or within 3 days after submission of the application. A
mortgage broker (MLB/MLO) in California may not engage in “table funding” (with a limited exception
described below) is not required to issue a Servicing Disclosure Statement (Business and Professions Code
Section 10234; 10CCR, Chapter 3, Section 1460; Financial Code Section 50003(o) and (t); and 24 CFR Section
3500.21 (a), (b), (c), and (d)).

“Table Funding” Defined

The issue of “table funding” has been previously discussed in this Chapter. However, for the purposes of
completing and delivering the Servicing Disclosure Statement, a further discussion is necessary. Except in
narrow circumstances involving California mortgage bankers (licensed under the RMLA) that are relying on
funds advanced from an affiliated creditor/lender (as defined), “table funding” is unauthorized under and
inconsistent with applicable state law (Business and Professions Code Section 10234; 10CCR, Chapter 3,
Section 1460; and Financial Code Section 50003(o) and (t)).

While various references are made to “table funding” in federal regulations promulgated under RESPA or
otherwise, the definitions applied to this practice must first be understood to interpret the application of such
references to the relationships between creditors/lenders (as one category of loan originator) and mortgage
brokers (as another category of loan originator). In the federal regulations implementing RESPA, “table
funding” is defined to mean a settlement at which a loan is funded by a contemporaneous advance of loan funds
and an assignment of the loan to the person(s) advancing the funds. In California, such transactions are
“concurrent assignments”. For RESPA purposes, a “table funded” loan is not a secondary market transaction
(24 CFR Section 3500.2).

Secondary Market Transactions Defined

Secondary market transactions are defined under RESPA as a bona fide transfer of a loan obligation in the
secondary market, except as set forth in Section 6 of RESPA and in accordance with 24 CFR Section 3500.21.
The aforementioned regulation is relevant to this discussion and distinguishes a secondary market transaction

for the purposes of establishing the actual creditor/lender and thus the obligation to complete and deliver the
Servicing Disclosure Statement. While obligated to complete and deliver the Servicing Disclosure Statement, a
mortgage broker (MLB/MLO) in a “table funded” transaction (where authorized under federal law in
jurisdictions other than California) does not become the creditor/lender (12 USC Section 2602(1); 24 CFR
Section 3500.2; 15 USC Section 1602(f); and 12 CFR 226.2(a)(17)).

HUD has stated that in determining what constitutes a bona fide transfer for a secondary market transaction
will depend on the real source of funding and the real interest of the funding creditor/lender. Further, HUD
points out “table funded” mortgage broker transactions are not secondary market transactions; and neither is the
creation of a dealer loan nor a dealer consumer credit contract, nor is the assignment of such a contract to a
creditor/lender (24 CFR Section 3500.5 (b)(7)).

Table Funding Pursuant to California Law

The differences in definitions and use of the term “table funding” between federal and California law are
consistent. While applicable federal law does not seek to prohibit “table funding”, the previously identified
federal statutes and regulations clearly define such transactions as brokering and not lending, i.e., other than a
secondary market transaction. The mortgage broker (MLB/MLO) when authorized to engage in “table funding”
is to complete and deliver the Servicing Disclosure Statement (even though the relationship with the
creditor/lender advancing the funds is under applicable federal law other than a secondary market transaction).
A secondary market transaction occurs when a residential mortgage loan/a mortgage servicing loan is being
sold and assigned from one actual creditor/lender to another.

Rather, in such transactions the mortgage broker (MLB/MLO) is arranging and delivering the loan to the
creditor/lender that is the real party at interest while at the same time completing and delivering the Servicing
Disclosure Statement to the consumer/borrower. The purpose is for the MLB/MLO to disclose the material
facts regarding the transfer of loan servicing. Under California law, a mortgage broker (MLB/MLO) would be
misleading the consumer/borrower by claiming to be the creditor/lender when brokering or arranging the loan
rather than funding and making the loan. This is a misrepresentation of a material fact and an avoidance of and
a breach of fiduciary duty (Business and Professions Code Section 10176(a), (b), and (c); Civil Code Sections
2295 et seq. and 2923.1; and Financial Code Sections 4979.5, 4995(c) and (d) and 4995.3(c)).

The purpose of delivering the Servicing Disclosure Statement in “table funded” transactions is to ensure the
consumer/borrower is aware of the transfer of loan servicing by the person or entity identified on the
promissory note as the payee (24 CFR Section 3500.21 (a), (b), (c) and (d)). The Servicing Disclosure
Statement providing for the transfer of loan servicing, as defined, does not in and of itself establish the “table
funding” mortgage broker (MLB/MLO) held any loan servicing rights to transfer. California mortgage brokers
(MLBs/MLOs) who are unable to engage in “table funding” would not complete and deliver the Servicing
Disclosure Statement. Thus, no inconsistency exists with applicable federal law (24 CFR Sections 3500.5(b)(7)
and 3500.21 (a), (b), (c) and (d); Business and Professions Code 10234; 10 CCR, Chapter 3, Section 1460; and
Financial Code Section 50003 (o) and (t)).

Format for Servicing Disclosure Statement

A format for the Servicing Disclosure Statement appears in the Federal Register, Vol. 73 No 222 68259. The
specific language of the Servicing Disclosure Statement is not required to be used. The information set forth in
the “Instructions to Preparer” on the Servicing Disclosure Statement need not be included with the information
given to applicants (consumers/borrowers), and the material in the square brackets is optional or alternative
language.

The model format may be annotated with additional information that clarifies or enhances the model language.
The creditor/lender, “table funding” mortgage broker in authorized jurisdictions, or the dealer should use the
language that best describes the particular circumstances of each person or entity completing the statement. The
format appearing in the Federal Register is as follows:

“Sample language; use business stationery or similar heading”

[Date]

INITIAL ESCROW ACCOUNT DISCLOSURE STATEMENT

THIS IS AN ESTIMATE OF ACTIVITY IN YOUR ESCROW ACCOUNT DURING THE COMING YEAR BASED ON PAYMENTS ANTICIPATED TO BE MADE FROM YOUR ACCOUNT.

Month Payments to Payments from Description Escrow Account Escrow Account Escrow Account Balance

Initial deposit: ……………………………………………………………………………………..$

[A filled-out format follows.]

(PLEASE KEEP THIS STATEMENT FOR COMPARISON WITH THE ACTUAL ACTIVITY IN
YOUR ACCOUNT AT THE END OF THE ESCROW ACCOUNTING COMPUTATION YEAR.)

Cushion selected by servicer: $ .

[YOUR MONTHLY MORTGAGE PAYMENT FOR THE COMING YEAR WILL BE $ ,

OF WHICH $ WILL BE FOR PRINCIPAL AND INTEREST, $ WILL GO INTO

YOUR ESCROW ACCOUNT, AND $ WILL BE FOR DISCRETIONARY ITEMS (SUCH

AS LIFE INSURANCE, DISABILITY INSURANCE) THAT YOU CHOSE TO BE INCLUDED WITH
YOUR MONTHLY PAYMENT.]

[YOUR FIRST MONTHLY MORTGAGE PAYMENT FOR THE COMING YEAR WILL BE $ ,
OF WHICH $ WILL BE FOR PRINCIPAL AND INTEREST, $ WILL GO INTO YOUR

ESCROW ACCOUNT, AND $ WILL BE FOR DISCRETIONARY ITEMS (SUCH AS LIFE

INSURANCE, DISABILITY INSURANCE) THAT YOU CHOSE TO BE INCLUDED WITH YOUR
MONTHLY PAYMENT. THE TERMS OF YOUR LOAN MAY RESULT IN CHANGES TO THE
MONTHLY PRINCIPAL AND INTEREST PAYMENTS DURING THE YEAR.]

California Requirements for Escrow (Impound) Accounts

Funds held by the beneficiary/lender/mortgagee of a deed of trust or mortgage in an impound account for the
payment of property taxes, insurance premiums or other purposes relating to the security property are to be

retained and deposited in authorized California depository institutions. If funds in the impound accounts are
invested (as authorized by applicable law), such funds are to be only invested with California residences or
businesses (i.e., branches or subsidiaries of the businesses located in this state). The foregoing requirement is
subject to certain exemptions depending upon the identity and status of the creditor/lender (Civil Code Section
2955).

When a depository institution or a creditor/lender (as defined) makes a loan or purchases a promissory note
secured by a deed of trust or mortgage on real property located in this state (containing 1 to 4 residential units),
and the institution or creditor/lender creates an impound account for the payment of property taxes, insurance
premiums, or for other purposes related to the security property; a minimum of at least 2% simple interest per
annum shall be paid to the consumer/borrower on the funds maintained in the impound account. No fees or
charges are allowed for the maintenance or disbursements of monies received in advance in accordance with
the provisions of the escrow (impound) account. An exemption from the payment of the 2% simple interest is
provided for moneys that are required by state or federal regulation to be placed in non-interest bearing trust
fund accounts. This exemption does not apply to banks (Civil Code Section 2954.8).

Moneys maintained in escrow (impound) accounts represent trust funds held by loan servicers as agents of
identified principals. Real estate brokers are required to place such moneys into trust accounts to be established
and maintained in accordance with the Real Estate Law. Generally, real estate brokers when acting as
mortgage brokers (MLBs/MLOs) maintain trust funds in non-interest bearing accounts. However, if interest is
to be paid and disbursed in connection with the trust funds held, the trust accounts are to be segregated by each
principal for whom the funds are being held (Business and Professions Code Section 10145 and 10 CCR,
Chapter 6, Section 2830.1 et seq.).

Affiliated Business Arrangements

The sixth disclosure that may be required in transactions subject to RESPA is in connection with Affiliated
Business Arrangements (ABAs or AFBAs), formerly called Controlled Business Arrangements. ABAs occur
when affiliated service providers refer consumers/borrowers to each other in transactions subject to RESPA.
ABAs include entities with a defined percentage of common ownership. This common ownership may be held
by shareholders or by an entity common to both (e.g., a holding company). ABAs also apply to associated
relationships where one entity exercises control over, or shares control with the other (i.e., by joint venture,
partnership or, in certain fact situations, a common business plan). If one service provider benefits financially
by referring borrowers to another service provider, the cautious approach is to assume that the referral is subject
to ABA disclosures (24 CFR Section 3500.15(a), (b), and (c)).

Unless the affiliated entities or associated relationships occur pursuant to an acceptable division of labor or
services agreement, the ABA must function through a separate entity that may not be a division of either of the
affiliated parties. HUD has required adequately capitalized separate entities to be either corporations or
partnerships. Depending upon the activities of the service provider and unless a professional license is required
(as defined), it is possible under California law to structure separate entities as Limited Liability Companies
(LLCs) or Limited Liability Partnerships (LLPs). The preferred option is that of a corporation. The separate
entity must accept its own business risk, obtain licensing as required; and have, among other attributes, its own
facilities, management, and employees (24 CFR Section 3500.15(b) and (c)).

An ABA, whether a separate entity or structured pursuant to an acceptable division of labor agreement, may
receive payment for performing compensable loan services when engaged in loan originations subject to
RESPA. HUD has made it clear that sham entities will not be recognized and considered ploys for avoiding the
unauthorized payment of referral fees. The only thing of value that may be received from an ABA (other than
payments of fees, salaries, compensation or other forms of payment authorized pursuant to 24 CFR Section
3500.14(g)) is a return on an ownership interest or through a franchise relationship from the affiliated entity.
This may include bona fide dividends and distributions of capital or equity. Bona fide business loans, advances,
and capital or equity contributions among entitles in an affiliated relationship are not prohibited so long as they
are for ordinary business purposes and are not for fees for referral of settlement services, or fees that are
unearned (24 CFR Section 3500.15(a), (b), and (c)).

A return on ownership interests does not include any payment that has as a basis of calculation no apparent
business motive other than distinguishing among recipients payments predicated on the amount of the actual,

estimated, or anticipated referrals. Further, payments that vary according to the relative amount of referrals by
different recipients of similar payments; or that are based on an ownership, partnership, or a joint venture share
that has been adjusted for previous relative referrals by recipients of similar payments are also excluded from
the definition of a return on an ownership interest (24 CFR Section 3500.15(b)(3)).

When a face-to-face interview occurs with or when a written or electronic referral is offered to a
consumer/borrower, the ABA disclosure must be delivered at or before the time of the referral and the
creditor/lender must keep a record of the delivery to the consumer/borrower. The ABA disclosure must be in a
separate writing and may be delivered at the time the GFE is completed and delivered (whether separately or
with disclosures required pursuant to TILA). After a face-to-face interview, the creditor/lender must attempt to
obtain a written receipt from the consumer/borrower for the ABA disclosure. If the consumer/borrower refuses
to sign the receipt, the creditor/lender must note the refusal in the business records which must be maintained
for this purpose for five years after the date of execution (24 CFR 3500.15(b) and (d)).

If an ABA referral is made telephonically, the substance of the ABA disclosure must be given during the
conversation, together with an explanation that a separate written disclosure will follow within three business
days of the conversation. A record of the telephone discussion and mailing of the ABA disclosure must be
included in the records of the creditor/lender. Further, if a referral is made by a creditor/lender to an affiliated
creditor/lender, the ABA disclosure is to be delivered to the borrower at the time of the referral or no later than
three business days thereafter. The earliest point for delivery of the ABA disclosure is when the booklet
entitled, “Shopping for Your Home Loan, HUD’s Settlement Cost Booklet” is delivered. Again, the
creditor/lender should retain a record of this as well as any other delivery of the ABA disclosure (24 CFR
Section 3500.15(b) and (c)).

When a referral is made by an attorney or law firm to a client who is a consumer/borrower to a particular title
insurance agent, the ABA disclosure must be provided no latter than at the time the attorney or law firm is
engaged by the client. A creditor/lender may require the use of a particular provider of settlement services or a
business incident thereto when the provider is an attorney, credit reporting agency, or a real estate appraiser
chosen to represent the interests of the creditor/lender in the real estate transaction (24 CFR Section
3500.15(b)(1) and (2)).

Prohibition against Kickbacks and Unearned Fees

No person is to give and no person may accept any fee, kickback or other thing of value pursuant to any
agreement or understanding, oral or otherwise, in connection with a settlement service involving a federally
related mortgage loan transaction for the referral of such service to any other person (including an entity). A
thing of value is defined broadly to include, among others: moneys; things; discounts; salaries; commissions;
duplicate payments of a charge; stock; dividends; distributions of partnership profits; franchise royalties; credits
representing moneys that may be paid at a future date; the opportunity to participate in a money-making
program; payment of retained or increased earnings; increased equity in a parent or subsidiary; special bank
deposits or accounts; special or unusual banking terms; services, sales, or rentals at special prices or rates
including free rates, leases or rental payments based all or in part on the amount of business referred; providing
trips or the payment of expenses of another person; or reductions in credit against existing obligations.

HUD indicates the term “payment” as used in the context of the prohibition against kickbacks and unearned
fees is intended to be synonymous with the giving and receiving of any “thing of value” and does not require
the transferring of money from one person or entity to another. The payment of fees or other compensation
(including thing of value) must be reasonably related to the value of the goods and facilities provided and of the
services rendered (24 CFR Section 3500.14 and .15).

Division of Labor Agreements

In February 1995, HUD responded by letter to an inquiry from the Independent Banker’s Association of
American (IBAA) regarding agreements dividing loan origination services and compensation between IBAA
members and other service providers. HUD provided an opinion letter which allowed division of labor or
service agreements between service providers in certain fact situations. Before this letter, HUD generally
refused to recognize any cooperative mortgage brokerage agreements in loan transactions subject to RESPA.
Mortgage loan brokers (MLBs/MLOs) may now share the performance of compensable services when
originating RESPA loans.

A written agreement is necessary between mortgage brokers (MLBs/MLOs) describing the services each will
perform. Each MLB/MLO must perform at least six identifiable functions (e.g., 5 plus the loan application for
the broker representing the borrower). The division of compensation among cooperating brokers
(MLBs/MLOs) must be reasonably related to the value of the services each performs. Likewise, agreements
between brokers (MLBs/MLOs) and creditors/lenders to share origination functions must be based upon
performance of compensable services for fees that are reasonably related to the value of the services provided.
Such agreements will not work in transactions that are FHA insured.

Cooperating Brokers (MLBs/MLOs)

RESPA contemplates the parties to a loan transaction would include the creditor/lender, a mortgage broker, a
borrower, and a security property. RESPA did not contemplate the use of two mortgage brokers
(MLBs/MLOs) in the same loan transaction. Notwithstanding the foregoing, on February 14, 1995, HUD issued
a letter to the IBAA in response to inquiries regarding cooperative brokering arrangements. The letter
described when compensation paid to more than one mortgage broker in a loan transaction subject to RESPA
would not be in violation of Section 8 (i.e., a "Division of Labor"). This letter provided a "safe harbor" to
creditors/lenders and to mortgage brokers (12 USC Section 2601 et seq. and 24 CFR Section 3500 et seq.). In
the IBAA letter, HUD identified the following services typically performed in the "origination" of a federally
related mortgage loan:

(a) Taking information from the Borrower and filling out the loan application;

(b) Analyzing the prospective Borrower's income and debt and pre-qualifying the prospective Borrower to
determine the maximum mortgage that the prospective Borrower can afford;

(c) Educating the prospective Borrower in the home buying and financing process, advising the Borrower
about the different types of loan products available, and demonstrating how closing costs and monthly
payments could vary under each product;

(d) Collecting financial information (tax returns, bank statements) and other related documents that are part
of the application process;

(e) Initiating/ordering VOEs (verifications of employment) and VODs (verifications of deposit);

(f) Initiating/ordering requests for mortgage and other loan verifications;

(g) Initiating/ordering appraisals;

(h) Initiating/ordering inspections or engineering reports;

(i) Providing disclosures (truth in lending, good faith estimate, others) to the Borrower;

(j) Assisting the Borrower in understanding and clearing credit problems;

(k) Maintaining regular contact with the Borrower, Realtors, Lender, between application and closing to
apprise them of the status of the application and gather any additional information as needed;

(l) Ordering legal documents;

(m) Determining whether the Security Property was located in a flood zone or ordering such service; and,

(n) Participating in the loan closing” (24 CFR Section 3500.14(b), (c), (d), (e), (f), and (g)).

HUD indicates it would generally be satisfied that no RESPA violation had occurred if it found that:

“The lender's agent or contractor (i.e., mortgage broker or cooperating broker) took the application information
under item (a);

The mortgage broker or cooperating broker performed at least five additional items on the list above, i.e., (a)
through (n); and,

The fees imposed by mortgage brokers are reasonably related to the value of the services performed.”

When two mortgage brokers (MLBs/MLOS) act in a loan transaction subject to RESPA, the mortgage broker
who solicited and/or initially undertook to represent the consumer/borrower to procure a creditor/lender to

extend credit and make a loan are the agents and fiduciaries of the consumer/borrower. The mortgage broker
(MLB/MLO) may perform (among others) each of the services described in (a) through (n) above. The
mortgage broker (MLB/MLO) may also delegate to a cooperating broker (as the subagent) the performance of
some of the aforedescribed settlement services. When such delegation lawfully occurs, and the
consumer/borrower acknowledges and consents to the appointment of the cooperating broker, the latter
becomes the subagent and fiduciary of the consumer/borrower and may be for certain limited purposes the
agent of the delegating mortgage broker (Business and Professions Code Sections 10176(d) and 10177(q); Civil
Code Sections 2295 et seq., 2349 et seq., and 2923.1; and Financial Code Sections 4979.5, 4995(c) and (d) and
4995.3(c)).

When one mortgage broker (MLB/MLO) performs the settlement services of taking the loan application plus
five additional items, the other mortgage broker (MLB/MLO) must perform each of the remaining items on the
list included in the IBAA letter. Accordingly, the settlement services to be performed by each mortgage broker
must be memorialized in writing in a document executed by both mortgage brokers (MLBs/MLOs). HUD is
particularly concerned the additional services of the second mortgage broker (MLB/MLO) are not limited to
"counseling-type" activities that result in unauthorized "steering" of the consumer/borrower. To engage in
meaningful counseling and to avoid "steering", the "counseling-type" services, i.e., (b), (c), (d), (j), and (k) on
the list in the IBAA letter when performed by the mortgage broker (MLB/MLO) must meet the following
standards:

■ “The "counseling" gave the Borrowers the opportunity to consider products from at least three
different approved lender(s);

■ The broker performing the "counseling" is to receive the same compensation regardless of which
approved lender(s)' product is ultimately selected; and,

■ Any payment made for the ‘counseling-type’ services is reasonably related to the value of the services
performed and not based on the amount of loan business referred.”

Bona Fide HUD Employee Exemptions

In 1997 HUD modified the limitations imposed on payment of referral fees or fee-splitting in RESPA loan
transactions. The modifications apply to payments which are made by employers to bona fide employees,
(recipients of W-2 tax forms). The employer/employee relationship must be neither a sham nor established on a
temporary basis to circumvent the intent of the regulation. HUD has outlined the following general exemptions
for payments made by employers to bona fide employees:

■ Payments for generating business for the employer, or for providing services in the loan origination
process;

■ Payments to marketing employees and managerial employees (employees not providing services) for
referrals to the employer or another provider within an ABA. (The latter must include an ABA notice);
and,

■ Payments to managerial employees based upon criteria relating to performance, as long as the
payments are not on a per loan basis” (24 CFR Section 3500.14(f) and (g)).

Independent Contractor Limitations

Independent contractor relationships are not subject to the same exemptions. Accordingly, loan representatives
who are independent contractors of a mortgage firm must be licensed and registered as MLBs/MLOs and are to
perform compensable loan services to be compensated in RESPA loan transactions. The compensation paid to
independent contractors must be reasonably related to the services they provide and should be evidenced by a
division of labor agreement between the mortgage firm and its independent contractors (24 CFR Section
3500.14(b), (c), (d), (e), (f), and (g)).

Affiliated Business Disclosure Statement Format

To:

From:

Property:

Date:

This is to give you notice that [referring party] has a business relationship with [settlement services
providers(s)]. [Describe the nature of the relationship between the referring party and the providers(s),
including percentage of ownership interest, if applicable.] Because of this relationship, this referral may provide
[referring party] a financial or other benefit.

[A.] Set forth below is the estimated charge or range of charges for the settlement services listed. You are NOT
required to use the listed provider(s) as a condition for [settlement of your loan on] [or] [purchase, sale, or
refinance of] the subject property. THERE ARE FREQUENTLY OTHER SETTLEMENT SERVICE
PROVIDERS AVAILABLE WITH SIMILAR SERVICES. YOU ARE FREE TO SHOP AROUND TO
DETERMINE THAT YOU ARE RECEIVING THE BEST SERVICES AND THE BEST RATE FOR THESE SERVICES.

[provider and settlement service] [charge or range of charges]

[B.] Set forth below is the estimated charge or range of charges for the settlement services of an attorney, credit
reporting agency, or real estate appraiser that we, as your lender, will require you to use, as a condition of your
loan on this property, to represent our interests in the transaction.

[provider and settlement service][charge or range of charges]

LENDER’S REMEDIES IN CASE OF DEFAULT

Foreclosures Generally

Foreclosure is a procedure used to terminate the right, title, and interest of a trustor/mortgagor in the security
real property by selling the encumbered property and using the sale proceeds in an effort to satisfy the debt/loan
of the lender/creditor.

A mortgage without a power of sale can only be foreclosed judicially (i.e., by court proceeding) pursuant to the
Code of Civil Procedure, commencing with Section 695.010, “The Enforcement of Money Judgments”. A deed
of trust or mortgage that contains a power of sale may be foreclosed nonjudicially by trustee’s sale in
accordance with the procedural law provided for in Civil Code Section 2924 et seq. Most security instruments
utilized in California expressly provide for power of sale, thus offering a choice to the lender/creditor of
electing a non-judicial or judicial foreclosure sale.

As previously discussed in this Chapter, where anti-deficiency judgments are sought and permitted by law, the
foreclosure must be accomplished judicially. The lender/creditor may proceed in the same court action to
foreclose, quiet title, and to eject the trustor/mortgagor, and to then proceed through the sale of the security
property (should the proceeds prove to be insufficient to fully pay the debt/loan) to obtain a money judgment as
ordered by the court. Money judgments are evidenced by an abstract of judgment which may be enforced
against the assets of the borrower/debtor through a writ of execution. The entire proceeding constitutes one
form of action comprised of respective parts (Code of Civil Procedures 726 et seq.).

As a general rule, procedural requirements in effect at the time the judicial foreclosure is begun will govern,
even if the requirements change (Code of Civil Procedure Section 725a et seq.). However, when amendments
occur to the non-judicial foreclosure procedural law, careful reading of the amendments is required to learn the
operative dates of each amendment and the effect the amendments may have on non-judicial foreclosures in
process (Civil Code 2924 et seq.).

“One-Action” Rule

Under California law, the “one-action” rule applies for recovery of any debt or enforcement of any right
secured by a deed of trust or mortgage on real property (Code of Civil Procedure Section 726).

The “one-action” rule requires the beneficiary/lender/mortgagee to first foreclose the security property before
seeking a personal money judgment against the maker/trustor/mortgagor. The personal money judgment
represents the deficiency between the amount of debt/loan (including any related authorized fees, costs and
expenses), and the amount received for the property at the judicial foreclosure sale.

The foregoing assumes this second part of the action is permitted under the anti-deficiency rules. Only after the
security has been exhausted may the unpaid lender/creditor seek a personal money judgment against the
maker/trustor/mortgagor. However, this stepped judicial procedure may not apply to guarantors. It should be
noted that a maker/trustor/mortgagor cannot guaranty his or her own debt. Depending upon the facts, limited
exceptions to the “one-action” rule may be available, e.g., the security becomes worthless due to the act or
negligence of the maker/trustor/mortgagor.

If a property is ‘‘legally” worthless (i. e., nonexistent or not actually owned by the maker/trustor/mortgagor, or
in a situation in which foreclosure would be meaningless because the security has been destroyed or has
become valueless not from any action of the creditor/lender) or where fraud is involved, the creditor/lender is
not limited to the “one-action” rule. Under such circumstances, the creditor/lender may sue directly on the
promissory note and need not first judicially foreclose.

California Financial Code Section 7460 authorizes depository institutions and their affiliates (as defined) to
seek damages for alleged fraud from the maker/trustor/mortgagor in an amount not to exceed 50% of the actual
damages, unless the security property is the owneroccupied residence of the borrower and the amount of the
loan is $150,000 or less (this amount being adjusted annually, commencing January 1, 1987, in accordance with
the Consumer Price Index published by the United States Department of Labor).

“Worthless security” does not include a loss in property or security value due to marketplace or economic
declines. Unless expressly authorized in the security instrument to occur with prior notice during the loan term,
the creditor/lender must generally first foreclose to have the court determine “economic worthlessness” in the
form of an opinion of value of the security property (an appraisal) and whether a writ of attachment may be
granted in connection therewith.

Status of “Sold Out” Junior Lien Holders

A first deed of trust or mortgage is a security instrument that achieves in the records of the county where the
security property is located first priority as the result of the date and time of recordation or through an express
subordination of a previously recorded security instrument. First deeds of trust or mortgages take precedent and
have priority over junior deeds of trusts or mortgages, i. e., security instruments that are either recorded
subsequent to or expressly subordinated to the prior recorded deed of trust or mortgage. A foreclosure by the
holder of a first deed of trust or mortgage will extinguish junior deeds of trust and mortgages and other liens
that are recorded subsequent to the prior recorded deed of trust or mortgage (as defined) except for super liens,
e. g., property taxes or certain bonds and assessments. This is known as lien cleansing.

A holder of a junior deed of trust or mortgage or other lien holders in such circumstances are “sold out” juniors.
Should the junior lien be a purchase money deed of trust or mortgage, the holder cannot proceed with a suit for
a money judgment for the amounts owed in accordance with the terms of the promissory note. However, if the
junior lien is a non-purchase money deed of trust or mortgage, the holder is not barred from proceeding with
such a suit.

As to the Parties

When the deed of trust or mortgage includes a power of sale, there are three parties to the security instrument.
In a deed of trust the three parties are: the trustor (borrower), the trustee (third party), and the beneficiary
(creditor/lender). In a mortgage with power of sale, the three parties are the mortgagor (borrower), the trustee
(third party), the mortgagee (creditor/lender). The trustor/mortgagor conveys technical title to the trustee to
hold until the trustor/mortgagor performs or defaults under the terms of the promissory note and deed of trust or
mortgage.

California is a lien theory not a title theory state. Accordingly, the technical title conveyed does not carry with it
limitations on the exercise of the “Bundle of Rights” extended to property owners under our constitutional
system, including the rights of possession and use of the security property. Therefore, the conveyance of
technical title is to accomplish a hypothecation or pledging of the security property as collateral for the
repayment of the debt/loan or the performance of an obligation without giving up the right to use and further
encumber the security property.

In the deed of trust or mortgage, the trustee’s function is to reconvey or release the technical title received by
the trustee to the security property back to the trustor/mortgagor when the debt/loan is paid in full. The trustee

also is authorized to proceed with the power of sale to nonjudicially foreclose and sell the security property to
pay the debt/loan, should the trustor/borrower breach the terms of the promissory note and deed of trust or
mortgage. The third power or authority conveyed to the trustee is to execute any instruments as directed by the
beneficiary/creditor/lender to reform the description of or any other provision of the deed of trust or mortgage.

The trustee in a mortgage with power of sale performs much the same functions as under the deed of trust. In a
mortgage, the manner through which to evidence the repayment of the debt/loan is historically known as a
certificate of discharge/satisfaction of mortgage. However, a mortgage with power of sale should be treated by
the trustee in the same manner as a deed of trust with a power of sale for this purpose, i. e., a deed of
reconveyance may be used.

As to Reinstatement

Under a deed of trust or mortgage, the trustor/mortgagor and certain other persons, including successors in
interest and subordinate lien holders listed in Civil Code Section 2924c, may reinstate the loan by curing the
default at any time in a non-judicial foreclosure proceeding up to five days prior to the date of the scheduled
trustee’s sale or the date of the postponed trustee’s sale.

In a judicial foreclosure proceeding, the same parties may reinstate before the sale is conducted as ordered by
the court. Reinstatement is accomplished by paying all delinquencies, including advances made by the lender to
a senior lien holder , plus all authorized fees, costs and expenses incurred because of the foreclosure action.

Under either security instrument, the lender’s right to accelerate payment of the debt/loan in the event of a
breach or default is limited by the statutory right of reinstatement. This right is intended to provide the
trustor/mortgagor with an opportunity to cure the breach or default (assuming it is curable) within a defined
period prior to the trustee’s sale or prior to the court ordered judicial sale. An example of a non-curable default
is a breach of the due-on-sale or due on further encumbrance provisions.

As to Redemption

Code of Civil Procedure Section 729.020 provides that property sold subject to the right of redemption may be
redeemed after the sale only by the judgment debtor or his successor in interest (i.e., the trustor/mortgagor).
Liens are money claims and include, among others, deeds of trust and mortgages. Junior lien holders are no
longer entitled to redeem the debt or loan represented by a senior lien. The junior lien (including deed of trust
or mortgage) cannot reattach unless pursuant to an order by a court of competent jurisdiction.

Accordingly, a junior lien holder must proceed with a lawsuit in the form of an action for a money claim for
amounts remaining owed to secure an abstract of judgment as an unsecured creditor. As indicated, liens are
money claims and also are encumbrances against the title of the security property; however, all encumbrances
are not liens. An example of an encumbrance that is not a lien is an easement.

The redemption period is three months after the judicial sale date, if the sale proceeds are sufficient to pay the
secured indebtedness (debt/loan) plus interest and costs of foreclosure. The redemption period is one year after
the judicial sale date, if the sale proceeds do not satisfy the amount of the debt/loan plus interest, authorized
fees, costs, and expenses. However, if the beneficiary/lender/mortgagee waives or is prohibited from obtaining
a deficiency judgment (e.g., a non-purchase money loan subject to a non-recourse agreement), there no longer
would be any right of redemption according to Code of Civil Procedure Section 726 (the “one-action” rule).

Under a deed of trust or a mortgage with power of sale, the trustor/mortgagor in most cases has a statutory right
of reinstatement after the notice of default up to five business days prior to the date of the trustee’s sale or the
date of any postponed sale and a right of redemption thereafter up to the time that the trustee or the agent of the
trustee cries the sale. No right of redemption applies following the trustee’s sale. The sale is absolute unless
otherwise ordered by a court of competent jurisdiction in a subsequent proceeding brought to set aside the sale.

As to Deficiency Judgments

A deficiency judgment is a personal judgment against a debtor/borrower for the difference between the unpaid
balance of the secured debt/loan (plus interest, authorized fees, costs, and expenses of sale) and the amount of
the actual proceeds of the sale. Depending upon the language used in establishing prepayment or yield
maintenance provisions (and assuming these provisions have not been imposed inconsistent with applicable
law), the additional amount due will increase the unpaid balance of the secured debt/loan.

Anti-deficiency Rules

Where a beneficiary or mortgagee elects to foreclose the security by power of sale (non-judicial foreclosure)
rather than by judicial foreclosure, a deficiency judgment is automatically barred under Code of Civil
Procedure Section 580d. Section 726 et seq. of the same code sets certain limits for a deficiency judgment; and
Section 580b prohibits deficiency judgments when specified purchase money secured loans are involved (as
previously discussed in this Chapter).

A seller/vendor extending purchase money credit generally cannot obtain a deficiency judgment if the
trustor/mortgagor breaches or defaults and a foreclosure sale fails to bring sufficient proceeds to pay off the
entire amount owing under the promissory note. An exception to this rule exists in the sale of a property to a
developer for land development or vertical construction and the seller/vendor subordinates his or her purchase
money lien to the deed of trust or mortgage evidencing the land development or construction loan. Upon default
by the purchaser/developer, the seller/vendor would typically lose his or her security interest after a foreclosure
sale under the senior lien. However, Code of Civil Procedure Section 580b will not be applied to bar recovery
by the subordinating junior seller/vendor of the unpaid balance of the purchase price of the security property
when the senior deed of trust or mortgage is a land development or vertical construction loan (Spangler v.
Memel (1972) 7Cal. 3rd603).

As previously discussed, if the proceeds of the court ordered sale pursuant to a judicial foreclosure were
adequate to satisfy the entire amount owing, the redemption right extended to the debtor/borrower would be
limited to three months. Should the proceeds from the court ordered sale of the security property be insufficient
to pay the entire amount owing (as defined), the lender/creditor may elect to sue the debtor/trustor/mortgagor
for the residual balance owing pursuant to the terms of the promissory note. When a deficiency judgment is
permitted following a judicial foreclosure and the court ordered sale of the security property, the redemption
right extended to the debtor/trustor/mortgagor is for one year following the sale.

Purchase money anti-deficiency provisions also apply to installment land contracts, and to instruments
determined to be, in fact, security devices (disguised mortgages such as equitable liens or, as previously
mentioned, hidden security devices). Disguised mortgages of whatever nature are not to be pursued by MLBs
without the involvement of and advice from knowledgeable legal counsel.

To determine whether a deficiency judgment will be allowed where third-party lenders are involved, secured
transactions falling outside the provisions of Code of Civil Procedure Section 580b (i.e., non-purchase money
transactions) depend upon a “purpose” scrutiny and a security property and related analysis by a court of
competent jurisdiction.

A borrower/trustor/mortgagor generally cannot waive at the time of executing the security instruments and
related loan documents the anti-deficiency protections granted by applicable law. These protections are
generally deemed to be a non-waiveable public policy (Civil Code Section 1667). In narrow fact situations, it
may be possible for the borrower/trustor/mortgagor to execute a waiver of rights concerning the protections
granted against deficiency judgments or the “one-action” rule. However, such waiver attempts should not be
accomplished without the prior advice of knowledgeable legal counsel.

Short Sales

Finally, legislation effective January 1, 2011 altered the anti-deficiency rules with respect to short sales. Senate
Bill 931 amended Section 580e of the Code of Civil Procedure stating that a lender holding a first deed of trust
secured by a dwelling consisting of not more than 4 units cannot obtain a deficiency judgment in a short sale
transaction if the lender agrees in writing that they will accept the sale proceeds as payment in full for the
amount owed. However, if the borrower commits fraud in the transaction or commits waste with respect to the
property, the lender can seek damages against the borrower.

As to Guarantors

When the deed of trust or mortgage is guaranteed by a third party other than the maker/trustor/mortgagor, the
surety or guarantor may waive rights of subrogation, reimbursement, indemnification, or contribution and any
other rights and defenses that are or may become available to the surety or guarantor by reason of applicable
law. This would include, among others, any rights or defenses the surety or guarantor may have by reason of an

election of remedies by the lender/creditor or that the promissory note or other obligations are secured by real
property.

In the context of the repayment of the debt/loan or performance of the obligation being secured by real
property, the rights or defenses the surety or guarantor may have include, but are not limited to, any rights or
defenses pursuant to sections 580a, 580b, 580d, or 726 et seq. of the Code of Civil Procedure. As a predicate to
the waiver of the foregoing rights and defenses, the surety or guarantor must affirmatively waive these rights
and defenses in the manner described and with the language required pursuant to Civil Code Section 2856,
commonly known as the Gradsky waiver.

As to Satisfaction of Mortgages

When any mortgage has been satisfied, the mortgagee or the assignee of the mortgagee must initiate the
discharge procedure by executing a certificate of the discharge/satisfaction, as provided in Civil Code Section
2939. This provision applies to mortgages without the power of sale. The mortgagee is to within 30 days of
satisfaction, record or cause to be recorded (except as limited by applicable law) such certificate of
discharge/satisfaction in the office of the county recorder in which the mortgage is recorded. Upon written
request of the mortgagor, the mortgagee shall then deliver the original promissory note marked paid in full and
the mortgage instrument to the person entitled to make such request and to receive these instruments (Civil
Code Section 2941).

When the debt/loan or the obligations secured by any deed of trust or mortgage with power of sale has been
paid in full or satisfied, the beneficiary or mortgagee or the assignee of either shall deliver to the trustee the
original note and deed of trust or mortgage together with a request for a full reconveyance or for a certificate of
discharge/satisfaction with such other documents as may be necessary to reconvey and extinguish the deed of
trust or mortgage from the title of the security property.

Within 21 calendar days after receipt of all necessary documents, instructions and authorized fees, costs, and
expenses, the trustee is to execute and record or cause to be recorded (except as limited by applicable law), a
full reconveyance or a certificate of discharge/satisfaction in the office of the county recorder in which the deed
of trust or mortgage is recorded. Upon the written request of the trustor/mortgagor, the trustee shall then deliver
the original note marked paid in full and the deed of trust or mortgage to the person entitled to make such
request and receive such instruments. A copy of the reconveyance or discharge shall be delivered to the
lender/beneficiary/mortgagee, its successor in interest, or its servicing agent, if known (Civil Code Section
2941).

Limitations to Recording of Reconveyance or Certificate of Discharge/Satisfaction

Pursuant to Civil Code Section 2941 and other applicable law, the trustee under a deed of trust or a mortgage
with power of sale (or a mortgagee of a mortgage without power of sale) are not to record or cause the deed of
reconveyance or the certificate of discharge/satisfaction to be recorded when any of the following
circumstances exist:

1. The trustee or mortgagee has received written instructions to the contrary from the trustor or
mortgagor, from the current owner of the land, or from the lender/mortgagee of the debt/loan or
obligations secured by the deed of trust or mortgage (or from the lender’s/mortgagee’s servicing agent,
if known), or from the escrow holder designated for this purpose;

2. The deed of full reconveyance or certificate of discharge/satisfaction is to be delivered to the
mortgagor or trustor, or to the current owner of the land, through an escrow (as requested by the
escrow holder) to which the mortgagor, trustor, or current owner of the land is a principal or a party;
and,

3. When personal delivery is requested in writing by the mortgagor or trustor, or by the current owner of
the land, or by the authorized agent of either (with the understanding the reconveyance or discharge is
to be recorded by said parties).

Required Timely Recording of the Deed of Full Reconveyance or Certificate of Discharge/Satisfaction

If a deed of full reconveyance (or certificate of discharge/satisfaction) is not issued and recorded within 60
calendar days of the payment in full of the debt/loan, or release of or the performance of the obligations, and
upon receipt of a written request by the trustor/mortgagor or the trustor’s/mortgagor’s heirs, successors in

interest (including assignees), or by an authorized agent of the foregoing, the beneficiary/lender/mortgagee may
execute and acknowledge a document substituting another as trustee to issue a deed of full reconveyance or a
certificate of discharge/satisfaction (Civil Code Sections 2934a, 2939 and 2941).

It is clear deeds of trust and mortgages have been deemed to be functional equivalents under applicable
California law and that each security instrument may include a power of sale. What remains unclear as of this
writing is whether the mortgagee of a mortgage with power of sale will issue or cause to be issued a certificate
of discharge/satisfaction or whether the trustee will be instructed to issue such certificate. In any event, the
trustee’s interest in a mortgage with power of sale must also be extinguished at the time of payment in full of
the debt/loan or performance of the obligations.

If a deed of full reconveyance (or as applicable, a certificate of discharge/satisfaction) is not executed and
recorded in accordance with the previous paragraphs or within 21 days of the trustee’s receipt of all required
documents, instruments, instructions and authorized fees, costs, and expenses necessary to effect the
reconveyance or discharge, then within 75 calendar days of payment in full or satisfaction of the debt/loan or
release of or performance of the obligations, a title insurance company may elect to prepare and record a release
of the debt/loan or of the obligations. The release shall be deemed, when recorded, to be the equivalent of a
reconveyance of the deed of trust (or as applicable, the discharge/satisfaction of the mortgage).

However, at least 10 days prior to issuance and recording of a full release pursuant to this paragraph, the title
insurance company shall mail by U. S. Mail, first-class with postage prepaid, to the trustee, trustor/mortgagor,
and beneficiary/mortgagee (beneficiary/lender/creditor) of record, or their successors in interest, at the last
known address for each party the intention to release the debt/loan or the obligations.

The release shall set forth:

1. The name of the beneficiary/lender/mortgagee;

2. The name of the trustor/mortgagor;

3. The recording reference to the deed of trust or mortgage;

4. A recital that the debt/loan or obligations secured by the deed of trust or mortgagee have been paid in
full; released or performed; and,

5. The date and amount of payment, release or performance.

Sanctions and Penalties

Failure to comply with Civil Code Section 2941 makes the violator liable to the person affected for all damages
sustained by reason of the violation. Further, the violator must forfeit to that person the sum of $500. In
addition, Civil Code Section 2941.5 provides that every person who willfully violates Section 2941 is guilty of
a misdemeanor punishable by a fine of not less than $50 or more than $400, or by imprisonment in a county jail
not to exceed 6 months, or by both such fine and imprisonment. The trustee’s failure to timely deliver the deed
of reconveyance (or the certificate of discharge/satisfaction, if applicable) has resulted in the trustee being
subjected to emotional damages under a tort theory in addition to the sanctions and penalties (Pintor v. Ong
(1989) 211 Cal.App 3rd 837).

Fees for Services Rendered

A trustee, beneficiary or lender/mortgagee may charge a reasonable fee to the trustor or mortgagor or the
current owner of the land for services involved in the preparation, execution and recordation of the full
reconveyance (or as applicable, the discharge/satisfaction) including, but not limited to, document preparation
and forwarding services, plus any additional official fees that may be required (e.g., notary and recording).

Unless the lender/mortgagee is exempt from applicable state law, the fees charged for the foregoing are not to
exceed $45 plus official fees. These fees are conclusively presumed to be reasonable. It is important to note that
such fees cannot be charged prior to the opening of a bona fide escrow, or more than 60 days prior to full
satisfaction of the debt or obligations secured by the deed of trust or mortgage.

Reinstatement Rights - Pre-sale

As previously discussed under a judicial foreclosure, a trustor/mortgagor or his or her successor in interest, any
beneficiary/lender/mortgagee under a subordinate deed of trust or mortgage, or any other person having a
subordinate lien or encumbrance of record, may reinstate the debt/loan at any time before entry of judgment by
restoring the loan (usually to its installmentpayment basis) by paying the delinquencies and advances on the
debt/loan plus authorized fees, costs, and expenses. Thereupon, all foreclosure proceedings terminate and the
loan continues in full force and effect as if no such acceleration proceeding had taken place.

As previously mentioned, under a power of sale exercised in a non-judicial foreclosure, the statutory right of
reinstatement for the individuals named above ends five business days prior to the date of the trustee’s sale or
the date of any postponed sale.

Redemption Rights - Post-sale

By way of review, only the judgment debtor or his or her successor in interest may redeem the security property
subsequent to a judicial foreclosure sale. All junior lien holders are eliminated under the law effective July 1,
1983 (Code of Civil Procedure Section 729.020). Further, the redemption period is three months, if the sale
proceeds satisfy the debt/loan plus interest, costs of the action, and authorized fees, costs, and expenses. If sale
proceeds are insufficient to pay the entire amount owed (as defined), the redemption period is one year (Code
of Civil Procedure Section 729.030). If the creditor waived the deficiency judgment or it was prohibited, there
is no right of redemption (Code of Civil Procedure Section 726(e)).

During the redemption period permitted following a judicial foreclosure and a court ordered sale of the security
property, the judgment debtor or tenant occupying the property is entitled to remain in possession but must pay
rent to the successful bidder/buyer following the judicial foreclosure sale.

Often a deed of trust or mortgage permits the beneficiary/lender/mortgagee to take legal possession of the
security property upon default prior to the foreclosure sale (whether a judicial or a trustee’s sale) under the
“assignment of rents” provision and manage the property, pay expenses, and collect the rents, applying the net
proceeds to the maintenance of the property and to preserve the lender’s security. However, to proceed to
exercise an “assignment of rents” provision may require a court order appointing a receiver who will collect the
rents and maintain the security property as authorized by the order.

Should the assignment of rents provision in a deed of trust or mortgage be in connection with a loan made on
security property that is non-owneroccupied and the provision is deemed to be an absolute rather than a
conditional assignment of rents (and a court of competent jurisdiction does not disagree with this legal
conclusion), the lender/beneficiary/mortgagee may be able to take control of the security property without a
receiver as a beneficiary/mortgagee in possession. Such an action should not be taken without the prior advice
of knowledgeable legal counsel.

Statute of Limitations

Civil Code Section 2911 provides that a lien is extinguished if an action on the underlying debt or obligation is
not brought within the required time limits. Judicial foreclosure actions must be filed within four years after
maturity of the obligation or any installment payment. Deeds of trust and mortgages secure a written debt/loan
or the performance of obligations that if not paid as agreed or performed create a cause of action in connection
with the promissory note (evidencing the debt and representing the agreement to repay) for four years following
the default, the date the loan matures, or the date that the debt was last acknowledged by the debtor/borrower,
whichever occurs last.

However, a deed of trust or a mortgage with power of sale conveys to the trustee technical legal title to the
security property for the purposes of exercising the powers granted to the trustee. Even though the statute of
limitations bars an action on the promissory note, the power of sale continues and may be exercised, whether
the security instrument is a deed of trust or mortgage. Except as amended in Civil Code Section 822.020, the
“1982 Marketable Title Act” requires the security instrument to be periodically renewed to continue to be
enforceable.

The 2006 amendments to Civil Code Section 882.020 provide the lien of a deed of trust or mortgage shall
expire 10 years after the final maturity date or the last date fixed for payment of the debt/loan, if the date can be
ascertained from the recorded document. If the final maturity date cannot be determined from the recorded

document, then the deed of trust or mortgage shall expire 60 years after the date the security instrument was
originally recorded.

However, if a “notice of intent to preserve interest” is recorded prior to the expiration of the lien (whether a
deed of trust or mortgage) under either of the above scenarios, then the enforceability of the security instrument
shall be extended for an additional 10 years after the notice is recorded.

Judicial Sale

A judicial foreclosure is usually sought when a beneficiary or mortgagee wants to obtain a deficiency judgment.
The mortgagee or beneficiary, as well as the servicing agent (including MLBs), must be mindful of whether a
deficiency judgment against the debtor/borrower will be sought before electing the foreclosure remedy.
Consultation with knowledgeable legal counsel is recommended before selecting the foreclosure remedy, i.e., a
judicial foreclosure or non-judicial foreclosure.

The Process

The judicial foreclosure sale process involves:

1. Filing a complaint and notice of action (lis pendens) which will bind all persons acquiring liens or
interests in the property during the pendency of the action;

2. A summons served on the parties whose interests are to be eliminated/extinguished, such as the trustor
or his successor in interest and junior lien holders, including in deeds of trust or mortgages;

3. The trial, after which the judgment is entered (decree of foreclosure and order of sale); and,

4. The recording and serving by the Sheriff of Notice of Levy followed by the Notice of Sale.

The Notice of Sale cannot be earlier than 120 days after recording and serving of the Notice of Levy if a
deficiency judgment is barred or properly waived.

When a deficiency judgment is available, the property is sold subject to the one-year redemption period, the
120-day notice period is not required and only a 20-day Notice of Sale is needed. The 20-day Notice of Sale
must be made by posting the Notice of Sale in a public place and on the property at least 20 days before the sale
and by publishing the notice once a week for three weeks in a newspaper of general circulation in the city or
judicial district in which the property or any portion of the property is located. The notice must also be mailed
to all defendants at their last known address and to any other person who has requested to be notified.

The Court Supervised Sale

The court ordered sale is to be held between 9 a.m. and 5 p.m. on a business day in the county where the
property or some portion of the property is located. The foreclosing lender/creditor, debtor/borrower, junior lien
holders (including deeds of trust or mortgages) and others may bid at the sale. The foreclosing lender/creditor
may credit-bid up to the amount owed to it, him or her, and cash bid in excess of the amount of the debt/loan.

All other bidders must bid cash except that a bidder may, if the bid price exceeds $5,000, deposit with the party
conducting the sale the greater of $5,000 or 10 percent of the bid amount, and pay the balance within ten days
of the sale, plus interests, fees, costs, and expenses as authorized by the court. Should the successful bidder fail
to pay the amounts owed pursuant to the successful bid, he or she may be subject to costs and damages as
determined by the court. In such an event, a second sale is required.

After the Sale

The Sheriff issues the highest bidder a prescribed Certificate of Sale stating the title is subject to any
redemption privilege of the debtor/borrower. The certificate operates to transfer title to the highest/successful
bidder. The bidder/purchaser receives no rights to possession for the period of redemption, but does have the
right to receive the rents inuring from or impose rents for the occupancy of the property. The title received by
the highest/successful bidder is subject to any senior liens but free of any junior liens, including deeds of trust
or mortgages. The Certificate of Sale is recorded. Recording of the certificate does not result in clear,
marketable title. Such title will not be achieved until the Sheriff issues a Deed of Conveyance, as described
below.

Sale proceeds are applied to costs of the lawsuit and attorney fees; to selling expenses; to the amount due the
beneficiary/mortgagee of the security instrument foreclosed; to junior lien holders (including deeds of trust or
mortgages) in order of priority; and finally the excess to the debtor/borrower (if any).

If the debtor/borrower does not redeem the property within the 3-month or l-year redemption period (as
applicable), the Sheriff will issue a Deed of Conveyance containing special recitals concerning the judicial
foreclosure and court ordered sale and will record or cause to be recorded the deed conveying title to the
highest/successful bidder to whom the Certificate of Sale was previously issued. The grantee receives all right,
title and interest of the trustor/mortgagor as of the date of initial recording of the deed of trust or mortgage
foreclosed upon (i.e., the title conveyed relates back to the date of initial recording). The grantee may now evict
the trustor/mortgagor or tenant in possession.

A lender/creditor seeking a deficiency judgment must file application in the court case within three months of
the sale for a determination of the deficiency. If the court enters a deficiency judgment against the
trustor/mortgagor and it is recorded by the beneficiary/lender/mortgagee, the judgment becomes a lien upon all
property owned by the debtor/borrower or acquired by him or her within ten years of the entering of the
judgment ruling.

If a debt/loan is secured by both real and personal property, the creditor may foreclose upon the real property
under the power of sale and bring a separate action on the personal property security pursuant to the
Commercial Code, or may (if authorized in the security instruments) elect to foreclose both the real and
personal property security pursuant to the rules applicable to real property as set forth in Civil Code Section
2924 et seq.

Trustee’s Sale - “Power of Sale”- Non-Judicial Foreclosure

When the security instrument includes a power of sale, the alternative remedy for a creditor/lender to proceed
against the security property (in the event of a breach or default by the debtor/borrower) is through a non-
judicial foreclosure. A non-judicial foreclosure results in a privately conducted but publicly held “trustee’s
sale” pursuant to the power of sale included within the security instrument. The exercise of the power of sale
must be at the direction of the beneficiary/lender/mortgagee to whom the power is typically conferred (Civil
Code Sections 2932 and 2932.5).

The Procedure

Accordingly, the beneficiary/lender/mortgagee following a breach of the terms and provisions of the
promissory note and/or the security instrument (usually a failure to make specified installment payments of
principal and interest or to make a balloon payment) and will notify the trustee to issue and record a Notice of
Default. When notifying the trustee, the beneficiary/lender/mortgagee may (but often does not) deliver the
original note and deed of trust or mortgage to the trustee. Further, adequate evidence of the amounts owing that
are delinquent and/or in breach in the case of a monetary default, and/or in breach of the required performance
of the obligations described in the security instruments in the case of a non-monetary default are to be provided
to the trustee by the beneficiary/lender/mortgagee.

The amounts to reinstate or cure a monetary default will likely vary during the non-judicial foreclosure
proceeding. Accordingly, the amounts owing that are reported delinquent and in breach to the trustee will not
be comprehensively set forth in the Notice of Default as these amount may increase. Also, the debtor/borrower
may be required as a condition of reinstatement to provide reliable evidence of the payment of senior liens
(including deeds of trust and mortgages), property taxes, assessments, property casualty insurance premiums,
and of the payment of any other liens in the chain of title that are to be paid to protect the security of the
beneficiary/lender/mortgagee).

The document prepared by the beneficiary/lender/mortgagee to inform the trustee of the breach is generally
referred to as a Declaration of Default. Usually, the trustee named in the security instrument is a corporate
entity. The named trustee or properly substituted trustee prepares and records the Notice of Default and
proceeds thereafter as a limited agent with the non-judicial foreclosure (Civil Code Sections 2924c and 2934a).

In the absence of an applicable agreement to the contrary, any one beneficiary in a “fractionalized” deed of trust
may invoke the power of sale and initiate the non-judicial foreclosure by preparing and delivering to the trustee
a Declaration of Default. Civil Code Section 2941.9 was added to establish a process through which the

beneficiaries of a deed of trust may agree to be governed by beneficiaries holding more than 50% of the
recorded beneficial interests in the fractionalized promissory note evidencing the debt secured by the deed of
trust (or in a series of notes secured by the same property by a deed of trust or deeds of trust of equal priority),
exclusive from any notes or interests therein held by a licensed real estate broker (including MLBs) or any
affiliate of the broker that is the issuer or servicer of the promissory notes and deeds of trust. Applicable law
establishes a process through which the parties must agree in writing to majority rule and each “fractionalized”
note holder or holders of notes issued in series must be noticed of the action taken. The majority action
agreement between the note holders must be in the form of an affidavit and is to be acknowledged and recorded
(Business and Professions Code Section 10238 et seq.; and Civil Code Section 2941.9).

The individual action of the holder of a fractional interest in a promissory note or of the holders of notes issued
in series secured by the same deed of trust or by deeds of trust of equal priority, may also be limited by the
administration, operation and management agreement (including loan servicing) representing the investment
contract relationship established as part of the offering/prospectus resulting in the issuance of securities either
by exemption, registration, or coordination (Securities and Exchange Comm. v. W. J. Howey Co., 328 U.S. 293
(1946) and Securities and Exchange Comm. v. Glenn W. Turner Enterprises, Inc., et al., No. 72-2544, 474 F.2d
476(1973)).

At the time of the preparation of the Declaration of Default, the beneficiary/lender/mortgagee will inform the
trustee of the date of the original breach or default. Typically, the trustee obtains from the title company a
trustee’s sale guarantee report (TSG) assuring the trustee of the identity of the holders of and the priority of
liens against the security property (including deeds of trust and mortgages) and to whom notice is required,
among other matters. The trustee then prepares, records, mails, and posts on the security property the Notice of
Default and Election to Sell pursuant to the power of sale (Civil Code Section 2924 et seq.).

Since non-judicial foreclosures are conducted in accordance with procedural law, it is important compliance
with applicable law occurs. Any irregularity or defect in carrying out this procedure may invalidate the trustee’s
sale. The power of sale and the procedural law to which non-judicial foreclosures are subject are based upon
Civil Code Section 2924 et seq., a codification of the process through which non-judicial foreclosures may be
conducted without state action, i.e., a procedural and not a substantive law (I.E. Associates v. Safeco Title Ins.
Co. (1985) 39 Cal.3d 281, 287-288).

Unless a mortgagor or trustor files suit contesting the trustee’s sale to obtain a court ordered temporary
restraining order (TRO) and/or a preliminary injunction (e.g., to determine whether a valid lien exists, whether
there is a breach resulting in the alleged default, or whether there is a dispute in the amount owing), a judicial
proceeding may be entirely bypassed in non-judicial foreclosures resulting in a trustee’s sale of the security
property (Anderson v. Heart Federal Savings ("Heart") 208 Cal. App. 3d 202, 256).

Asking a court to intervene can be costly and time consuming and will generally require the use of legal
counsel. The debtor/borrower may be required to tender the amount owing in a manner acceptable to the court
and must make an adequate showing of the grounds the court believes will likely result in a preliminary
injunction for a TRO to be issued. For a preliminary injunction to follow, the debtor/borrower must
demonstrate to the court that triable issues exist over the grounds raised in the dispute for the matter to be set
for trial and for the non-judicial foreclosure to be enjoined until resolution of the dispute occurs by court order.

Under existing statutes, the time required between filing of the Notice of Default and of the Notice of Sale and
the actual sale date allows the debtor the opportunity to pursue the judicial process discussed in the previous
paragraph to ultimately establish underlying facts and applicable law. As previously noted, after the trustee’s
sale, the trustor/mortgagor, or any other party affected by the sale, may bring an action to set aside the sale
(usually on procedural grounds), even though the sale is characterized as absolute.

Special Rules

Special rules apply in trustee’s sales involving bankruptcy, substitution of trustee, federally insured or
indemnified loans, individuals in military service, senior citizens, and Unruh Act deeds of trust or mortgages
(on single-family owneroccupied residences arising from a contract for goods or services). The advice of
knowledgeable legal counsel should be obtained in advance of proceeding with a non-judicial foreclosure
involving any of the foregoing fact situations.

Notice of Default and Election to Sell

The Notice of Default must be executed by the beneficiary or the trustee and must state an election on the part
of the beneficiary/lender/mortgagee to declare the entire debt due because of the breaches and defaults. Absent
this declaration, the full amount owing on the debt cannot be collected at the trustee’s foreclosure sale. The
Notice should make it clear that unless the default is non-curable, the trustor/mortgagor or the successor in
interest of the foregoing may reinstate and cure the default prior to five business days immediately before the
date of the trustee’s sale or of the date of any postponed sale.

The Notice of Default is recorded in the office of the county recorder where the real property or some portion
of the property is located at least three months before Notice of Sale is given. Within ten days after recordation
of the Notice of Default, a copy of the Notice containing the recording information must be sent by certified or
registered mail to all persons who have requested notice and to the trustor/mortgagor at his or her last known
address.

If there has been no request for notice by the trustor/mortgagor or the request by the trustor/mortgagor includes
no address, then the Notice of Default must be published weekly for four weeks in a newspaper of general
circulation in the judicial jurisdiction starting within ten days of the recording date, or the notice may be
personally delivered to the trustor/mortgagor (Civil Code Section 2924b(d)).

The Notice of Default and the Notice of Sale are valid if the foreclosure procedural law has been strictly
followed, whether the trustor/mortgagor has actual knowledge of the notices. The Notice of Default must also
be sent within one month of recording by U. S. Mail, registered or certified, to persons listed in Civil Code
Section 2924b, even though they have not recorded a request to receive notice. These persons are: successors in
interest to the trustor/mortgagor; a beneficiary/lender/mortgagee of any junior recorded deed of trust or
mortgage or the assignee of such beneficiary/lender/mortgagee; the vendee of a contract of sale; or to a lessee
of a lease encumbering the security property being foreclosed that is junior to the security instrument being
foreclosed or to the successor in interest to such vendee or lessee; to the State Controller, if a recorded lien for
postponed property taxes exists against the property; and such other parties as are required by law, including
the IRS in the event of an income tax lien.

Notice of Sale

If the loan is not reinstated and the trustee issues a Notice of Sale, the content and form of the notice is
prescribed by Civil Code Section 2924f(b). The Notice of Sale sets a sale date not sooner than twenty days after
the recording date of the notice. Actual practice usually requires a longer time (e.g., 31 days), especially if
federal tax lien notice requirements are to be met or other justifiable delays are encountered. In any event, the
sale date is set to allow time for the required recording, publication, posting, and mailing of the Notice of Sale.

The Notice of Sale must be recorded at least fourteen days, and mailed by registered or certified mail to the
trustor/mortgagor and other persons requesting/receiving the Notice of Default, at least twenty days before the
sale (Civil Code Section 2924b). The notice must be published once a week over a period of at least twenty
days in a newspaper of general circulation in the city, county, or judicial district where the security real
property or a portion of the property is located. Three publications of the notice not more than seven days apart
are required. The notice must be posted for no less than twenty days in at least one public place in the city,
judicial district, or county of the sale, and in a conspicuous place on the property (a door, if possible, if the
property is a single-family residence).

If the loan has not been reinstated by the trustor/mortgagor, a partial payment accepted by the beneficiary may
not terminate the foreclosure unless received in consideration of a forbearance agreement among the parties.
The beneficiary/lender/mortgagee should be careful when accepting partial payments to set forth in writing:

1. Whether it is the intention of the parties that the partial payment constitute a reinstatement and,
therefore, a cure of the default; or

2. Whether the partial payment is to be construed to be part of a work-out or forbearance agreement
providing a plan for payment of all delinquencies and related and authorized fees, costs, and expenses;
or

3. Whether the partial payment has been received without any effect on the foreclosure process, thereby
permitting the beneficiary/lender/mortgagee to proceed with foreclosure as though no payment had
been received.

The Trustee’s Sale

The sale is to be conducted at a public auction by the trustee, or the crier/auctioneer named by the trustee, on a
business day between 9 a.m. and 5 p.m. in a public place in the county where the property or some portion of
the property is located. The sale is to occur on the date and at the time noticed for the scheduled sale, or on the
date and time of the postponed sale. The date and time of a postponed sale is to be cried on the date and time of
the scheduled sale or a previously postponed sale.

Unless expressly authorized in the notice by the trustee, all bids must be for payment in cash, cashier’s check or
its equivalent from a qualified depository financial institution specified in Section 5102 of the Financial Code
that is authorized to do business in this state, or a “cash equivalent” which is authorized by law or has been
designated in the Notice of Sale as acceptable to the trustee (Civil Code Section 2924h).

Until the bidding commences, the trustor/mortgagor or a holder of a junior deed of trust or mortgage may still
redeem the property by paying off the defaulted loan in full, plus all authorized fees, costs, and expenses (as
permitted by law). Reinstatement of a monetary default may be made at any time within the period commencing
with the date of recordation of the Notice of Default, until five business days prior to the date of sale set forth in
the initial recorded notice of sale. As previously stated, the reinstatement period revives as a result of each
postponed sale where the postponed sale date is more than five business days subsequent to the initial sale date
or the date of a previous postponed sale (Civil Code Section 2924c(e)).

Any person may bid at the trustee’s sale, including the trustor/mortgagor, lender/creditor, or a junior lien holder
( such as deeds of trust or mortgages). Only the foreclosing beneficiary/lender/mortgagee (who is the holder of
the debt/loan evidenced by the promissory note and the security instrument being foreclosed) may credit-bid to
offset up to the amount owed plus interest and authorized fees, costs, and expenses. Junior lien holders
(including deeds of trust and mortgages) may not credit-bid the amount of their junior liens. However, amounts
bid at the foreclosure sale by the junior lien holder would serve to reduce any potential liability that the
trustor/mortgagor has to the junior lien holder. Further, if the junior lien holder (deed of trust or mortgage) is
one and the same as the holder of the senior security instrument being foreclosed (or effectively controls the
security instrument being foreclosed), then this holder is not entitled to purchase the security property and later
sue the trustor/mortgagor for deficiency under a “sold out junior” status.

A trustee may reject all bids if the trustee reasonably believes they are inadequate (Civil Code Section 2924h).
At the trustee’s discretion, the sale may be postponed and a postponed sale date at the same location
announced. Generally, the trustee’s actions to reject bids or to postpone the sale are the result of prior
instructions from the holder of the security instrument being foreclosed. Bid fixing, restraining from bidding,
or the offering or accepting of consideration for not bidding at a trustee’s sale (“chilling the bidding process”)
is unlawful and subjects the participants to fine, imprisonment, or both (Civil Code Section 2924h(g)). A
trustee may state that the security property is being sold at the trustee’s sale “as is”. However, the trustee must
disclose any material facts that affect the security property and its condition or value about which the holder has
notice or knowledge (Karoutas vs. Home Fed Bank, 232 Cal. App. 3d. 767 (1991)).

In the event that the trustee’s sale proceedings are postponed for a period or periods totaling more than 365
days, the scheduling of any further sale is to be proceeded by giving a new Notice of Sale that must be
published, recorded, mailed, and posted in the manner required by applicable law (Civil Code Section 2924f).
Fees and costs incurred to process the new notice of sale are not to exceed the amount specified by applicable
law (Civil Code Sections 2924c, d, and 2924g(c)(2)). When postponing a sale, the trustee must publicly declare
the reason for the postponement and announce the date, time, and place the postponed sale is to occur.

After the Sale

The successful bidder receives a trustee’s deed to the property containing special recitals giving notice of
compliance with the foreclosure statutes to protect this bidder and subsequent purchasers of the security
property. The title conveyed is without covenant or warranty that no title defects exist, and the title relates back
in time to the date the trustor/mortgagor signed the deed of trust or mortgage. The trustee’s deed passes to the

successful bidder/purchaser the title held at the time the security instrument was recorded and any after-
acquired title of the trustor/mortgagor, not the trustor’s/mortgagor’s title as of the sale date.

However, title will remain subject to certain liens:

1. Federal tax liens filed more than thirty days before the date of the trustee’s sale unless the proper
twenty-five day notice has been given the Internal Revenue Service;

2. Real property taxes and assessments; and,

3. Valid mechanic’s liens.

Even with proper notice to the IRS, the federal government may have the right for 120 days following the
trustee’s sale to redeem the security property by paying the amount advanced by the successful
bidder/purchaser.

Provided that the beneficiary/lender/mortgagee successfully makes a “full credit bid” (bids the full amount of
unpaid principal and interest and any authorized charges, penalties, costs, expenses, attorneys’ fees, trustee’s
fees, and any advances that may be lawfully due and owing to the beneficiary/lender/mortgagee); the sale
eliminates the debt/loan and obligations of the trustor/mortgagor. Whether a beneficiary/lender/mortgagee “full
credit bids” or “underbids”, completion of a trustee’s sale will extinguish the deed of trust or mortgage securing
the debt/loan and the obligations in favor of a beneficiary/lender/mortgagee.

In addition, junior liens and encumbrances (e.g., deeds of trust or mortgages, judgment liens, easements, and
leases which do not have priority over the security instrument that has been foreclosed) will be extinguished
from the record of title to the security property. The interests of tenants who occupy a residential security
property subject to a local rent control ordinance may not be extinguished by the foreclosure sale. Even if no
local rent control ordinance is operative, tenants may not be removed from the foreclosed property prior to the
time required pursuant to applicable to California law, generally no less than 60 days following the date of a
properly delivered Notice to Vacate.

A beneficiary/lender/mortgagee may elect to “underbid” when a collateral action is anticipated against the
debtor/trustor/mortgagor or a claim is anticipated against a third party for part payment of the amount due and
owing under the promissory note and security instrument being foreclosed. A beneficiary/lender/mortgagee
may elect to proceed with a legal action for fraud, waste or malicious destruction of the security property
against the debtor/trustor/mortgagor or against third parties.

Further, if a casualty loss has occurred to the security property for which insurance coverage is available (even
if not a result of the actions described in the previous sentence), a beneficiary/lender/mortgagee should
“underbid” and then file a claim against the insurer under the terms of coverage extended by the insurance
policy to recover the cost of damages to the security property as part of the amount due. The failure to
“underbid” in such circumstances may result in the denial if the claim by the insurance carrier (Alliance
Mortgage Co. v. Rothwell 10 Cal. 4th 1226 (Cal. 1995)). The issue of whether to “underbid” should be
discussed in advance with knowledgeable legal counsel.

Liens or encumbrances, including real property taxes and assessments, which are senior to the foreclosed deed
of trust or mortgage remain on the title to the security property. In a trustee’s foreclosure sale, the title is free of
any right of redemption by the debtor/trustor and the debtor/trustor has no further rights or interests in the
security property absent a successful legal action to set aside or void the trustee’s sale.

Separate from a civil action to set aside the trustee’s sale, a Petition in Bankruptcy can be filed by the
debtor/trustor/mortgagor. As part of the bankruptcy proceedings, the court may void the trustee’s foreclosure
sale at the request of the debtor/trustor/mortgagor or of the trustee appointed by the bankruptcy court, or as
otherwise authorized under the U.S. Bankruptcy Code. Upon voiding the foreclosure sale, the security property
may be returned to the bankrupt estate or ultimately to the estate of the debtor/trustor/mortgagor in a manner
consistent with the order of the bankruptcy court.

It is important to note that sales transactions of residential real property during a non-judicial foreclosure
proceeding may be rescinded by the debtor/trustor within two years from the date of such transaction upon
written notice if unconscionable advantage has been taken of the debtor/trustor (Civil Code Section 1695.14).

The issues presented by the Home Equity Sales Contracts Act, commencing with Civil Code Section 1695 will
be discussed later in this Chapter.

The successful bidder/purchaser is generally entitled to immediate possession of the security property and may
evict the former debtor/trustor/mortgagor by instituting an Unlawful Detainer action subsequent to delivery of a
three-day Notice to Quit. As previously mentioned, should the occupant be a tenant pursuant to a local rent
control ordinance or who occupies under the terms of a lease junior to the foreclosed lien without a non-
disturbance and attornment agreement, the successful bidder/purchaser at the foreclosure sale may evict the
tenant in accordance with applicable law subsequent to the delivery of a 60 day Notice to Vacate. If the tenant
fails to vacate, an Unlawful Detainer action could then be pursued by the successful bidder/purchaser
subsequent to the delivery of a three-day Notice to Quit.

If a tenant occupies pursuant to a lease agreement that is either senior in priority to the foreclosed lien (or is
junior but subject to a non-disturbance and attornment agreement) or whose occupancy is subject to the
provisions of a local rent control ordinance, the successful bidder/purchaser should seek legal advice before
taking any action to evict the tenant or otherwise terminate the occupancy of the tenant. On the other hand, the
successful bidder/purchaser should also seek professional advice regarding whether an eviction is in the
interests of the successful bidder/purchaser or if continuing the occupancy of the tenant is economically
preferable, particularly in the context of a commercial or industrial property where the occupancy is pursuant to
a long term lease.

When deciding to continue a tenancy or to evict the tenant in occupancy, the successful bidder/purchaser
should consider whether a local ordinance has been adopted requiring the property be properly maintained,
including the interior and exterior, e.g., grounds, landscaping and such amenities as a pool by the current owner
of the fee title. These local ordinances often impose fines up to $1,000 per day up to a maximum of $100,000
which may attach to the property in the form of an assessment and, therefore, may be foreclosed in accordance
with applicable law and subject to payment in the event of a conveyance or further encumbrance. This is a
significant issue for beneficiaries/lenders/mortgagees who foreclose their security instrument when there is no
third-party successful bidder resulting in the security property becoming real estate owned (an REO).

Disposition of Sale Proceeds

The trustee distributes the foreclosure sale proceeds in the following order:

1. To authorized trustee’s fees, costs, and sale expenses;

2. To beneficiary/lender/mortgagee to satisfy the full amount of unpaid principal and interest and any
charges, penalties, costs, expenses, attorney’s fees, and advances that may be lawfully due and owing;

3. To junior lien holders in order of priority, whether their debt/loan is matured; and,

4. Any surplus that remains would then be distributed to the debtor/trustor/mortgagor.

If either a junior lien holder or the debtor/trustor/mortgagor disputes the distribution of funds, the trustee should
file a Complaint for Interpleader and Declaratory Relief to have the court decide the issue.

Statement of Condition of Debt

Pursuant to Civil Code Section 2943, any time before or within two months after the recording of a Notice of
Default under a deed of trust or mortgage with power of sale or before thirty days prior to entry of a decree of
judicial foreclosure; the debtor/trustor/mortgagor or entitled person (as defined in the law) may make written
demand of the beneficiary or mortgagee for a written beneficiary statement showing:

1. The amount of the unpaid balance of the obligation secured by the deed of trust or mortgage and the
interest rate together with the total amounts, if any, of all overdue installments of either principal or
interest, or both;

2. The amounts of periodic payments, if any;

3. The date on which the obligation is due in whole or in part;

4. The date to which real estate taxes and special assessments have been paid to the extent the
information is known to the beneficiary/lender/mortgagee;

5. The amount of hazard insurance in effect and the term and premium of such insurance coverage to the
extent the information is known to the beneficiary/lender/mortgagee;

6. The amount in an account, if any, maintained for the accumulation of funds with which to pay taxes
and insurance premiums (escrow impound account);

7. The nature and amount, if known, of any additional charges, costs, or expenses paid or incurred by the
beneficiary/lender/mortgagee which have become a lien on the security real property; and,

8. Whether the obligation secured by the deed of trust or mortgage can or may be transferred to a new
borrower.

Section 2943 of the Civil Code also provides that the beneficiary/lender/mortgagee may make a charge not to
exceed $30 for furnishing each required beneficiary statement, except when the loan is insured by FHA or
indemnified by VA or is subject to some other federal exemption. The deed of trust or mortgage should provide
whether the charge may be imposed and how much may be charged for the statement.

Within 21 days of receipt of the written demand, the beneficiary/lender/mortgagee or his or her authorized
agent shall prepare and deliver the statement together with a complete copy of the promissory note or other
evidence of indebtedness. If requested, the beneficiary/lender/mortgagee or its authorized agent shall furnish a
copy of the deed of trust or mortgage at no additional charge. Such statements may be requested in connection
with the sale, refinance, or further encumbrance of the security property.

A penalty of $300 and liability for damages is prescribed for the beneficiary’s/lender’s/mortgagee’s willful
failure to deliver the statement within 21 days. The beneficiary/lender/mortgagee may reasonably require the
entitled person to produce evidence that he/she/they are eligible to make the request in accordance with
applicable law. The beneficiary/lender/mortgagee may demand payment of the authorized fee at the time of
request. The entitled person should include within the written request for the beneficiary statement that the
request is being made pursuant to Civil Code Section 2943.

Civil Code Section 2943 includes the definition and use of pay-off demand statements as distinct from
beneficiary statements. The beneficiary statement is intended to provide information when the loan may be
transferred to a buyer of the security property or for loan status purposes. The pay-off demand statement details
amounts owing for purposes of loan pay-off. While the beneficiary statement may not be requested subsequent
to 60 days following the recordation of notice of default, the pay-off demand statement may be requested
anytime except following the first publication of the notice of a trustee sale or of the applicable hearing before
the court supervising the judicial sale.

The “Short-Pay Demand”

Recent California legislation has added requirements in connection with “Short-Pay Demand Statement”. This
phrase means a written statement issued subsequent to and conditioned on the existence of a “Short-Pay
Agreement” that is in the possession of the entitled person and that was prepared in response to a written
demand made therefor by an entitled person including an authorized agent. The “Short-Pay Demand Statement”
is to set forth the amount less than the outstanding indebtedness (debt/loan) together with any terms and
conditions under which the beneficiary/lender/mortgagee will execute and deliver a reconveyance of the deed
of trust or discharge/satisfaction of the mortgage securing the promissory note. The operative period of this
demand statement shall not be greater than 30 days from date of preparation by the
beneficiary/lender/mortgagee.

The “Short-Pay Request” is defined to mean a written request made by an entitled person, including an
authorized agent, requesting the beneficiary/lender/mortgagee to provide a “Short-Pay Demand Statement” that
includes the following:

1. A copy of an existing contract to purchase the property for an amount certain;

2. A copy of the “Short-Pay Agreement” in possession of the entitled person; and,

3. Information related to the release of any other lien on the security property, if any.

Unless otherwise provided by applicable law, a beneficiary/lender/mortgagee or his or her authorized agent is
required (upon receipt of a “Short-Pay Request”) to prepare and deliver a “Short-Pay Demand Statement” to the
person requesting the statement within 21 days of receipt of the “Short-Pay Request”. The
beneficiary/lender/mortgage or its authorized agent may elect not to proceed with the transaction that is subject
to the “Short-Pay Request” and may refuse to provide a “Short-Pay Demand Statement” for the transaction. In
lieu, a beneficiary/lender/mortgagee is to provide a written statement to the person requesting the “Short-Pay
Demand Statement”, within 21 days of the receipt of the “Short-Pay Request” that the
beneficiary/lender/mortgagee elects not to proceed with the transaction.

Should the terms and conditions of the “Short-Pay Agreement” require approval by the
beneficiary/lender/mortgagee of a closing statement or similar statement prepared by an escrow holder,
approval or disapproval is to be provided in not more than 4 days after receipt by the
beneficiary/lender/mortgagee of the closing statement, or the closing statement shall be deemed approved
(provided the statement is not clearly contrary to the terms of the “Short-Pay Agreement” or to the “Short-Pay
Demand Statement” provided to the escrow holder).

As is the case with a request for beneficiary statement, the beneficiary/lender/mortgagee must respond to a
request for a pay-off demand statement or a “Short-Pay Demand Statement” within 21 days after receipt, and
the failure of a beneficiary/lender/mortgage to timely respond may subject the beneficiary/lender/mortgagee to
an automatic $300 sanction plus actual damages and attorney’s fees. Needless to say, each request for a payoff
demand statement or for a “Short-Pay Demand Statement” is to be in writing and should indicate that the
request is being made pursuant to Civil Code Section 2943, as amended.

The fee for a pay-off demand statement is the same as the fee for a beneficiary statement. Failure to specifically
identify whether the statement being requested is a beneficiary statement or a pay-off demand statement will
allow the beneficiary to “default” to the pay-off demand statement exclusive of a “Short-Pay Demand
Statement”. The provisions added to Civil Code Section 2943 describing and requiring the “Short-Pay Demand
Statement” procedure are subject to repeal as of January 1, 2014, unless a statute is enacted before January 1,
2014 that deletes or extends that date.

Annual and Monthly Accounting - Impound Accounts

Under Civil Code Section 2954, any trustor/mortgagor under a deed of trust or mortgage, or a vendee under a
real property sales contract, may make a written request of the beneficiary/lender/mortgagee or of the vendor
for a statement of condition of account. A statement is to be provided within 60 days after the end of each
calendar year.

The statement includes an itemized accounting of money received for interest and principal repayment or held
in or disbursed from an impound/trust account (an escrow account), if any, for payment of property taxes,
insurance premiums, or other purposes relating to the security property. The debtor/trustor/mortgagor is entitled
to receive one statement for each calendar year without charge. A monthly statement or passbook showing
money received for interest and principal or held in and disbursed from an impound/trust account (an escrow
account) constitutes compliance with this requirement.

No increase in the monthly rate of payment of a trustor/mortgagor or vendee for an impound/trust account (or
escrow account) will be effective until the beneficiary/lender/mortgagee or vendor has furnished the
trustor/mortgagor or vendee with an itemized accounting of the monies presently held in the impound account
and with a statement of the new monthly rate of payment and the factors necessitating the increase. The use
and maintenance of an impound/trust account (escrow account) by the beneficiary/lender/mortgagee is subject
to applicable federal and state law, including the fees that may be imposed on the trustor/mortgagor.

Existing law prohibits the use of impound/trust account (escrow accounts) except in those fact situations
described below:

1. When the security property is an owner occupied dwelling, unless required by state or federal
regulatory authority if the loan has been made, insured or indemnified by a state or federal government
lending or insurance agency; or upon the failure of the borrower to pay two consecutive tax
installments on the security property prior to the delinquency date for such payments;

2. When the security property is owner occupied, unless the original principal amount of the loan is 90%
or more of the sales price of the security property at the time of sale; or the loan is 90% or more of the
appraised value of the security property; or whenever the combined principal amount of the loans
against the security real property exceeds 80% of the appraised value of such property; or,

3. The loan is made in compliance with the requirements for higher priced mortgage loans established in
Regulation Z of the Federal Truth-In-Lending Act (TILA) pursuant to 15USC Section 1601et seq.,
whether the loan is a higher priced mortgage loan; or when a loan is refinanced or modified in
connection with a lender’s homeownership preservation program or a lender’s participation in such a
program is sponsored by a federal, state or local government or a non-profit organization.

Contact Requirements Prior to Filing a Notice of Default

Civil Code Section 2923.5 has been added to require an initial contact with the borrower (as defined) at least 30
days prior to the recording of a Notice of Default. This requirement applies to loans secured by residential real
property consisting of 1 to 4 dwelling units within which an owner occupies and the security instrument for the
loan was recorded during the period of January 1, 2003 through January 1, 2008, inclusive. Exemptions from
the required contact include:

1. When the borrower has previously surrendered the keys and possession of the security property to the
beneficiary/lender/mortgagee or its authorized agent;

2. When the borrower has contracted with an entity whose primary business is advising homeowners on
how to avoid or extend the foreclosure process; or,

3. When the borrower/homeowner has filed a petition in bankruptcy and an order has not been entered
closing or dismissing the bankruptcy or granting a relief from stay.

Unless an exemption applies, contact or attempted contact must be made with the borrower to discuss the
borrower’s financial situation and foreclosure alternatives. Due diligence to contact the borrower
(trustor/mortgagor) must be undertaken by the beneficiary/lender/mortgagee, its servicing agent, or another
lawfully authorized agent.

Due diligence requires that an initial contact be made with the borrower (trustor/mortgagor), either in person or
by telephone, advising of the availability of a United States Department of Housing and Urban Development
(HUD) certified housing counseling agency and the toll free telephone numbers of such agencies who may
provide counseling services to the borrower.

The borrower is also to be advised that he or she has a right to request a subsequent meeting with the
beneficiary/lender/mortgagee, its servicing agent, or other authorized agent, with the meeting scheduled to
occur within 14 days. The contact with the borrower is also to provide the opportunity to assess the borrower’s
financial situation and to explore options to avoid foreclosure.

A borrower may designate by written consent a HUD certified counseling agency, an attorney, or another
advisor to discuss with the beneficiary/lender/mortgagee, its servicing agent or other authorized agent, the
borrower’s financial situation, options for the borrower to avoid foreclosure, or any loan modification or
workout plan offered by the beneficiary/lender/mortgagee.

When the borrower, the loan transaction, and security property are subject to this law; a Notice of Default filed
or recorded pursuant to Civil Code Section 2924 et seq. is to include a declaration that the
beneficiary/lender/mortgagee its agent or other authorized agent has:

1. Contacted the borrower;

2. Has tried with due diligence to contact the borrower in accordance with applicable law; or,

3. That no contact was made with the borrower because the borrower has surrendered the keys and
possession of the security property to the beneficiary/lender/mortgagee, its servicing agent, or other
authorized agent; or the borrower has contracted with an organization, person, or entity, whose
primary business is to advise homeowners how to extend the foreclosure and/or how to avoid the
borrower’s contractual obligations to beneficiaries/lender/mortgagees; or the borrower has filed a
petition in bankruptcy pursuant to Chapters 7, 11, 12 or 13 and the bankruptcy court has not entered an
order closing or dismissing the bankruptcy or granting a stay of relief from a foreclosure.

If the beneficiary/lender/mortgagee, its servicing agent or other authorized agent, has previously directed the
trustee to record the Notice of Default (prior to the enactment of Civil Code Section 2923.5) and no Notice of
Rescission has been recorded, then the Notice of Sale issued and recorded pursuant to Civil Code Section 2924
shall include a declaration that the borrower (trustor/mortgagor) was contacted to assess the borrower’s
financial situation and to explore alternatives to foreclosure, or that efforts were made exercising due diligence
in accordance with applicable law and no contact occurred. Civil Code Section 2923.5 is to remain in effect
until January 1, 2013, and as of that date is repealed, unless a later enacted statute extends the aforementioned
date of repeal.

Delayed Notice of Sale

Civil Code Section 2923.52 has been added to require the delay period of three months between
filing/recording of the Notice of Default and filing/recording of the Notice of Sale (Civil Code Section
2924(a)(2)) to be extended for an additional 90 days to allow the parties to pursue a loan modification as a
means to delay foreclosure. The requirement for such further extension is subject to the following conditions:

1. The loan was recorded during the period from January 1, 2003 to January 1, 2008 inclusive, and the
loan is secured by residential property;

2. The loan at issue is the first deed of trust or mortgage against the security property;

3. The borrower occupied the property as the borrower’s principal residence at the time the loan became
delinquent; and,

4. A Notice of Default has been recorded on the security property.

The requirement for the further extension of 90 days does not apply to loans made, purchased, or serviced by a
California state or local public housing agency or authority; a state or local housing finance agency; a secured
transaction that is subject to the Military and Veterans Code; or the loan is collateral for securities purchased by
an agency or authority referred to hereinbefore. In addition, the 90 day further extension does not apply to
loans serviced by a mortgage loan servicing agent, if the servicing agent has obtained a temporary or final order
of exemption pursuant to Civil Code Section 2923.53 that is current and valid at the time the Notice of Sale is
given.

For example, if the servicing agent is licensed and regulated by the DRE, the exemption order must be obtained
from the Commissioner of the DRE. A comprehensive loan modification program must be implemented by the
servicing agent that meets the requirements imposed by the commissioner of the department or agency through
whom the servicing agent is licensed.

The loan modification program is to consider the objective of keeping borrowers in their California homes
rather than foreclosing when the anticipated recovery under the loan modification or workout plan exceeds the
anticipated recovery through foreclosure on a net present value basis. The loan modification program targets a

ratio of the borrower’s housing related debt to the borrower’s gross income of 38% or less on an aggregate
basis for the lender’s loan modification program. As a predicate to the loan modification program being
acceptable to the commissioner licensing and regulating the servicing agent, the program is to include a
combination of the following features:

1. An interest rate reduction, as needed, for a fixed term of at least five years;

2. An extension of the amortization period of the loan term to no more than 40 years from the original
date of the loan;

3. Deferral of some portion of the principal amount of the unpaid principal balance until maturity of the
loan;

4. A reduction of principal amount owing;

5. Compliance with an applicable federally mandated loan modification program; and,

6. Such other factors the commissioner determines are appropriate, and the commissioner may consider
efforts implemented in other jurisdictions that have resulted in a reduction in foreclosures.

When determining a loan modification solution for a borrower, the servicing agent is to seek to achieve long-
term sustainability for the borrower. The commissioner has been given 30 days of receipt of an initial or revised
application to determine whether the proposed loan modification program meets the requirements imposed by
applicable law.

Upon approval of the loan modification program for which the servicing agent has applied, the commissioner is
to issue a final order exempting the loan servicer pursuant to the terms of the order from the requirements of
Civil Code Section 2923.52. If the commissioner concludes that the loan modification program is not
acceptable, the application is to be denied. However, the servicing agent may submit a revised or modified
application. The commissioners were required to adopt emergency and final regulations to clarify the
application of this law (Civil Code Section 2923.52 and 2923.53) no later than 10 days after the date the law
took effect, i.e., May 21, 2009. Civil Code Sections 2923.52 and 2923.53 are to remain in effect until January

1, 2011 and as of that date is repealed, unless a later enacted statute extends the aforementioned date of repeal.

LOAN PURPOSE

Purchase Loan

A purchase loan is made to finance a portion of the purchase price of the security property. The intended
occupancy of the borrower/buyer should be determined at the outset. This status will affect the type of loan
product available for the transaction. Owner-occupied conventional purchase loans typically require a down
payment of from 5 to 25%. The greater the down payment, the better the rates and terms will be. Minimum
down payments and loan-to-value ratios in excess of 80% will generally require mortgage insurance. FHA
insured and VA indemnified loans are often used in purchase transactions.

Refinance Loan

A refinance loan is one made to replace an existing loan to borrowers who hold title to the security property. In
most cases:

■ It occurs for the borrower to obtain more attractive interest rates and loan terms (the interest rate is
adjusted to more closely reflect the current market and to achieve a new schedule of payments);

■ Some additional credit may be extended (“cash-out”); and,

■ The lender and borrower may desire to substitute a basically different kind of loan (e.g., a
conventional fixed rate loan to replace an adjustable rate or a negatively amortizing loan).

(Note: As previously discussed, the character of the loan and the deed of trust or mortgage against the security
property may be changed through refinancing from that of a purchase money mortgage to a non-purchase
money mortgage resulting in personal liability for the borrower and a possibility of a money judgment for
deficiencies against the borrower.)

OVERVIEW OF THE LOAN PROCESS

Originating a new loan begins when a prospective borrower contacts an MLB or lender representative now also
referred to as a mortgage loan originator (MLO). The MLO should be prepared to listen to the applicant’s

needs, gather appropriate information and respond to the inquiry with accurate program descriptions that would
be best suited to the applicant, the consumer/borrower. Preparing for inquiries in advance will enable the MLO
to handle the inquiries in a logical and uniform manner.

Whether the loan will be delivered to a depository institution, to a non-bank (including licensed
creditors/lenders), or to private investors/lenders; the MLO should know the details of each loan program
offered as well as the guidelines, policies and procedures of the funding sources with respect to originating
residential mortgage loans. The MLO’s ability to obtain comprehensive information up front will result in the
best service to both the applicant and to prospective lenders or permanent investors.

There are four steps to originating a real estate loan:

1. The Application;

2. Loan Processing;

3. Underwriting Analysis; and,

4. Loan Approval, Funding and Closing.

The Application

The application form is a summary of all key components required by a lender or permanent investor to
determine if an applicant qualifies for the loan request, has the ability to repay the loan, and whether collateral
sufficient to support the debt/loan will be provided by the borrower. The loan application is to be completed
with the assistance of a representative of the lender or the MLB (as previously mentioned, each is also known
as MLOs). The application is to be completed accurately and entirely to facilitate processing, underwriting,
funding and closing the requested loan.

Historically, application forms varied from lender to lender. Now, a “standard” form for residential mortgage
loan applications is commonly used in the mortgage lending and brokerage industries. The form is a
collaborative effort between FNMA and FHLMC. Each agency has assigned a different number to the same
form; the FNMA Form is 1003 and the FHLMC Form is 65. The application form most often referred is the
FNMA 1003. Today, even FHA and VA use this form.

An initial interview with the prospective borrower is necessary, whether occurring telephonically,
electronically, or in person (face-to-face). The interview provides MLOs with the opportunity to make certain
the applicants understand the terms of the loan requested, among other important issues within the loan process.
The requirements of the lender to whom the loan application is or will be submitted will often control how the
initial interview is to occur. Interviews with the prospective consumer/borrower are necessary to complete
accurately the loan application package.

The proposed loan request is normally set forth in writing on the 1003. It identifies the amount and proposed
terms of the requested loan, the purpose of the loan, and how and when the loan is to be repaid. Each loan
request is to be evaluated in a fair, impartial, and non-discriminatory manner.

The Federal Equal Credit Opportunity Act (ECOA) prohibits discrimination based on age, sex, race, marital
status, color, religion, national origin, receipt of public assistance, or that the applicants (consumers/borrowers)
have, in good faith, exercised any right under the Consumer Credit Protection Act. In addition under the Fair
Housing Act, discrimination is prohibited based on the existence of a handicap or on familial status, e.g., the
age and presence of children, except when the housing qualifies under HUD standards as senior housing. Each
person’s character and capacity must be considered fairly and equitably based on income adequacy; satisfactory
net worth, financial standing and management; job stability; on an acceptable credit rating, and on other
pertinent factors that are not unlawfully discriminatory. Credit guidelines are to be applied to each potential
consumer/borrower in an equal manner, including the income of each spouse.

Advance Fees

MLOs who are MLBs as well as lenders may wish to collect money in advance from a loan applicant to cover
the cost of services to be performed in arranging or originating the mortgage loan. Money collected “up front”
is an advance fee. Advance fees are defined in and subject to the regulation of the Real Estate Commissioner
pursuant to Business and Professions Code Sections 10026, 10085, 10085.5, 10131.2 and 10146. Fees imposed

at the time of the loan application are also subject to the requirements imposed under the Real Estate Settlement
Procedures Act (RESPA) that is discussed later in this Chapter (12 USC Section 2601 et seq. and 24 CFR
Section 3500 et seq.).

Unless the advanced fee is for a credit or appraisal report and is in the exact amount required by the service
providers, an MLB/MLO may only collect an advance fee pursuant to a written agreement previously reviewed
and authorized by the Department of Real Estate (DRE). Real Estate Commissioner’s Regulation 2970 sets
forth the basic contents of an advance fee agreement. The MLB must also submit for the DRE’s prior approval,
advertising materials used in conjunction with an advance fee arrangement. Additionally, the verified
accountings and trust fund handling as required by Business and Professions Code Section 10146 and set forth
in Commissioner’s Regulation 2972 must be reviewed for and to establish the appropriate policies and
procedures to maintain the MLB’s/MLO’s books and records in compliance with the foregoing.

Any real estate broker or MLB who contracts for or collects advance fees from a principal must deposit the
funds into a properly constructed trust account. Advance fees are not the broker’s/MLB’s funds. Amounts may
be withdrawn for the benefit of the broker/MLB only when actually expended for the benefit of the principal or
five days after verified accounts have been mailed to the principal for whom the fees are being held. If advance
fees are not handled in accordance with the Real Estate Law, it will be presumed that the broker/MLB has
violated Penal Code Sections 506 and 506a (i.e., embezzlement and conversion). Penalties, fines and jail or
prison terms may result.

As previously mentioned, the DRE permits by policy MLBs/MLOs to collect fees in advance for appraisal and
credit reports as long as the broker collects as near as possible the exact amount(s) necessary and deposits these
funds into a properly constructed trust account. Refunds of any excess to the principal are required as soon as
the excess is identified. Though credit and appraisal report fees are not treated as advance fees for the purposes
of prior approval of the DRE (as defined above), these funds are trust funds. On October 11, 2009, Governor
Schwarzenegger signed Senate Bill 94 (Calderon), and the legislation took effect immediately upon his
signature. California law prohibits any person, including real estate licensees and attorneys, from demanding or
collecting an advance fee from a consumer for loan modification or mortgage loan forbearance services
affecting 1-4 unit residential dwellings.

Loan Processing

Once the application is complete with the assistance of an MLB/MLO, the applicant will be given a list of items
that will comprise a loan application package. In addition, certain disclosures to the applicant
(consumer/borrower) are required. Disclosures and notices of rights will be addressed later in this Chapter.

The MLB/MLO will usually submit the application to loan processing to assemble a loan application package.
A loan application package consists of a properly completed application form and the supporting
documentation required to process the loan and to make a credit decision. During the loan process, the lender
typically uses a series of checklists to ensure each of the required steps properly occurred and the necessary
documentation and support information has been gathered to approve and to close the loan requested (the loan
for which the applicants applied). The loan processing checklists often include:

1. A Compliance Checklist;

2. A Stack Order;

3. A Borrower Checklist; and,

4. A Property Checklist.

Borrower Information

The following information is gathered by the processor and helps the lender to assess their risk by
understanding the borrower’s capacity/ability and willingness/desire to repay the loan:

1. Purpose of the loan. Learning why the applicant (consumer/borrower) wants to borrow money and the
use of the loan funds will help to determine the risk associated with the extension of credit. The loan
purpose will categorize the loan requested to determine the program criteria and what disclosures are
required. The three common categories of loan purpose include (a) purchase, either for occupancy or

investment; (b) refinance, either to obtain a better loan rate and terms, or to receive a “cash-out”; or (c)
an equity loan to obtain financing for home improvement or other described financial needs or
objectives.

2. Source of Repayment. Typically, the primary source of repayment will be from the combined income
received through the employment or professional activities of the applicants. Determining the type of
business or profession pursued by or the employment of the applicants, how long the applicants have
been in business or have engaged in a defined professional activity or how long employed in acurrent
or related job in the same industry, will help to establish the stability of the income. Most lenders look
for a minimum of 2 years in the same line of work or professional pursuit. In some instances, the
source of income is through self-employment, from either a business or professional activity.

3. The applicant (consumer/borrower) may also present investment income as the source of repayment.
In such instances, support documentation will prove to be critical in this analysis. The underwriting
lender will look at the applicants’ historical income and longevity of employment; the future expected
trends of the employment, business, or profession of the applicant; and whether there is a likelihood of
continuance in the same employment, business, or professional activity.

4. Assets. The asset breakdown represents the strength and composition of the financial standing of the
applicants. Liquidity is important to determine the applicants’ ability to provide down payment funds
and required cash reserves, as well as to overcome unforeseen interruptions in income or irregular
expense items. It is also an indication of the applicants’ ability to save. Equity in other real estate,
businesses, investments, or insurance policies also serves to demonstrate the applicants’ overall
substance.

5. Liabilities. Liabilities represent the applicants’ leverage/debt against assets and the financial
obligations that result in monthly payments, referred to as expenses. These expenses are usually
broken into two categories, defined as the monthly housing expenses to establish a “front-end” ratio of
debt to income, and the total monthly obligations to establish a “back-end” ratio of debt to income.
The monthly housing expenses include the required monthly loan debt service, the debt service on any
other financing against the security property, property taxes, assessments, causality and hazard
insurance premiums, mortgage insurance premiums, and the dues or assessments of homeowners
associations. The total monthly obligations include housing expenses and additional monthly debt
service such as long-term contractual installment debt (vehicle or furniture payments), revolving debt
such as credit card payments and open accounts, spousal and child support, and other liabilities that
require monthly payments. The foregoing currently does not include when underwriting conventional
loans or alternative mortgages or non-traditional loan products, utilities or the maintenance of the
property (unless the loan product is FHA insured or VA indemnified).

6. Credit History. Each lender sets general policy guidelines outlining acceptable credit quality. These
policies typically include loan terms that are predicated on different credit score thresholds. Credit
policies are influenced by the lender’s intent to keep the loan in their portfolio or to sell the loan in the
secondary marketplace. Whether the lender relies solely on a credit score or on the overall repayment
habits of the applicants, the credit history is a good indication of the applicants’ financial management
and how the prospective mortgage loan will be repaid, given a continuance of represented income. A
lender may favorably consider repeat consumers/borrowers who have a proven “track record” of
repayment or other banking or loan relationships with the lender.

Property Information

The value, condition of title, and overall quality of the property is evaluated to ensure the collateral will be
adequate to secure repayment of the loan. Because of the long terms associated with real estate loans, the lender
will estimate not only the current value and condition of the intended security property, but the economic trends
in the neighborhood and community where the property is located. To further this evaluation, the loan
processor will order the following reports:

1. Preliminary “Title” Report. A primary concern is that the consumer/borrower has good title to the real
property which would secure the loan. Once a lender decides that serious consideration can be given to

a loan application, a preliminary report will be obtained on the proposed security property from a title
company or from the intended title insurer to describe the terms of the offer to insure title to the
property.

The purpose of a preliminary report is to:

a. Identify the property, including assessor’s parcel number, street address, legal description and
any issue that may be presented by the legal description;

b. Identify the current vesting (owner of record); and,

c. Reveal proposed title policy exceptions, including property taxes, assessments, encumbrances,
liens, easements, claims and conditions of record, etc.

When all objections to title are resolved to the satisfaction of the lender, a title policy insuring the interest
of the lender must ordinarily be obtained at the time the loan is funded. In this policy, the title insurer
agrees to defend and indemnify the lender against damages/losses suffered by the lender arising from
actions founded upon claims of encumbrances or title defects which were known, or should have been
discovered, by the title insurer when the policy was issued.

2. Appraisal. A staff or independent fee appraiser will be engaged to inspect the property and estimate
present market value and future value trends. The relationship between the amount of the proposed
loan and the estimate of fair market value of the intended security property is the “Loan-to-Value”
ratio. Most lenders base their loan amounts on the purchase price or appraised value, whichever is
less.

The purpose of the appraisal report is to ascertain:

a. An estimate of the current market value of the intended security property;

b. Description and condition of land and improvements;

c. Applicable zoning and if the current uses of the land and improvements are consistent with the
zoning;

d. Neighborhood and community market conditions;

e. Any discernable issues with the legal and physical description of the intended security
property; and,

f. The nature of the occupancy.

3. Property due diligence. Depending upon the fact situation, the following property issues may also
be addressed:

a. If other than the borrower, the status of and whether the occupant is asserting a title claim;

b. If a loan is to finance the purchase of the proposed security property, the sales price and
proposed terms;

c. If a refinance, the date of original purchase, the price and terms of such purchase;

d. Are there additional assessments (regular or special);

e. If income producing property, the historical and projected operating income and expenses,
and the amount of expected net operating income available to support the mortgage loan debt
service; and,

f. Has any work occurred on or related to the security property within the last 90 days that
might result in a mechanics’ lien or other title claim.

Once up front disclosures are provided, the applicant has supplied all requested support documentation, and the
credit, prelim and appraisal reports have been received, among any other items requested by the lender; the loan
file should contain enough information to be presented to an underwriter. The application package should be
organized in a logical manner using application and processing checklists to ensure conformity and compliance
with the lender’s policies and procedures.

Construction and Rehabilitation Loan Requests

In addition to the elements of loan processing for loan transactions where the intended security property is
improved residential or commercial, as defined, vertical construction loan transactions require the gathering of
additional documentation to support the loan request.

The following list is included to illustrate the documents and information to be gathered for vertical
construction loans. Many of the items on the list will also apply to land acquisition and development loans
whether residential, income producing or other forms of commercial property:

1. Current Preliminary Report meeting the requirements of the intended lender or permanent investor
regarding the date of issuance and subsequent “date down” showing the condition of and the claims
against title (including conditions, covenants, restrictions, encumbrances, liens, etc.);

2. Land Survey, if applicable or required for ALTA extended coverage, showing the exact location of the
security property and the improvements thereon, or a proper final tract map or parcel map (if a
subdivision) in accordance with the Subdivision Map Act;

3. Soils Report, if obtained, showing the composition and condition of the soil and sub-soil, topography,
flood, and landslide or soil subsidence hazards, or related existing conditions, etc. (including whether
the report is generic to a subdivision or site specific);

4. Geologic Hazard Report, if applicable, showing any known geologic or seismic hazards including
historic landslides which may affect the intended security property;

5. Environmental Impact Report or Negative Declaration as required by the governmental agencies
having jurisdiction over the matter;

6. If the financing contemplated is to be secured by a junior encumbrance in a context of a subdivision or
contiguous phases or units in the same subdivision, whether the financing is subject to the
requirements imposed for promotional notes pursuant to the Securities Law;

7. Contractor’s resume and qualifications, and the contract for new construction showing a cost
breakdown and description of materials, building plans and specifications as approved by the local
government of jurisdiction, etc.;

8. Contracts from design professionals and bids from the major subcontractors intended to be engaged
for the project;

9. Approvals from local and regional governments, districts or commissions having jurisdiction over the
project, e.g. Coastal Commission;

10. Appraisal report in a form appropriate for the transaction, including an estimate of the market value of
the intended security property “as is” and “as completed” applying a discounted cash flow or an
anticipated development analysis with absorption rates and estimating costs for holding periods when
appropriate, in accordance with USPAP;

11. Evidence of compliance with the Subdivided Lands Law if the project is a CID subject to the issuance
of a Public Report and of the financial arrangements and bonding to ensure lien free completion in
accordance with the requirements imposed by local governments and the DRE; and,

12. Insurance policies extending coverage for course of construction, general liability and workers
compensation, among others, including proper endorsements.

The above list is intended to be illustrative and not comprehensive. The documents and information to be
gathered will vary substantially depending on the nature of the land development or vertical construction to be
financed. Loan documents/instruments evidencing and securing land development or construction loans are
unique and include construction loan and security agreements; UCC-1 filings; assignments of contracts with
contractors, subcontractors and design professionals; assignments of plans, specifications, and building permits,
among many others. These transactional loan documents/instruments, agreements, disclosures, etc., should be
reviewed by knowledgeable legal counsel before proceeding with land development or vertical construction
loans.

Loan Processing Wrap Up

When the loan is packaged by an MLB, the broker’s file should be maintained in a logical manner consistent
with the practices of the broker (MLB) recognizing the policies and procedures of the lender to whom the loan
is to be delivered. The lender or the authorized agent of the lender can then underwrite a properly developed
loan package.

Underwriting Analyses

The underwriter’s role is to assess the risk of the proposed loan and make recommendations whether to approve
the loan. In addition, the underwriter will ensure the loan package is in compliance with not only applicable
laws but with the lender’s policies. The underwriter will typically use an underwriting checklist to make sure all
components, elements, and conditions are considered and/or included, and that a credit memo or other written
summary of verified information, recommendations, and conclusions of the underwriter will be completed.

The underwriter will carefully consider the ability/capacity and willingness/desire of the consumer/borrower to
repay the loan as well as the adequacy of the collateral. This analysis is based on:

1. Information contained in the loan application and supporting documents;

2. Information developed by the lender in checking the credit and character of the prospective
consumer/borrower;

3. Verification of employment, bank deposits, etc. of the consumer/borrower;

4. A review of the information obtained in the preliminary “title” and appraisal reports and from the
property due diligence;

5. A interview with the consumer/borrower either telephonically or in person; and,

6. A review of the specific loan file to ensure compliance with the lender’s policies and procedures,
including the loan product being offered to the consumer/borrower.

Lenders evaluate residential loan requests using various measures to answer two basic questions concerning the
consumer/borrower. What is the borrower’s capacity for repaying the loan? What is the borrower’s
willingness/desire to repay the loan? The first issue deals with the capacity to repay and involves calculating
debt ratios. The traditional secondary mortgage market (primarily represented by Fannie Mae and Freddie Mac)
dictated standard underwriting ratios of 28% and 36%.

The first number of 28% is the historic “front-end” ratio that was often ignored when underwriting alternative
mortgages or non-traditional loan products. As previously indicated, the borrower’s housing expenses include,
principal and interest payments on senior and junior encumbrances, property taxes, and homeowners insurance
premiums, collectively referred to as PITI. If the property is located within a common interest development
(CID), many lenders add on to the housing expenses the dues/assessments imposed by the homeowners
association (HOA). The relationship between total housing expenses and the borrower’s gross monthly
income is translated into a ratio with the housing expenses not to exceed 28% of the gross monthly income, i.e.,

the “front-end” ratio. In restructuring existing mortgage loan/debt, an acceptable “front-end” ratio is as much as
38% of the borrower’s gross monthly income.

The second traditional number of 36% is the historic “back-end” ratio that was also often ignored when
underwriting alternative mortgages or non-traditional loan products. As previously indicated, the borrower’s
total monthly obligations include, the aforementioned housing expenses, as well as any other long-term
installment debt (defined as obligations that have more than 10 months of payments remaining before they are
paid off); certain forms of revolving debt such as credit cards and open account payments; spousal or child
support; and other qualifying liabilities subject to monthly debt service. The historic relationship between the
total housing expenses plus other qualifying monthly obligations was translated into a ratio not to exceed 36%
of the borrower’s gross monthly income.

Fannie Mae as part of revamping their underwriting guidelines has since abandoned the above described
housing ratios in favor of a total debt ratio, now called the benchmark ratio of from 36% to 38%, depending
upon the fact situation. It is important to understand the 36% to 38% benchmark ratio is a guideline only which
is considered in conjunction with other factors as part of a comprehensive risk assessment. An incremental
increase in the ratio above 36% to 38% may not be considered significant in the overall decision. Underwriting
guidelines currently consider a low or high ratio as a contributory risk factor that may decrease overall risk
when the ratio is less than 30%, or increase the overall risk when the ratio is over 42%. Part of the risk analysis
is the consideration of the net available income to service the consumer/borrower’s general obligations and
living expenses including income taxes, food, utilities, transportation, etc.

The credit report is the means the lender uses to measure the borrower’s willingness/desire to repay.
Traditionally, lenders evaluated a borrower’s credit by doing a line-by-line analysis of each “tradeline” or
source of credit appearing on the consumer/borrower’s credit report. This often resulted in a level of scrutiny
which required consumers/borrowers to provide additional loan documentation by way of a letter to explain,
“why they were late once on a department store credit card four years ago”. This was true even though it may
have had little relevance in predicting risk for the current credit decision.

Today, most lenders rely on credit scores to summarize a consumer/borrower’s credit profile with respect to its
overall predictability of future delinquency risk. Even with the use of credit scores which have become
commonplace, specific issues may result in the requirement for a letter of explanation. For example, a past
record that includes a Notice of Default, a bankruptcy, or an action by a creditor/lender to obtain a judgment for
non-payment of a debt will likely result in a letter of explanation (See additional discussion of credit scores
under Fannie Mae’s Automated Underwriting).

Fannie Mae’s Automated Underwriting

Fannie Mae has automated the underwriting process for lenders through its Desktop Underwriter (DU)
program. DU is a knowledge based software tool that contains rules for the quantitative assessment of risk
associated with a given loan request. It not only provides a comprehensive risk assessment of the borrower’s
capacity and willingness/desire to repay a loan, but also determines whether the loan meets the eligibility
criteria for purchase by Fannie Mae.

MLBs/MLOs through Desktop Originator (DO) are able to access the DU to deliver point of sale underwriting
decisions for the consumers/borrowers who are their clients. This results in greater efficiencies for lenders and
MLBs. In addition, the immediate feedback enables the MLB/MLO and the consumer/borrower to utilize “what
if scenarios” in putting together a structured loan program that is the most suitable for the client while at the
same time pursuing the objective of loan approval.

Automated underwriting initiatives rely heavily on credit scores generated from each of the three national
repositories of credit data: Experian, Transunion, and Equifax. Credit scores are derived from statistical models
applying complex mathematical formulas to evaluate the raw credit data in a consumer/borrower’s file to
predict the desired repayment of the loan being requested. These three digit scores generally range from 300 –
850 with the higher the score representing the lesser risk. The borrower should ask the MLB or MLO to whom
they are applying about credit practices the borrower should avoid that could result in an inadvertent decline in
the reported credit score.

The historic statistical analysis has suggested that one out of every 39 consumers with a score from 660–679
(considered a fair or acceptable score for many loan programs) will become 90 days or more late on a loan. A
score of 700 or higher is considered a very good score and will generally qualify a consumer/borrower for most
loan programs. The general benchmarks used by lenders for credit scores are 620, 650 and 680. A credit score
of less than 650 issued to a borrower will likely result in a higher interest rate. Conversely, a credit score in
excess of 680 will likely result in a preferential lower interest rate.

Freddie Mac offers an automated loan-underwriting program called Loan Prospector (LP). It operates in a
similar manner to the Fannie Mae automated underwriting system and relies, as well, on credit scores generated
from each of the three national repositories of credit data. Freddie Mac also uses similar credit score
benchmarks which are applied in the same manner.

Underwriting Income Property

There are different methods of underwriting income property. The methodology is often dependent on the type
of loan request and the primary source of repayment. For example, if the loan is secured by a rented or leased
fee commercial investment property (such as an apartment building, retail store, or an office building), the
lender likely will rely heavily on the security property’s cash flow that is available to service the mortgage debt.
Since the income from the security property will be the primary source of repayment, the lender will ask to
review rental and lease agreements and for lessee estoppel certificates to be obtained.

In the case of an apartment property, the rent roll and the status of the rent on each unit are included in the
information required to underwrite the loan. Secondary sources of repayment may come from the borrower’s
excess cash flow or liquidity (depending on if the loan is recourse or non-recourse). The tertiary source of
repayment may come from the sale of the security property. In this method of underwriting, a debt coverage
ratio will be established. Generally, the underwriter determines the debt coverage ratio by using the following
formula:

Plus Projected Gross Rents Other Income (Economic or projected gross rent scenarios will be considered) (e.g., laundry, parking, common area maintenance reimbursements)
Equals Total Gross Income ( Economic or projected)
Less Equals Vacancy Factor Effective Gross (Includes projected vacancies, collection, and credit losses)
Less Operating Expenses (Economic or projected)
Equals Net Operating Income (Economic or projected)

The projected gross rents estimate the income the security property should generate if rented at economic or the
then current market rents. If long-term leases encumber the security property with contract rents that are less
than economic or the then current market rents, the market value of the intended security property is burdened
by these actual rents. The available income stream upon which to rely for a debt coverage ratio is reduced by
the contract rents from the long-term leases. The actual gross income from the contract (actual) rents will
correspondingly reduce the available economic or projected net operating income (NOI), i.e., the actual NOI
will be less than the economic or projected NOI. The actual NOI will prevail when calculating the debt
coverage ratio.

The NOI is the cash flow of the property and the amount available to service the mortgage debt. The debt
coverage ratio (DCR) is determined by dividing the annual NOI by the annual mortgage debt service. The debt
coverage ratio will vary depending on the loan, property type, and the creditor/lender or the permanent investor.
For example, an institutional lender making a loan on an apartment building may require a 1:15:1.0 DCR. This
means that for every dollar of debt service, there must be $1.15 of NOI. In a commercial loan transaction where
the intended security property is other than an apartment building and the underwriter believes the loan
represents a greater risk to the creditor/lender or to the permanent investor, the lender may ask for a 1.25:1.0
DCR.

If the loan is a recourse transaction or there is a third party guarantor, the financials of the borrower and the
guarantor will be evaluated to determine their overall financial strength. The objective is to estimate the
financial ability to service any shortfalls, should the security property’s income stream be interrupted.

In the case of income property that is occupied by an owner/user (such as an industrial building where the
borrower’s business is located) another underwriting method may be used. In this instance, the primary source
of repayment is from the borrower’s business. Accordingly, a global cash flow analysis will be considered
encompassing not only the income of the business, but also income from other sources the borrower may have.
The available cash flow is compared to the expenses of the business as well as to any personal debt/loans of the
borrower. The lender will also consider the continued viability of the business as a “going concern”. This
analysis of the business is an essential element in the qualification for a loan to be insured by the Small
Business Administration (SBA).

Further, if the loan is a non-recourse transaction secured by a single-tenant building (such as a fast food
restaurant), the strength of the tenant, the ability to produce sufficient cash flow to support the mortgage debt
service, and the continued long-term viability of the business as a “going concern” will be evaluated by the
underwriter.

In addition, when evaluating an investment grade commercial loan transaction, the tools of analysis used may
include an inquiry into four main categories:

1. Liquidity. One component of the borrower’s assets is their liquidity. The borrower’s liquidity includes
cash and cash equivalents that are available for down payment, liquid reserves, and in some cases from
additional collateral. An underwriter must consider how able a borrower is to pay bills as they come
due. Current assets are compared to current liabilities. A liquidity ratio of 2 to 1 or better (current
assets are twice the liabilities) is recognized as acceptable by most lenders. Cash on hand and accounts
and notes receivable due within one year are considered “current assets”; debts and obligations due or
payable within one year are considered “current liabilities.”

2. Leverage. This is the ability of the borrower to control a large investment with a small amount of his
or her own equity capital and a large amount of other people’s money (the use of leverage). The more
money borrowed in relation to the value of the security property, the greater the leverage. Leverage
tests reveal how much of the total financing for the project is supplied by the owner and how much is
supplied by creditors such as the mortgage lender.

Included in the leverage analysis is a consideration of the “debt-to-equity ratio”. Leverage tests in
connection with analysis of a borrower’s financial statements are completed by comparing the
borrower’s equity interest in the assets owned and the total value of the capital investment to the long-
term debt. The purpose is to find how much of the total investment is ownership and how much is
debt. In a purchase transaction, to determine the original equity ratio, the down payment is divided by
the purchase price; and to determine the original debt ratio, the loan amount is divided by the purchase
price.

It is common for equity investors to seek debt ratios in excess of 75-80%. However, the ability to
exceed this ratio is often capped by applicable regulatory law. Lenders, looking at risk factors,
carefully scrutinize loan proposals to assure a safe equity ratio based on property characteristics and
the borrower’s repayment record. The rule of thumb for debt to equity ratio will be something between
3:1 and 4:1. The borrower often wants a more extreme ratio, because it reduces the amount of equity
capital that is at risk in the transaction. Real estate investment examples in a liquid money market have
been presented where ratios of 1 to almost zero are achieved by borrowers. This is usually a very
dangerous situation for the lender and is not available in a highly regulated atmosphere. An exception
allowing for zero debt to equity ratio is when the repayment of the loan is guaranteed or insured by
some reputable third party in the transaction, e.g., the United States Department of Agriculture
(USDA), or a financially strong company such as a major chain store or oil company.

Some lenders are willing to risk entering a high debt to equity loan situation in anticipation of market
prices going up, which automatically achieves growth in the owner’s equity resulting a more moderate
ratio through property appreciation. History has repeatedly shown that the expectation of market
appreciation is uncertain, especially in unstable economic conditions where a flat or down market
often occurs.

Coverage of fixed expenses is a test of how many times net income before income taxes and fixed
expenses (gross income minus operating expenses) will cover the fixed expenses. It reveals how far
the income can drop before the security property (or the borrower) will be unable to meet the fixed
expenses such as real estate taxes, insurance, license and permit fees. Net operating income after
operating expenses is divided by fixed expenses to get this ratio. If the ratio is 1:1, the net operating
income after operating expenses is just barely able to cover the fixed expenses. This is known as the
break-even ratio.

3. Activity. Activity tests are designed to reveal just how hard and effectively assets are working. There
are several tests for this but the most widely used is the income to total asset ratio. This ratio is found
by dividing total income by the value of the total assets.

4. Profitability. Profitability tests are designed to see how much net profit results from the operation. The
following are several of a variety of ratios and tests that are used to inquire into profitability.

Included is the “return on net worth.” This is the ratio of net profit (after taxes) to the net worth of the
project. This will yield a percentage return on investment which can be compared with the return
available from other investments of comparable risk. This is known as the alternative investment
theory.

Another profitability test is “yield analysis”. This form of analysis is well suited to estimating
profitability of real estate projects because it is relatively easy to compute and takes into consideration
three factors unique in their combination to real estate investment: cash return, equity return, and tax
shelter. It involves dividing the total return (net spendable cash income, principal reduction of
mortgage loans, and tax shelter) by the borrower’s equity. This is referred to as the internal rate of
return (IRR).

Loan Approval, Funding and Closing

Lender’s Action

Most lenders operate with a Loan Committee of experienced senior officers who consider loan applications
recommended to them by loan officers or borrower representatives (MLBs/MLOs). These MLOs have
screened the applications through borrower interviews including due diligence about the borrower and the
intended security property. The due diligence includes obtaining appraisal reports and other applicable reports
such as credit data. The underwriting analysis will typically represent the summary of the due diligence
accomplished regarding the borrower and the intended security property.

Through the underwriting analysis, the loan request will be approved, declined or the file may be closed for
incompleteness. The file is closed if the applicants have failed to provide required documentation and support
information. If the loan request and application is approved, the file progresses to the Loan Funding/Closing
Department for document/instrument preparation, funding of the loan, and ultimate closing of the loan
transaction.

Funding and Closing of the Loan

Depending upon how the lender is organized, the Loan Funding/Closing Department or the Document
Preparation Department will (subsequent to loan approval) prepare and complete the documents and
instruments required to evidence and secure the intended loan as well as the federal and state disclosures and
notices of rights to which the borrower is entitled. A loan closing and funding checklist will be added to the file
to ensure all appropriate documents/instruments are included. In addition, lender’s escrow instructions will be
prepared and transmitted with the documents, instruments, disclosures, and notices of rights to the escrow
holder for the signature of the borrowers.

The mechanics of closing the loan will vary. For the sale of a residence, an escrow holder is usually handling a
sale transaction between the seller and buyer and a loan transaction between the lender and the buyer/borrower.
In a loan transaction where no sale is involved (i.e., a refinance or further encumbrance of the security
property), the escrow holder’s assignment will be limited to escrowing the intended loan as well as obtaining

the signatures of the borrowers on the loan documents, instruments, disclosures, notices of rights and escrow
instructions necessary to close the loan transaction.

The escrow holder will typically furnish the lender with a certified copy of the signed escrow instructions,
together with any amendments thereto, and other documents, instruments the lender may require. As indicated,
an escrow officer employed by the escrow holder should obtain the signatures of the borrower on the required
documents, instruments, instructions, disclosures and notices of rights as directed by the lender. This activity
should not be delegated to independent signing agents without the express authority of the lender. MLBs/MLOs
are not authorized under the Real Estate Law to participate in the delegation of this function to independent
signing agents to carry out the obligations imposed under the Real Estate Law and pursuant to the exemption
available under the Financial Code when the broker is acting as the escrow holder (Business and Professions
Code Section 10133.1(c)(1) and (c)(2) and 10 CCR, Chapter 6, Section 2841; and Financial Code Section
17006(a) and (b)).

The escrow holder returns the loan documents and certified copies of the instruments to be recorded to the
lender for final review and approval in advance of loan funding. The escrow holder then awaits confirmation
that the lender is ready to fund the loan and for the receipt of the loan funds to close the loan escrow.

Recordation

When the lender’s instructions have been complied with, no conflicts remain or exist in the instructions of the
principals, and the lender approves the documents, instruments, agreement, disclosures, etc., as executed; the
lender sends/wires the loan funds to escrow. Upon receipt and verification of the loan funds, the escrow holder
transmits or causes to be transmitted to the county recorder for recordation the appropriate instruments
conveying or encumbering the title to the security property as instructed by the principals of the escrow. The
escrow holder confirms the recording and then proceeds to order the requested title insurance coverage.

Subsequent to recordation and close of the loan escrow, the escrow holder distributes the loan documents,
instruments, agreements, disclosures, etc., pursuant to the instructions of the principals of the escrow that were
not otherwise previously delivered. Loan funds are disbursed in accordance with the foregoing instructions.

PREDATORY LENDING AND BROKERING PRACTICES

Background

“Predatory Lending” is a general term used to describe abusive lending practices by some depository
institutions, licensed creditors/lenders, and by some MLBs viewed as “preying” on unsophisticated
consumers/borrowers. The U. S. Congress and the California legislature have each acted to address these
practices through the introduction of legislation that has added substantial new law regarding the making and
arranging of residential mortgage loans with the primary focus on owner occupied dwellings. In addition, new
federal regulations have been adopted as guidance for lenders and MLBs/MLOs when engaged in the making
and arranging of alternative mortgage instruments or non-traditional mortgage products. “Redlining” of certain
neighborhoods and communities was among the practices considered to be unacceptable.

In this section, the term “lender(s)” are the persons or entities that regularly make loans and whose names
appear on the promissory notes as the initial payee or that meet a defined status, when the mortgage loans are
subject to the Real Estate Settlement Procedures Act (RESPA) implemented through Regulation X, as well as
other applicable federal law. Regulation X is found in 24 CFR Section 3500 et seq. The term “creditor(s)” are
the persons or entities that, among other defined responsibilities and reporting obligations, extend credit to
consumers/borrowers in transactions subject to the Truth-In-Lending Act (TILA). Accordingly, the federal
definition is two-pronged, i.e., the “creditor(s)” for the purpose of making disclosures and delivering notices of
rights pursuant to TILA and “lender(s)” that regularly make loans and whose names appear on the promissory
notes as the initial payees and on the security devices/instruments as the beneficiaries/lenders/mortgagees.

California and Federal Legislation

The first effort to address predatory lending practices was accomplished by the California Legislature in 2001.
This legislation is now commonly known as the Predatory Lending Law and is found in Financial Code Section
4970 et seq. This law became operative on July 1, 2002. During the same period, the U.S. Congress and the

FRB pursued amendments to TILA found in 15 USC Section 1601 et seq. and in Regulation Z, 12 CFR Section
226 et seq. On December 20, 2001, the FRB issued final amendments to Section 226.32 of Regulation Z and to
the related “Commentary”. Creditors/lenders were required to comply with these amendments on October 1,
2002, commonly known as “Section 32” or the “High-Cost Loan Law”.

The aforementioned state law limited or controlled specific loan terms and added prohibited conducts by
creditors/lenders and MLBs in connection with consumer loans defined to be secured by the borrower’s
principal dwelling. The federal law amendments added disclosures to consumers/borrowers in loan transactions
where the security property is an owner occupied dwelling (as defined).

Federal Regulations

As previously mentioned, the Office of the Comptroller of the Currency (OCC); the Board of Governors of the
Federal Reserve System (Fed or FRB); the Federal Deposit Insurance Corporation (FDIC); the Office of Thrift
Supervision (OTS); and the National Credit Union Administration (NCUA); (collectively the Agencies)
published the, “Interagency Guidance on Non-Traditional Mortgage Product Risks,” November 7, 2006, which
became effective November 14, 2006. The same Agencies issued the, “Statement on Subprime Mortgage
Lending”, which became effective June 29, 2007.

The Guidance and the Statement were adopted by state regulators of banking (depository institutions), licensed
lenders, and of MLBs, including the Commissioner of the DRE (Business and Professions Code Section
10240.3). Accordingly, these documents/regulations had a sweeping affect on mortgage lending and brokering
(as well as severely limiting the secondary market for alternative mortgage instruments and non-traditional
mortgage products) throughout the entire country, including the terms available for residential loans.
Limitations and prohibitions on certain conducts by creditors/lenders and MLBs were imposed through these
documents/regulations.

Redlining

The aforementioned “redlining” practices by creditors/lenders and MLBs have been outlawed. The practices
defined as a violation of applicable law included creditors/lenders and MLBs drawing lines on maps around
areas within neighborhoods and communities in which lending and brokering activities did not occur (i.e.,
creditors/lenders and MLBs refused to make or arrange residential mortgage loans, as defined). This past and
unlawful practice of “redlining” was replaced by a much bigger problem of “reverse redlining”.

Reverse redlining involves targeting these previously underserved areas that were occupied by residents and
tenants who were often members of lower socio-economic classes or who were members of racial and ethnic
minorities (as well as recent immigrants). A catalyst for targeting these previously underserved areas was the
federal Community Reinvestment Act that was amended and expanded in 1999 by the Gramm-Leach-Bliley
Act.

The occupants of these geographic areas were generally less knowledgeable about loan programs and the
lending process and were typically uncertain or afraid to assert their legal rights, even in instances where it
appeared they were taken advantage of by creditors/lenders and MLBs (who failed to appropriately perform
their disclosure duties and related obligations, including the fiduciary duties owed to consumers/borrowers by
MLBs). Because of the reverse redlining, the individuals residing in these geographic areas became targets for
abusive lending and brokering practices.

Consumer/Borrower Abuses by Creditors/Lenders and MLBs

These practices involved unlawful tactics such as fraud, deceit, misrepresentation or deception, and unfair
business practices that may otherwise not be unlawful; but were unethical and, if pursued by MLBs, resulted in
breaches of fiduciary duties owed to consumers/borrowers. Inducing consumers/borrowers to repeatedly
refinance the mortgage loan secured by their principal residences and charging high rates and fees each time
(sometimes referred to as “churning”) is an example of the unfairness cited by the Federal Reserve System in
their background commentary for the Home Ownership and Equity Protection Act (HOEPA), the “High-Cost
Loan Law”. This “churning” practice is patently unfair and unethical, particularly when no demonstrable
benefit from the refinance inures to the consumer/borrower (such as improving the rate and terms as the
borrower’s credit worthiness and financial standing improves), i.e., the refinance was not in the interest of
consumers/borrowers.

As previously discussed in this section, federal and state legislation was enacted and regulations were adopted
in an effort to curb predatory practices. These regulations expanded regulatory oversight of what are described
as “High-Cost Loans” or “Higher-Cost or Priced Loans”. Until a California Supreme Court decision struck
down the City of Oakland’s Predatory Lending statute in favor of regulation at the state and federal level, some
cities and other local political subdivisions had adopted or considered adopting their own predatory lending
statutes. In the previously mentioned case, the court held California through its state legislation had occupied
the field and that any local ordinance was preempted thereby.

“High-Cost Loans” – An Overview of Sections 32 and 35

Federal legislation was enacted to regulate predatory lending practices pursuant to the aforementioned HOEPA
in Section 226.32 in Regulation Z where the regulations were promulgated to implement the amendments to
TILA (as mentioned, commonly known as Section 32). In addition, the Federal Higher Cost Mortgage Loan
Act, commonly referred to as Section 35, was adopted by Congress. Section 226.35 in Regulation Z of TILA is
where the regulations were promulgated implementing this law (15 USC Section 1601 and 12 CFR Sections
226.32 and 226.35).

In “High-Cost Loans” (Section 32), the interest rate threshold is determined by comparing the Annual
Percentage Rate (APR) with United States Treasury Securities of a comparable maturity. The APR is the
effective mortgage loan interest rate, which includes fees and charges considered prepaid finance charges, as
defined (12 CFR Section 226.4 (a)(b)). For first or senior deeds of trust or mortgages, if the difference in the
APR exceeds the rate of comparable Treasury Securities by 8% or more, then the APR has met one of the two
defined thresholds for a “High-Cost Loan”. For second or junior loans, the APR threshold is 10% over
Treasury Securities of comparable maturities.

The second of the two tests is whether the defined points and fees (including compensation paid to MLBs)
exceeds a threshold equivalent to 8% or more of the “net” loan amount (after deduction of the qualifying
prepaid finance charges, except for the prepaid interest represented by the initial partial month’s interest
proration imposed at the time of loan closing). If either the APR based test or the fee based test is met or
exceeded, then the mortgage loan is considered a “High-Cost Loan” for purposes of applying HOEPA.

“Higher-Cost/Priced Loans” (Section 35) are defined for federal purposes as a consumer credit transaction
secured by the consumer/borrower’s principal dwelling with an APR that exceeds the average prime offer rate
for a comparable transaction as of the date the interest rate is set on the subject mortgage loan. When the
subject mortgage loan is a first or senior encumbrance, the applicable APR that triggers Section 35 is set at
1.5% or more than the applicable prime offer rate. If the loan is a second or junior encumbrance, the applicable
APR that triggers Section 35 is set at 3.5% or more than the applicable prime offer rate. The applicable prime
offer rate is the average prime offer rate for conventional loans.

The average prime offer rate means an APR that is derived from average interest rates, points, and other loan
pricing terms currently offered to consumers by a representative sample of creditors/lenders for mortgage loan
transactions (including compensation paid to MLBs) that have low-risk pricing characteristics. The Federal
Reserve Board (FRB) publishes average prime offer rates for a broad range of types of transactions including
conventional mortgages in a table updated weekly known as the H15 Statistical Release
(http://www.federalreserve.gov/releases/h15/update/). Key issues included in Section 35 require
creditors/lenders to not extend credit solely based on the value of the consumer/borrower’s collateral without at
the same time considering the consumer/borrower’s ability to repay the mortgage loan debt service.

In addition, prepayment penalty fees are regulated and escrow (impound) accounts must be established by
creditors/lenders to provide for the monthly collection of sufficient sums for the future payment of property
taxes and property and casualty and other mortgage related insurance coverage when the property taxes and the
premiums for such coverage become due and payable. These escrow (impound) accounts are established by
creditors/lenders or by their servicing agents on behalf of consumers/borrowers in such loan transactions.

These federal and state laws to prevent creditors/lenders and MLBs from engaging in predatory practices will
be discussed further in this Chapter. MLBs/MLOs are well advised to familiarize themselves with each of these
laws, including implementing regulations, as the remedies include rescission of the mortgage loan, actual and
punitive damages, attorney’s fees and costs, license revocation or suspension, possible exclusion from the

mortgage and other real estate related industries for specified periods, and in some circumstances criminal
penalties. MLBs/MLOs should seek the advice of knowledgeable legal counsel prior to engaging in residential
mortgage loan transactions when the intended security property is the owner occupied dwelling of the
consumer/borrower.

California “High-Cost Loans” – “The Covered Loan Law”

Legislation was passed into law in 2001 that created California’s “Covered Loan Law” effective with
transactions originated on or after July 1, 2002. As previously discussed, this law provides that mortgage loans
(as defined) with annual percentage rates or points and fees that exceed certain levels must adhere to specific
restrictions and limitations.

The law is intended to protect consumers/borrowers of these “High-Cost Loans” from abusive lending and
brokering practices and is limited to consumer credit transactions that are secured by residential real property
located in California and used, or intended to be used, as the consumer’s/borrower’s principal residence and
improved by a 1 to 4 unit residential dwelling. For the purposes of this law, “consumer loans” exclude bridge
loans (defined as temporary loans having a maturity of one year or less that fund the acquisition or construction
of a dwelling intended to be the primary residence of the consumer/borrower) or a reverse mortgage (as
defined) (Regulation Z, 12 CFR Section 226.32 and Financial Code Section 4970(d)).

The state’s “High-Cost Loan” legislation was codified in the California Financial Code, commencing with
Section 4970. This Predatory Lending Law is more restrictive than federal law regarding the application of the
APR tests. The first test to be applied under state law is whether the amount of the original principal balance
qualifies the mortgage loan as a “Covered Loan”, defined to mean a loan secured by real property located in
this state used or intended to be used or occupied as the principal dwelling of the consumer/borrower and which
is improved by a 1 to 4 dwelling unit. To establish “Covered Loan” status, the original principal balance of the
loan is not to exceed the most current conforming loan limit for a single-family first mortgage loan, as
established by FNMA for the community in which the security property is located. Applicable federal law does
not apply a “Covered Loan” original principal balance limit/test.

The second test is the APR threshold standard. State law applies a standard of more than 8% greater than the
yield of Treasury Securities of comparable maturities (established on the 15th day of the month immediately
proceeding the month in which the application is received by the creditor/lender) as the threshold for purposes
of determining “Covered Loan” status. This 8% APR threshold standard applies to both first or senior and
second or junior mortgage loans. Again, the FRB H15 Statistical Release identifies the yield of the Treasury
Securities of comparable maturities.

A third test is applied to determine whether a mortgage loan is subject to the California Predatory Lending Law.
This test is measured by the total points and fees paid by the consumer/borrower at or before closing for a loan
secured by a deed of trust or mortgage. If the total points and fees exceed 6% (including compensation paid to
MLBs) of the “total loan amount”, which fees and points are defined as the items required to be disclosed as
prepaid finance charges under Regulation Z (12 CFR Sections 226.4(a) and (b)); “Covered Loan” status applies
to the mortgage loan transaction, i.e., the mortgage loan is subject to the California Predatory Lending Law (the
common title applied to “Covered Loan” transactions).

When persons MLBs/MLOs arrange the “Covered Loan”, such persons are fiduciaries of the
consumer/borrower and any violation of these fiduciary duties is a violation of applicable law. Further, brokers
(MLBs/MLOs) arranging “Covered Loans” owe fiduciary duties to the consumers/borrowers in such loan
transactions, regardless of any other representation the brokers may have as agents and fiduciaries in “Covered
Loan” transactions (Financial Code Section 4979.5).

This means the brokers (MLBs/MLOs) who are delivering “Covered Loans” to private investors/lenders for
whom they must act as agent and fiduciaries are “dual agents”, and this status is to be disclosed and consented
to by each principal to the loan transaction. Brokers (MLBs/MLOs) are agent and fiduciaries of
consumers/borrowers in residential mortgage loan transactions (whether “Covered Loans” or otherwise) and
are agents and fiduciaries of private investors/lenders, regardless of the nature of the loan transactions or the
intended security properties. Brokers (MLBs) who are engaging in commercial loan transactions, as defined
(loans secured by other than 1 to 4 dwelling units) are the agents and fiduciaries of commercial borrowers,

unless such borrowers are either separately represented or have received and consented to disclosures that they
are unrepresented and no conduct has occurred that would otherwise establish and agency and fiduciary
relationship with the borrower. It is important to understand that brokers (MLBs) whether registered as MLOs
are not facilitators in mortgage loan transactions (Business and Professions Code Sections 10131(d) and (e),
10131.3, 10176(d), 10177(q), and 10237 et seq.; Civil Code Sections 2295 et seq., 2349 et seq., and 2923.1;
Corporations Code Section 25100(e) and 25206; Corporations Commissioner’s Regulations 10CCR, Chapter 3,
Sections 260.115 and 260.204.1; and Financial Code Sections 4979.5, 4995(c) and (d) and 4995.3(c), among
others).

The Predatory Lending Law restricts or prohibits loan terms that provide for prepayment penalties, balloon
payments, negative amortizations, advance payments, default interest rates, and single premium life and
disability insurance. The law also establishes rules for the payment of home improvement loan proceeds to
contractors. Generally, such loan proceeds are to be paid jointly to the consumer/borrower and to the home
improvement contractor (Financial Code Section 4973(a), (b), (c), (d), (e), and (g)).

To make or arrange a “Covered Loan”, the person originating such loan must have a reasonable belief, based on
certain criteria, the consumer/borrower can repay the loan from income or financial resources other than the
equity in the property securing the loan. The law also limits the amount of points and fees that can be financed
by the consumer/borrower as part of the loan proceeds. Persons originating “Covered Loans’ (whether
creditors/lenders or MLBs) must give consumers/borrowers a notice required by statute entitled, “Consumer
Caution and Home Ownership Counseling Notice”. This notice is to be delivered not less than three business
days prior to signing of the loan documents by consumers/borrowers. The font size, content, and format of this
notice is prescribed by statute (Financial Code Section 4973(k)).

This law provides for administrative and civil penalties for violators, other than an assignee who is a “holder in
due course” (which may not include private investors/lenders). In addition, violating certain restrictions or
prohibitions regarding loan terms can render those terms unenforceable. For example, this law establishes rules
for prepayment penalty fees and for a minimum loan term length, if a balloon payment transaction is
contemplated. Consumers/borrowers must be qualified in accordance with the guidance included in this law
applying debt to income ratios; and a “Covered Loan” is not to contain a “call” or acceleration provision that
would permit creditors/lenders (in their sole discretion) to accelerate the indebtedness evidenced by the
promissory notes and deeds of trust or mortgages, except as expressly authorized in accordance with this law
and in the loan documents (Financial Code Section 4973(a), (b), and (i)).

The three authorized circumstances permitting creditors/lenders to accelerate all sums due irrespective of the
maturity date include:

1. As a result of the consumer’s/borrower’s default;

2. Pursuant to a “due-on-sale” provision; or,

3. Due to a fraud or material misrepresentation by the consumer/borrower in connection with the
mortgage loan or the value of the security real property (Financial Code Section 4973(i)).

Further, persons who originate “Covered Loans” shall not refinance or arrange the refinancing if the new loan
is made for the purpose of debt consolidation or “cash-out”, unless the refinanced “Covered Loan” results in
identifiable benefits to the consumer/borrower measured by the stated loan purpose and the fees, interest rate,
points (including MLB compensation), and total finance charges.

This law further provides that it is unlawful for persons (creditors/lenders and MLBs) who originate (make or
arrange) “Covered Loans” to steer, counsel, or direct any perspective consumer/borrower to accept a loan
product with a risk grade less favorable than the risk grade for which the consumer/borrower would qualify
based upon the creditor’s/lender’s and the MLB’s then current underwriting guidelines, prudently applied,
including information available to such persons and as provided by the consumer/borrower. If the person is a
broker (MLB), the MLB/MLO is not to steer, counsel, or direct any prospective consumer/borrower to accept a
mortgage loan product at a higher cost than that for which the consumer/borrower qualifies, based upon the
loan products offered by the persons (creditors/lenders) with whom the broker (MLB) regularly does business
(Financial Code Section 4973(l)).

It is also important to understand persons who originate covered loans are not to avoid, attempt to avoid, or
otherwise circumvent the Predatory Lending Law by structuring the loan transaction for the purpose of evading
the law. This includes using an open-end credit plan (e.g., Home Equity Line Of Credit); dividing the loan into
separate parts; or proceeding in any other manner, whether specifically prohibited or of a different character,
that constitutes fraud (Financial Code Sections 4970(d) and 4973(m)(n)).

In addition, “stated income” loans may not be made or arranged unless the consumer’s/borrower’s income is
based upon a reasonable belief (supported by information in the possession of the person originating the loan
after the solicitation of all information customarily solicited in connection with loans of this type). A “Covered
Loan” is not to be knowingly or willfully originated as a stated income loan with the intent or the effect of
evading the Predatory Lending Law. Further, persons making or arranging “Covered Loans” must be able to
demonstrate a reasonable belief the consumer/borrower will be able to make the scheduled payments to repay
the loan based upon their current and expected income, current obligations, current employment status and
other financial sources, excluding the equity in the consumer’s/borrower’s dwelling (Financial Code Section
4973(f)).

Depending upon the issue, loan terms negotiated in violation of this law may result in voiding (rendering
unenforceable) such loan terms. Furthermore, persons who make “Covered Loans” (creditors/lenders) when the
person is on notice of, knew, or otherwise showed reckless disregard of violation(s) of the Predatory Lending
Law by MLBs, such persons and the brokers shall be jointly and severally liable for all damages awarded under
this law with respect to the unlawful conduct of the brokers (Business and Professions Code Section 10177(d)
and Financial Code Section 4974(b)).

The provisions of the “Covered Loan” law are in addition to the consumer/borrower protections established in
Article 7 of the Real Estate Law and in the Home Ownership and Equity Protection Act of 1994 (Section 32) of
TILA (HOEPA). Section 32 was discussed previously in this section as was Section 35 of TILA which also
provides additional consumer/borrower protections. Article 7 will be discussed later in this Chapter. The
following subsection will discuss recently enacted law, California “Higher-Cost/Priced Mortgage Loans”
(Financial Code Section 4995 et seq.). This law is also intended to provide further consumer/borrower
protections.

California “Higher-Cost/Priced Mortgage Loans”

The California law identified as “Higher-Cost/Priced Mortgage Loans” was codified in Financial Code Section
4995 et seq. The definition of loan transactions subject to this law to be applied for state purposes is the same
as established under federal law (Regulation Z, 12 CFR Section 226.35). This state law imposes limits on
prepayment penalty fees. Creditors/lenders and MLBs who violate the duty of fair dealing, i.e., licensed persons
(as defined) who in bad faith attempt to avoid the application of the law by engaging in one or more of a
defined series of prohibited activities or conducts, are subject to damages, civil sanctions, to license discipline,
and potentially to criminal sanctions.

“Higher-Cost/Priced Mortgage Loans” are defined under state law in the same manner as under federal law
(Financial Code Section 4995(a)). Each law applies to consumer credit transactions secured by the
consumer/borrower’s principal dwelling with an APR that exceeds the average prime offer rate for a
comparable transaction as of the date the interest rate is set on the subject mortgage loan. When the subject
mortgage loan is a first or senior encumbrance, the applicable APR that triggers this state law is set at 1.5% or
more than the applicable prime offer rate. If the loan is a second or junior encumbrance, the applicable APR
that triggers this state law is set at 3.5% or more than the applicable prime offer rate (Regulation Z, 12 CFR
Section 226.35). As previously mentioned, the applicable prime offer rate is the average prime offer rate of
conventional mortgage loans that may be determined by reference to the H15 statistical release.

This law applies to licensed persons and to mortgage brokers (MLBs), as defined. Licensed persons include real
estate brokers licensed under the Real Estate Law; finance lenders or brokers licensed under the Finance
Lenders Law; residential mortgage lenders/brokers licensed under the Residential Mortgage Lending Act;
commercial or industrial banks organized under the Banking Law; savings associations organized under the
Savings Associations Law; and credit unions organized under the Credit Union Law (Financial Code Section
4995(b)). Licensed persons also include mortgage brokers who are providing mortgage brokerage services
(Financial Code Section 4995(c)). “Mortgage brokerage services” means arranging or attempting to arrange, as

the exclusive agent of the consumer/borrower, or as a dual agent for the borrower and the creditor/lender, for
compensation or expectation of compensation (whether paid directly or indirectly) a “Higher-Cost/Priced
Mortgage Loan” made by an “unaffiliated third party” (Financial Code Section 4995(d)).

The language “unaffiliated third party” may prove to be difficult to interpret (Financial Code Section 4995(d)).
The reasonable interpretation would suggest if the mortgage broker (MLB) is delivering the loan to an affiliated
party that “mortgage brokerage services” are not being provided. MLBs are apparently presumed to be
exclusive agents of the affiliated party (creditor/lender) funding and making the loan and, therefore, are not
required to be the agent and fiduciary of the consumer/borrower (Financial Code Section 4995(d)).

This relationship may be altered by the conduct of the mortgage broker (MLB). For example, should the MLB
solicit or cause the consumer/borrower to be solicited with express or implied representations (including
through conduct) the mortgage broker (MLB) will act as an agent to obtain and arrange the loan (whether a
residential mortgage that is a “High-Cost Loan” or a “Higher-Cost/Priced Mortgage Loan”, or another form of
mortgage loan, regardless of the nature of the intended security property) and the mortgage broker (MLB) in
fact makes the loan to the borrower from funds belonging to or controlled by the MLB (an affiliated party); the
mortgage broker is acting within the meaning of subdivision (d), Section 10131 of the Business and Professions
Code.

Accordingly, the MLB would be unable to discharge the agency fiduciary relationship with the
consumer/borrower or with a borrower in other than a consumer loan transaction (Business and Professions
Code Sections 10240(b) and 10241(j); Civil Code Sections 2295 et seq., 2349 et seq., and 2923.1; and
Financial Code Sections 4979.5, 4995(c) and (d) and 4995.3(c), among others).

Notwithstanding any other provision of applicable law, prepayment penalty fees imposed by a licensed person
in connection with a “Higher-Cost/Priced Mortgage Loan” shall not exceed 2 percent of the principal balance
prepaid during the first 12 months, or 1 percent of the principal balance prepaid during the second 12 months
following loan consummation (Financial Code Section 4995.1).

As aforementioned, this California law imposes a duty of fair dealing upon licensed persons when making or
arranging “Higher-Cost/Priced Mortgage Loans”. This means licensed persons may not in bad faith attempt to
avoid the application of the law by dividing the loan transaction into separate parts with the purpose and intent
of evading the law or through any other form of subterfuge (Financial Code Section 4995.2(a)). Licensed
persons are prohibited from making or causing to be made, any false, deceptive or misleading statement or
representation in connection with “Higher-Cost/Priced Mortgage Loans” (Financial Code Section 4995.2(b)).

Mortgage Brokers (MLBs) who limit their business plan/model to arranging only California “Higher-
Cost/Priced Mortgage Loans” are required to disclose that fact, orally and in writing, to consumers/borrowers at
the time of initially engaging in mortgage brokerage services. Further, MLBs who provide mortgage brokerage
services are prohibited from steering, counseling, or directing a consumer/borrower to accept a loan at a higher
cost than for which the consumer/borrower could qualify based upon the loans offered by the person from
whom the broker regularly does business. In addition, mortgage brokers providing mortgage brokerage services
for a consumer/borrower, cannot receive compensation (including a yield spread premium, fee, commission, or
any other compensation) for arranging “Higher-Cost/Priced Mortgage Loan” with a prepayment penalty
exceeding the compensation the MLB would otherwise received for arranging such a loan without a
prepayment penalty. When MLBs provide mortgage brokerage services for consumers/borrowers, the broker’s
compensation is to be the same whether paid by the creditor/lender, the consumer/borrower, or by a third party
(Financial Code Section 4995.2(c), (d), and (e)).

Licensed persons are prohibited from making or arranging California “Higher-Cost/Priced Mortgage Loans”
that include provisions for negative amortization, and licensed persons are also prohibited from recommending
or encouraging consumers/borrowers to default on existing mortgage loans or other debts prior to or in
connection with the closing or planned closing of a “Higher-Cost/Priced Mortgage Loan” that refinances all or
any portion of existing loans or debts (Financial Code Sections 4995.2(f) and (g)).

Licensed persons may avoid some of the sanctions if they voluntarily undertake (prior to any institution of any
action under this section) to notify the consumer/borrower within 90 days of loan closing of any compliance
failure, offer to correct the failure, and offer to make restitution, including changing the terms of the loan in a

manner authorized by this law (i.e., offering the consumer/borrower at his/her option a California “Higher-
Cost/Priced Mortgage Loan” consistent with the requirements of this law, or offering to change the terms of the
loan in a beneficial manner so that the loan would no longer be considered a “High-Cost/Priced Mortgage
Loan”) (Financial Code Section 4995.2(h)). Some of the foregoing remedies may not be available for a licensed
person who is a MLB/MLO as they require acts of creditors/lenders.

The California “High-Cost/Priced Mortgage Loan” Law becomes effective July 1, 2010. It is important to note
that the remedies for violations of this law are not exclusive, but will include any other rights or remedies
available under applicable law, including a violation of Civil Code Section 2923.1. Practitioners should not
pursue a business plan/model that includes making or arranging loans intended to be secured by property that is
the principal residence of or the owner occupied dwelling of the consumer/borrower which is a California
“High-Cost Loan” or “Higher-Cost/Priced Mortgage Loan” (as defined) or when such loans are subject to
federal law (i.e., Sections 32 and 35 of Regulation Z of TILA); without first obtaining the advice of
knowledgeable legal counsel.

In Summary

The basic premise of both federal and state statutory and regulatory responses is to limit or control specified
loan terms and to prohibit creditors/lenders and brokers (MLBs) from engaging in defined activities or
conducts. The terms “High-Cost Loans” or “Higher-Cost/Priced Loans” were employed in both federal and
state law to new law intended to apply to loans that exceed a prescribed interest rate and/or fee threshold for
which additional disclosures and noticed of rights are required. These new laws describe certain transactional
terms, activities, and conducts of creditors/lenders and MLBs that are prohibited and deemed unlawful.
Further, consumers/borrowers are provided with the opportunity (as defined) to cancel the contemplated
residential mortgage loan transaction (i.e., a loan secured by an owner occupied or principal dwelling).
Creditors/lenders and MLBs violating these statutory and regulatory provisions are subject to sanctions,
including fines, economic and punitive damages, attorney’s fees and court costs, and to license discipline.

Additional federal and state laws to prevent creditors/lenders and MLBs from engaging in predatory practices
will be discussed in this Chapter. MLBs/MLOs are well advised to familiarize themselves with each of these
laws, including implementing regulations, as the remedies include (among those outlined in the previous
paragraph) rescission of the residential mortgage loan, license revocation or suspension, possible exclusion
from the mortgage and other real estate related industries, and in some circumstances the possibility of criminal
penalties. MLBs/MLOs should seek the advice of knowledgeable legal counsel prior to engaging in residential
mortgage loan transactions when the intended security property is the owner occupied dwelling of the
consumer/borrower.

PREVENTING FORECLOSURE ABUSES

Brief Overview

Since 1979, corrective legislation has been passed and subsequently amended aimed at home-equity purchasers
and mortgage foreclosure consultants. These laws are found in Civil Code Sections 1695 et seq. and 2945 et
seq. The purpose of the laws is to provide protection for and to prevent foreclosure abuse of homeowners
whose residences are encumbered by deeds of trust or mortgages subject to an outstanding Notice of Default.
The term residential real property as used in these laws means a security property consisting of 1 to 4 family
dwelling units, one of which the owner occupies as his or her principal place of residence.

Home Equity Sales Contracts Law

Should a homeowner sell a residential property that he or she occupies (as defined) to an equity purchaser and
the property is the security for a loan subject to an outstanding Notice of Default, the provisions of Civil Code
Section 1695 et seq. (Home Equity Sales Contracts Law) would apply. An equity purchaser is defined to be a
person who acquires title to the residence of the seller subject to an outstanding Notice of Default, unless the
person acquires the title as follows:

1. For the purpose of using such property as a personal residence;

2. By deed in lieu of foreclosure of any voluntary lien or encumbrance of record (including deeds of trust
or mortgages);

3. By a deed from a trustee acting under the power of sale contained in a deed of trust or mortgage in a
non-judicial foreclosure sale conducted pursuant to Civil Code Section 2924 et seq.;

4. At a sale of the security property as otherwise authorized by statute;

5. By order or judgment of any court; or,

6. From a spouse, a blood relative, or a blood relative of a spouse.

If an equity purchaser intends to acquire a property subject to this law, the contents of the contract to effect
such a transaction are mandated by Civil Code Section 1695.3. Included among the required contract terms are:

1. The name, business address and telephone number of the equity purchaser;

2. The address of the residence in foreclosure;

3. The total consideration to be given by the equity purchaser in connection with or incident to the sale;

4. A complete description of the terms of payment or other consideration including, but not limited to,
any services of any nature which the equity purchaser represents he or she will perform for the equity
seller before or after the sale;

5. The time at which possession is to be transferred to the equity purchaser;

6. The terms of any rental agreement;

7. A Notice Of Cancellation (in at least 12 pt bold face type if the contract is printed, or in capital letters
if the contract is typed) as provided for in Civil Code Section 1695.5 setting forth the seller’s right to
cancel; and,

8. And a Notice Required By California law (in at least 14 pt bold face type if the contract is printed, or
in capital letters if the contract is typed) informing the equity seller that until the seller’s right to cancel
has ended, the equity purchaser or anyone working for the equity purchaser cannot ask the seller or
have the seller sign any deed or any other document related to the property or transaction. The name of
the equity purchaser must be included in this notice and the notice must immediately precede the
notice required in Civil Code Section 1695.5(a) and (b), i.e., the Notice of Cancellation.

The right to cancel any contract with an equity purchaser continues until midnight of the fifth business day (as
defined) following the day on which the equity seller signs a contract that complies with the Home Equity Sales
Contracts Law, or until 8:00AM on the day scheduled for the sale of the residential property pursuant to a
power of sale conferred in a deed of trust or mortgage, whichever occurs first. This law allows rescission of
such contracts under specified conditions (Civil Code Sections 1695.4, 1695.6, 1695.13, 1695.14, 1685.15,
1685.16 and 1695.17, or pursuant to any other applicable law).

Further, an equity purchaser who violates Section 1695.6 or Section 1695.13 may be liable for actual damages,
exemplary damages in an amount not less than three times the equity seller’s actual damages, attorney’s fees
and costs, and may be subject to an action for equitable relief. In addition, the court may award a civil penalty
of up to $2,500 under certain fact situations.

A criminal conviction for violation of Section 1695.6 (or for any practice which operates as fraud or deceit
upon the equity seller, including taking unconscionable advantage of the equity seller) may result in a fine of
not more than $25,000 or by imprisonment in the county jail, or in a state prison for a period of not more than
one year (or both the fine and the imprisonment) for each violation of this law.

The Home Equity Sales Contracts Law establishes a presumption that a grant to an equity purchaser with an
option for the equity seller to repurchase is a loan rather than a sale transaction (i.e., a hidden security device).

Any representative of a home equity purchaser as defined in Section 1695.15 deemed to be the agent or
employee of the equity purchaser is required to provide written proof to the equity seller that the representative
has a valid and current California real estate license and that the representative is bonded by an admitted surety
insurer in an amount equal to twice the amount of the fair market value of the property which is the subject of
the contract. However, a holding in a recent California case on this issue has made unenforceable the
requirement to obtain the bond as a predicate to representing the equity purchaser. As of this writing, the
requirement to obtain a bond to represent an equity purchaser is in doubt.

Because of the specific requirements of the Home Equity Sales Contracts Law, the standard real estate purchase
contracts and receipts for deposits (residential purchase agreements) customarily used in real estate brokerage
are not acceptable for use in home equity sales when the residential real property is subject to an outstanding
Notice of Default. Accordingly, a real estate licensee should seek the prior advice of legal counsel for
preparation of the proper contract forms and for advice regarding the manner in which such sales must be
conducted.

Mortgage Foreclosure Consultants Law

Civil Code Sections 2945 et seq. (Mortgage Foreclosure Consultants Law) addresses the problem of consultants
who represent that they can assist homeowners who are in foreclosure (their residence is subject to an
outstanding Notice of Default), often charge high fees, frequently secure the payment of their fees by a deed of
trust or mortgage on the residential property in foreclosure, and have been known to perform no service or
essentially a worthless service for the homeowner.

Foreclosure consultant means any person who makes any solicitation, representation, or an offer to any owner
to perform for compensation, or who for compensation, performs any service the person in any manner
represents he or she will do including any of the following:

1. Stop or postpone the foreclosure sale;

2. Obtain any forbearance from any beneficiary/lender/mortgagee;

3. Assist the owner in the right of reinstatement as provided for in Civil Code Section 2924c;

4. Obtain any extension of the period within which the owner may reinstate his or her debt/loan or
obligations;

5. Obtain any waiver of an acceleration clause contained in the promissory note or in a deed of trust or
mortgage on a residence in foreclosure (or in both the evidence of debt/loan and the security
instrument);

6. Assist the owner to obtain a loan or advance of funds;

7. Avoid or ameliorate the impairment of the owner’s credit rating resulting from the recording of a
Notice of Default or through the conduct of a foreclosure sale;

8. Save the owners residence from foreclosure; or,

9. Assist the owner in obtaining from the beneficiary/lender/mortgagee or trustee acting under a power of
sale or from a counsel acting for the beneficiary/lender/trustee the remaining proceeds from the
foreclosure sale of the owner’s residence (surpluses due to the owner as the borrower upon whom the
foreclosure was conducted).

Excluded from the definition of a foreclosure consultant are the following:

1. A person licensed to practice law in this state when the person renders services in the course and the
scope of the license;

2. A person licensed under Division 3 (commencing with section 12000) of the Financial Code when the
person is acting as a prorater as defined in the law;

3. A person licensed under the Real Estate Law when the person is acting under the authority of that
license as described in Sections 10131 or 10131.1 of the Business and Professions Code;

4. A person licensed under Chapter 1 of the Business and Professions Code (commencing with Section
5000 of Division 3) when the person is acting in any capacity under that license and under the
provisions of that law (as an accountant);

5. A person or his or her authorized agent acting under the express authority or with the written approval
of HUD or other department or agency of the United States or of this state to provide such services;

6. A person who holds or is owed an obligation secured by a lien on the residence in foreclosure
(including deeds of trust or mortgages) when the person performs services in connection with the
debt/loan and obligation or lien;

7. Any person acting under the California Finance Lender Law when the person is acting under the
authority of that license;

8. Any person acting under the Residential Mortgage Lending Act when the person is acting under the
authority of that license; or,

9. Any person or entity doing business under any law of this state, or the United States relating to banks,
trust companies, savings and loans, savings banks, industrial loan companies, pension trusts, credit
unions, insurance companies or any person or entity authorized under the law of this state to conduct a
title or escrow business, or a mortgagee which is a HUD approved mortgagee and any subsidiary or
affiliate of any of the above, or any agent or employee of any of the above while engaged in the
business of these persons or entities.

Service Means

“Service” means and includes, but is not limited to, any of the following:

1. Debt, budget, or financial counseling of any type.

2. Receiving money for the purpose of distributing it to creditors in payment or partial payment of any
obligation secured by a lien on a residence in foreclosure.

3. Contacting creditors on behalf of an owner of a residence in foreclosure.

4. Arranging or attempting to arrange for an extension of the period within which the owner of a
residence in foreclosure may cure his or her default and reinstate his or her obligation pursuant to
Section 2924c.

5. Arranging or attempting to arrange for any delay or postponement of the time of sale of the residence
in foreclosure.

6. Advising the filing of any document or assisting in any manner in the preparation of any document for
filing with any bankruptcy court.

7. Giving any advice, explanation, or instruction to an owner of a residence in foreclosure which in any
manner relates to the cure of a default in or the reinstatement of an obligation secured by a lien on the
residence in foreclosure, the full satisfaction of that obligation, or the postponement or avoidance of a
sale of a residence in foreclosure pursuant to a power of sale contained in any deed of trust.

8. Arranging or attempting to arrange for the payment by the beneficiary, mortgagee, trustee under a
power of sale, or counsel for the beneficiary, mortgagee, or trustee, of the remaining proceeds to
which the owner is entitled from a foreclosure sale of the owner's residence in foreclosure. Arranging
or attempting to arrange for the payment shall include any arrangement where the owner transfers or
assigns the right to the remaining proceeds of a foreclosure sale to the foreclosure consultant or any
person designated by the foreclosure consultant, whether that transfer is effected by agreement,
assignment, deed, power of attorney, or assignment of claim.

9. Arranging or attempting to arrange an audit of any obligation secured by a lien on a residence in
foreclosure, sometimes referred to as a “forensic loan audit”.

Notwithstanding the foregoing list of exemptions from the status of a foreclosure consultant, if the activity is to
assist the owner in obtaining surplus funds (if any) from the foreclosure sale of the owner’s residence, the

person is a foreclosure consultant (unless the person is the owner’s attorney). No exemption from the
foreclosure consultant’s law applies to a person except a licensed attorney when the foregoing service is being
offered or provided.

It is important to note the term “person” means for this purpose any individual, partnership, corporation, limited
liability company, association, or other group no matter how organized. The question of services that come
within the activities controlled by this law should be reviewed with knowledgeable legal counsel in advance of
performing any services or activities that may be subject to this law. They are broad and encompass most any
service, advice or activity offered or provided to a homeowner regarding the credit of the homeowner/borrower,
the ownership of the property, and concerning the security instruments of record when the residential property
is subject to an outstanding Notice of Default.

This law requires that contracts for services of foreclosure consultants contain specified provisions. The law
allows cancellation or rescission of such contracts under certain prescribed conditions (as well as the violation
of any applicable law that would result in cancellation or rescission of contracts). This law makes it a crime to
violate the provisions relating to such foreclosure consultant contracts.

Among the requirements for the contract for foreclosure consultants is a Notice Required by California Law
(printed in at least 14 pt bold face type) and the notice must be completed with the name of the foreclosure
consultant. The notice must immediately precede a second notice, a Notice of Cancellation. The purpose of the
notices is to ensure the homeowner is informed that no money may be paid to or received by the foreclosure
consultant until the foreclosure consultant has completely finished what the foreclosure consultant contracted to
do; that the homeowner may not be asked to sign or to sign any lien, deed of trust or mortgage, or execute a
deed that relates to the property or to the services being provided by the foreclosure consultant; and that the
homeowner may cancel the contract with the foreclosure consultant within five business days (as defined) from
the date of the transaction (i.e., entering into the contract). These notices are required pursuant to applicable law
(Civil Code Sections 2945.2 and 2945.3).

The foreclosure consultant’s fees are statutorily limited as well as the manner via which payment of the fees
may be obtained. The foreclosure consultant may not take a power of attorney from the homeowner for any
purpose and may not induce or attempt to induce a homeowner to enter into any contract that does not comply
in all respects with Civil Code Sections 2945.2 and 2945.3. Needless to say, foreclosure consultants may not act
in any manner that is deceptive, fraudulent, misleading or unconscionable.

Unless specifically exempt by this law, foreclosure consultants must register with the California Department of
Justice and must maintain in force a surety bond in the amount of $100,000 executed by a surety admitted to do
business in this state. As in the Home Equity Sales Contracts Law, the foreclosure consultant who commits any
violation described in Civil Code Section 2945.4 may be punished by a fine of not more than $10,000 or
imprisoned in the county jail or state prison for not more than one year, or both. Finally, any provision in a
contract with a foreclosure consultant that purports to limit the liability of the foreclosure consultant under Civil
Code Section 2949.9 is void and, at the option of the homeowner, would render the contract void.

Loan Modifications, Forbearances or Extensions, and Advance Fees

Background

The “Mortgage Meltdown” discussed earlier in this Chapter has resulted in significant problems for the
California housing market. Many borrowers are struggling or unable to make their mortgage loan payments.
Other borrowers are concerned about adjustable rate mortgages that have or are expected to reset to higher
interest rates producing increased monthly payments. Often these increased monthly payments are beyond the
capacity of many borrowers to pay. This is particularly true for those borrowers who obtained loan products by
qualifying at an initial “teaser” rate to achieve monthly payments that were affordable even for a short time.
Other borrowers qualified for their mortgage loans based on a represented stated income that was substantially
greater than the actual income earned.

Unable to make these increased mortgage loan payments, many of these borrowers turned to real estate brokers
(MLBs) to assist them with loan modifications or forbearances to prevent or delay foreclosure by the lenders or
the current holders of these mortgage loans. Real estate brokers (MLBs) can lawfully perform such services
pursuant to Section 10131(d) of the Business and Professions Code. Further, real estate brokers (MLBs) are

specifically exempt (with a notable exclusion regarding surplus funds) from the strict requirements of the
Mortgage Foreclosure Consultants Law that is discussed in this Chapter (Civil Code Section 2945.1).

Some borrowers sought the services of attorneys to obtain modifications of their mortgage loan terms,
including a reduction in the monthly payments. Under applicable law, California licensed attorneys may render
loan modification and/or forbearance services within the course and scope of their law practice. Attorneys who
are members of the California State Bar can lawfully perform such services. If not actively and principally
involved in the practice of negotiating loans secured by real property and when rendering services in the course
and scope of a law practice, attorneys are exempt from the Real Estate Law (Business and Professions Code
Sections 10133(a)(3) and 10133.1(a)(5)).

The DRE has reported “…financially distressed borrowers have fallen and continue to fall prey to pervasive
unlicensed loan modification and foreclosure rescue companies/entities, including natural persons offering such
services. In many cases, these companies are unlicensed entities that are nothing more than perpetrators of
fraud. They promise timely and helpful loan modification services, ask for and collect monies up front,
perform no valuable services, and simply pocket the monies paid in advance leaving borrowers exposed to
foreclosure of the mortgage loans secured by their homes.”

Evidence indicates persons or entities that are unlicensed have been involved in more “…monstrous and
unconscionable foreclosure rescue frauds, including ones where the unsophisticated homeowners surrender the
home title to the unlicensed scam artist or to an accomplice”.

California Legislation to Prevent Mortgage Loan Modification Abuses

Legislation was introduced, passed and signed by the Governor, which became effective October 11th, 2009
(Civil Code Sections 2944.6 and 2944.7). This law prohibits any person or entity that negotiates, attempts to
negotiate, arranges or attempts to arrange, or otherwise offers to perform for a fee or other compensation paid
by a borrower, a mortgage loan modification or other form of loan forbearance without first providing the
borrower with a notice prescribed by statute. The notice (statutory statement) is to be printed or word processed
in not less than 14pt bold type and provided to the borrower prior to entering into any fee agreement regarding
loan modification or loan forbearance services. This section shall remain in effect only until January 1, 2013,
and as of that date is repealed, unless a later enacted statute, that is enacted before January 1, 2013, deletes or
extends that date.

The obligation to provide the notice (statutory statement) in advance includes a contemplated loan modification
(as authorized by federal or state regulators) which proposes an extension of the amortization period for the
loan term to no more than 40 years from the original date of the loan. The specific content of the notice
(statutory statement) is set forth in Civil Code Section 2944.6(a).

In the notice, the borrower is referred to non-profit housing counseling agencies approved by HUD and a list of
these agencies is available by visiting a local HUD office or www.hud.gov. The borrower is to be informed of
the free services available through HUD approved non-profit counseling agencies (Business and Professions
Code Section 10147.6 and Civil Code Section 2944.6(a)).

This notice provision does not apply to a person or entity or an agent acting on behalf of the foregoing when the
loan modification or loan forbearance services are in connection with a mortgage loan owned (held) or serviced
by such persons or entities. If the loan modification or forbearance service is offered to the borrower in a
language specified in Civil Code Section 1632, the notices, documents and instruments (including the
agreement to provide such services) are to be translated into the language used. These languages include
Spanish, Vietnamese, Tagalog, Chinese, and Korean (Civil Code Sections 1632 and 2944.6(a)).

This recent legislation prohibits any person or entity who offers to negotiate or attempts to negotiate, or offers
to arrange or attempts to arrange, or offers to otherwise perform any loan modification or forbearance service
from claiming, demanding, charging, collecting, or receiving any compensation, until the person or entity
performs every service contracted for or represented to be performed. The purpose of this prohibition is to
prevent any form of advance fees in connection with loan modification or other loan forbearance services
(Business and Professions Code Sections 10026, 10085, 10085.5, 10085.6, 10131.2, 10146, and 10147.6; and
10CCR, Chapter 6, 2970 and 2972; and Civil Code Section 2944.7).

Prior to proceeding with the use of any advance fee agreement for the performance of any services for which a
real estate broker’s license is required, these agreements and materials used to obtain advance fees (including
contract forms, letters or cards used to solicit the public, radio and television ads, among other advertisements)
must be submitted to and requires the prior approval of the DRE. The DRE may elect to issue a no objection
statement. Either way, real estate brokers (MLBs) may not proceed until the DRE authorizes the advance fee
agreements and materials the licensee intends to use.

When advance fees are collected they are to be handled as trust funds and deposited into the trust account of the
real estate broker (MLB) and must be accounted for and disbursed in the manner authorized by the DRE
(Business and Professions Code Sections 10085 and 10146, and 10CCR, Chapter 6, 2970 and 2972). The
failure to comply with the advance fee requirements as described in this Chapter and in accordance with
applicable law is a presumptive violation of 506 and 506(a) of the Penal Code (conversion and embezzlement).

In addition, any person or entity contracting or representing to perform such services is prohibited from
receiving any wage assignment or any lien of any type on real or personal property to secure the payment of
compensation. Also, such persons are prohibited from accepting a power of attorney from the borrower for any
reason whatsoever. The prohibition of the payment of advance fees (as defined) does not preclude the lender or
the holder of the loan or its servicing agent from collecting principal, interest, or other charges under the terms
of the mortgage loan before the loan is modified (including charges to establish a new payment or amortization
schedule, or for structuring the modification providing for a reduction in the unpaid principal balance for the
express purpose of reducing the monthly payment under the terms of the loan).

The lender or holder of the mortgage loan and its servicing agent are not precluded for collecting interest, or
other charges under the terms of the loan after the loan is modified, or from accepting payments by a federal
agency in connection the “Making Home Affordable Plan” or other federal plan to help borrowers refinance or
modify their residential mortgage loans, as well as otherwise avoiding foreclosure. Each of these codified
sections are intended to apply to residential real property containing four or fewer units (Civil Code Sections
2944.6(e) and 2944.7(a), (c), and (d)).

A violation of this law by a natural person is a public offense punishable by a fine not exceeding $10,000 or by
imprisonment in the County jail for a term not to exceed one year or by both a fine and imprisonment. If the
violation of the law occurs by an entity, the violation is punishable by a fine not exceeding $50,000. The
penalties described in this law are cumulative to any other remedies or penalties provided by law (Business and
Professions Code Section 10147.6(e); and Civil Code Sections 2944.6(c) and 2944.7(b)). The section
prohibiting the collection of advance fees is repealed as of January 1, 2013, unless extended by a later statute
enacted before January 1, 2013 (Civil Code Section 2944.7).

Conclusion

It is illegal for any person to take “unconscionable advantage” of any property owner in foreclosure or in
connection with mortgage loan modification or loan forbearance services. While real estate broker licensees
may, under certain circumstances, be exempt from the provisions of the Mortgage Foreclosure Consultants
Law, a licensee should proceed with an abundance of caution when dealing with owners of residential property
where a Notice of Default has been recorded and remains outstanding or a Home Equity Sales Contract is being
considered. This note of caution extends to engaging in any activities involving mortgage loan modification or
other loan forbearance services, including the prohibition from collecting advance fees.

Among other requirements, real estate licensees must act within the course and scope of their licenses, must
not accept any advance fees, and must not acquire any interest in the residence in foreclosure. Prior to
representing either a seller of residential real property or an equity purchaser when the property is subject to an
outstanding Notice of Default, or prior to offering loan modification or other loan forbearance services, real
estate brokers (MLBs) should seek the advice of knowledgeable legal counsel.

PRIVATE INVESTORS/LENDERS

Private Money Loan Transactions

Loans funded by private investors/lenders and arranged by MLBs that are secured directly or collaterally by
liens on real property (deeds of trust or mortgages) have been historically referred to as “hard money” loans.
Whether the proceeds of the loan funded by private investors/lenders are for the purchase of the intended
security property or used to further encumber or refinance existing encumbrances (including the payment of
additional net proceeds to the borrower known as an “equity loan”), the term “hard money” has been
historically applied to such transactions.

The term “hard money” has also been applied to loan transactions funded by depository institutions and
licensed lenders when the loan proceeds are used to refinance existing encumbrances or to further encumber the
security property (including loan transactions where additional net proceeds are paid to the borrower known in
this setting as a “cash-out refinance”). The discussion in this Section is intended to apply to loan transactions
made or arranged by MLBs with the capital/funds of private investors/lenders.

MLBs also make and arrange loans relying on capital/funds from private investors/lenders where the loan
proceeds are used to purchase, develop, or improve the intended security property (land acquisition and
development or vertical construction loans). In addition, loans made or arranged by MLBs may be secured by
either senior or junior deeds of trust or mortgages.

Many practitioners have redefined making and arranging loans with the capital/funds of private
investors/lenders as “private money” transactions. Investment bankers and broker-dealers refer to the use of
funds from private investors/lenders as “private equity capital”. The traditional term “hard money” has given
way to industry use of the terms “private money” or “private equity capital”. As a cautionary note, the use of
“private money” in a loan transaction does not excuse MLBs from following applicable federal and state law,

including (among others) standards imposed regarding the appraisal of the intended security property and the
underwriting of the borrower’s credit worthiness and financial standing.

As agents and fiduciaries, MLBs remain subject to the responsibility of ensuring that a reasonable method of
repayment of the debt/loan has been established and that the borrower is capable of paying the required
mortgage debt service throughout the term of the loan, i.e., the proposed loan transaction is suitable for the
borrower. Equally, MLBs must assess whether the intended loan transaction is suitable for the private
investors/lenders whose capital/funds are being relied upon to make or arrange the loan. (Business and
Professions Code Sections 10131(d) and (e), 10131.1, 10131.3, 10176, 10177, 10232.4, .5 and .6, 10238(h)(3)
and (4), 10240 et seq., including 10241.3 and 11302(b), among others).

Transactions with Private Investors/Lenders are Securities

When relying on capital/funds obtained from private investors/lenders for loans secured directly or collaterally
by liens on real property (deeds of trusts or mortgages), MLBs must be aware they are performing in three roles
under the Real Estate Law and the Corporate Securities Law of 1968 and the respective Commissioners’
Regulations pertaining to each. The three roles include issuer, real estate broker acting within the course and
scope of his or her license as an agent and fiduciary, and de-facto broker/dealer (Business and Professions Code
Sections 10131.3, 10177.6, 10177(q), 10230 et seq., and 10240 et seq., and 10CCR, Chapter 6, Section 2840 et
seq. among others; Civil Code Sections 2295 et seq. and 2923.1; Corporations Code Sections 25019, 25100(e),
25206, and 10CCR, Chapter 3, Sections 260.115 and 260.204.1, among others).

If the loan is evidenced by promissory notes issued in series secured by the same deed of trust or mortgage,
secured by more than one deed of trust or mortgage of equal priority, or “fractionalized” interests in the
promissory notes are sold to private investors/lenders (in “multi-lender” transactions), the loan or the purchase
of the promissory notes or interests therein must occur through MLBs (Business and Professions Code Sections
10131.3, 10177(n) and 10237 et seq.; and Corporations Code Sections 25100(e), 25102(e), 25102(f), 25102(n),
25102.5 and 25206, and 10CCR, Chapter 3, Sections 260.115 and 260.204.1, among others).

These private investors/lenders are usually persons desiring higher returns on the capital/funds invested in
exchange for higher risks than might occur in other forms of investment vehicles. It is possible investments in
promissory notes and deeds of trusts may result in lower risks than some alternative investment vehicles.
Individual private investors/lenders acting for their own account in “whole note” loan transactions without the
loan being arranged by MLBs must still operate within applicable federal and state law governing lending and
usury.

Disclosures Required

Private investors/lenders making loans through MLBs must receive disclosures pursuant to Sections 10176,
10177, 10232.4, 10232.5, 10232.6, and 10237 et seq. of the Business and Professions Code, and 10CCR,
Chapter 6, Section 2846, among others, including any additional disclosures regarding material facts and
investment risks required under the Corporate Securities Law of 1968 and the Corporations Commissioner’s
Regulations pertaining thereto (Corporations Code Section 25000 et seq. and 10CCR, Chapter 6, Section
260.100 et seq.). These disclosures must be made to private investors/lenders prior to the MLB committing the
private investor/lender’s capital/funds to loan transactions or to the purchase of interests in promissory notes
and deeds of trusts or mortgages.

Borrowers must receive disclosures from MLBs pursuant to Sections 10176, 10177 and 10240 et seq. of the
Business and Professions Code and 10CCR, Chapter 6, Section 2840 et seq., among others, prior to becoming
obligated to complete the loan transaction.

Whether required to be delivered to private investors/lenders or to borrowers, the objective of these disclosures
is to ensure that in either residential or commercial loan transactions (as defined), the principals are making
informed and considered decisions to extend credit or to borrow the money, and the proposed loan transactions
are suitable for the intended private investors/lenders and the borrowers.

Usury

Private investors/lenders may loan money directly or they may benefit from the usury exemption by lending the
funds through an MLB. In California, the passage of Proposition 2 in 1979 made significant changes to the
constitutional provisions defining and controlling usury. Thereafter, loans secured directly or collaterally by

liens on real property in the form of deeds of trusts or mortgages made or arranged by licensed real estate
brokers (acting as MLBs) became exempt from the usury law.

The California Legislature has applied the usury exemption to loans or forbearances made or arranged by
licensed real estate brokers (whether acting as MLBs or as brokers in connection with a related real property
transaction) that are directly or collaterally (in whole or in part) secured by liens (deeds of trusts or mortgages)
on real property (Civil Code Section 1916.1). The usury exemption extended to real estate brokers (MLBs)
applies regardless of the nature of the intended security real property.

Whether a loan made or arranged by a real estate broker (MLB) may be secured “… in whole or in part by liens
on real property …” is controversial in the real estate and mortgage industries and among some members of the
legal community (Civil Code Section 1916.1). Some observers believe this phrase authorizes MLBs to make or
arrange loans secured in part by business or other forms of personal property (including the pledging as
additional collateral of other non-real property security interests) even though the real estate license authority
for such brokers does not extend beyond loans secured directly or collaterally by liens on real property.

Other observers believe the language was intended to preserve the usury exemption when real estate brokers
(MLBs) made or arranged part of the loan within the course and scope of their license authority with the
remaining part of the loan being made or arranged by other lenders acting within their license authority. A
further interpretation has been applied in narrow circumstances, i.e., when the loan is made in part directly by a
principal (person or entity) without the benefit of a license.

A principal acting directly raises additional questions involving the Securities Law and the applicable license
law, e.g., a real estate broker’s license is required when performing as a mortgage broker (MLB) to issue
“multi-lender” promissory notes (Business and Professions Code Sections 10131.3 and 10237; Corporations
Code Section 25102.5 and 10CCR, Chapter 3, Sections 260.115 and 260.204.1). Regardless of interpretation,
MLBs are unable to include other than the real property security when establishing loan-to-value ratios required
pursuant to Business and Professions Code Section 10238(h)(1) and (2).

A real estate broker arranged extension, forbearance, or refinancing of a loan secured in whole or in part by a
lien on real property (deed of trust or mortgage) in which the broker had originally been compensated (even
though not being specifically compensated for arranging the new credit terms) is also exempt from the usury
law. As previously mentioned, private investors/lenders making loans or engaging in such transactions
involving new credit terms without having the transaction arranged by a real estate broker are controlled by and
subject to the usury law (Article 15, Section 1 of the California Constitution; Civil Code Section 1916.1; Gibbo
v. Berger (2004) 123 Cal.App. 4th 396, and In re Lara, 731 F.2d 1455, 1459 (9th Cir. 1984)).

“Multi-Lender” Promissory Notes

Notes in series which are secured by a single deed of trust or more than one deed of trust of equal priority, or
notes providing fractionalized interests to no more than 10 investors/lenders (as defined) are securities requiring
issuance pursuant to the “quasi-private placement” exemption (as defined) set forth in Business and Professions
Code Section 10237 et seq., and in Corporations Code Section 25102.5. The phrase “quasi-private placement”
as used in this discussion means a “private placement”, which unlike any other such offering allows the issuer
to market to private investors/lenders through media and to accept funds from the foregoing even though no
preexisting business relationship exists with the issuer.

When private investors/lenders fund or make loans evidenced by promissory notes or purchase interests in
promissory notes, the issuance of securities must be addressed to ensure compliance with the Corporate
Securities Law of 1968 and the Corporations Commissioner’s Regulations pertaining thereto, particularly
Corporations Code Sections 25019, 25102 et seq., and 25110 et seq. The “quasi-private placement” exemption
is structured to allow “multi-lender” promissory notes to be issued without requiring the issuers to otherwise
qualify the offering by “exemption” (a private placement) or by “registration”.

The offering of securities must either be qualified pursuant to Sections 25110, 25120, or 25130 of the
Corporations Code, i.e., “registered” with and permitted by the DOC, or the securities must meet an exempt
“issuer” or “nonissuer” status, arise from an exempt “issuer” or “nonissuer” transaction, or from a transaction
exempt through issuance to a “qualified purchaser” (Corporations Code Section 25100 et seq.). The foregoing

“exemptions” must meet each of the standards and requirements imposed pursuant to the Corporate Securities
Law of 1968 and the Commissioner’s Regulations pertaining thereto.

If the issuer fails to meet each of the standards and requirements imposed to issue an offering pursuant to an
applicable “exemption”, the offering would be issued in violation of the Securities Law. Accordingly, the issuer
may be subject to an enforcement action for securities fraud due to the failure (among other violations) to
appropriately qualify the offering with the DOC, i.e., “registering” with and obtaining a permit from the DOC.
There are no exemptions from the Corporate Securities Law of 1968 and the Corporations Commissioner’s
regulations pertaining thereto for fraud or misrepresentation. Furthermore, the failure to comply with the
standards and requirements imposed for the applicable “exemption” negates the “exemption”, and the burden of
proving “…an exemption or an exception from a definition is upon the person claiming it” (Corporations Code
Section 25163).

For the purposes of this discussion, offerings of securities that meet the exempt “issuer” or “nonissuer” status,
arise from an exempt “issuer” or “nonissuer” transaction, or from a transaction exempt through issuance to a
“qualified purchaser” will be referred to as securities qualified by “exemption”. Offerings qualified with the
DOC and for which a permit has been issued will be referred to as securities qualified by “registration”.
Accordingly, the offering of securities must be qualified either by “exemption” or by “registration” with the
DOC (if the securities are to be issued intrastate) and qualified by coordination with the Securities and
Exchange Commission (SEC) when the securities are to be issued both intra and interstate.

Coordination with the SEC is also required if the issuer is unable to qualify the securities under the exemption
extended through Regulation D of the Securities Exchange Act of 1933, Section 18(b)(4), and as authorized in
17CFR Section 239.500. Among the standards imposed to qualify by exemption through Regulation D is the
requirement that 100 percent of the private investors/lenders and 80 percent of the business of the issuer must
be within the same state (Rule 147 promulgated by the SEC).

The issuance of securities by MLBs to private investors/lenders is a very complex matter requiring a practical
understanding (at a minimum) of an extensive body of law, including the Corporate Securities law of 1968 and
the Corporations Commissioner’s Regulations pertaining thereto (Corporations Code Section 25000 et seq. and
10 CCR, Chapter 3, commencing with Section 260.100). A further discussion is included later in this Chapter
regarding “multi-lender” transactions authorized by Article 6 of the Business and Professions Code (as noted, a
“quasi-private placement”).

Subdivision Projects

In recent years, MLBs have arranged loans funded by private investors/lenders secured by raw land for which
entitlements were to be obtained, entitled land for purposes of development of offsite (including backbone) and
onsite improvements, or for financing vertical construction of building improvements. These loans were made
or arranged in connection with subdivision projects. The term “backbone” when describing offsite
improvements refers to improvements required by a local political subdivision as part of the necessary public
infrastructure to accommodate the development/subdivision.

These loan products are subject to high although diminishing risks depending upon the stage of the project. The
highest risk is when the security property is raw land and the loans are made in advance of receiving
entitlements. The second level of risk is associated with loans to finance post entitlement land development of
offsite (including backbone) and onsite improvements. The third level of risk is the financing of the vertical
construction representing the improvements to be built upon the land. Each of the foregoing represent loans for
speculative objectives and, therefore, is an example of loans funded with “risk capital”.

In each case, the financing obtained from private investors/lenders represents “risk capital” which must be
distinguished from other forms of loan transactions in the securities offerings made to the public or pursuant to
an authorized exemption (private placement). The “quasi-private placement” authorized pursuant to Article 6 of
the Business and Professions Code, commencing with Section 10237 and pursuant to Corporations Code
Section 25102.5, is a securities specific exemption from otherwise qualifying by exemption or registration with
the DOC (and by coordination with the SEC, if applicable). This exemption is known as the “multi-lender
statutory exemption”.

MLBs as issuers, real estate broker agents and fiduciaries, and as de-facto broker-dealers must carefully follow
without deviation the provisions of the statutory “multi-lender” exemption and the related requirements of the
Real Estate Law. It is strongly recommended that MLBs not engage in the financing of land intended for
subdivision development, in the financing of offsite (including backbone) and onsite improvements, or in the
financing of vertical construction (including rehabilitation loans) without first obtaining the advice of
knowledgeable construction and securities legal counsel.

Whether a vertical construction loan is intended to finance a single spot loan for an identified borrower or is
intended to finance the construction of homes on a speculative basis within a subdivision project, permanent or
“take out” financing should be considered by the borrower and the private investors/lenders. MLBs acting as
agents of the private investors/lenders must undertake to underwrite adequately the borrower and the
subdivision project to determine whether a reasonable expectation exists to obtain permanent financing to pay
off the development or construction loan upon completion of the improvements.

It should be clear that engaging in the issuance of securities (whether in the form of a “multi-lender” transaction
authorized by Article 6 of the Business and Professions Code, through an offering otherwise meeting the
standards and requirements for exemption, or an offering qualified by registration) is a matter involving a
significant amount of complexity. Practitioners should not engage in the issuance of securities (whether the
investment vehicle is an equitable or fee interest in the title to or a mortgage interest in real property) without
the prior advice of knowledgeable securities legal counsel.

Article 5 – Private Investors/Lenders

The Real Estate Law imposes certain duties and restrictions on real estate brokers (MLBs) who make or arrange
mortgage loans directly or collaterally secured by liens on real property (deeds of trust or mortgages). MLBs
may act in the secured transaction as either a principal making the loan with the broker’s own funds or with
funds the broker controls (as defined), or as an agent of the private investors/lenders or of the borrower, or
both.

MLBs may also act as agents of the principals for the purpose of buying, selling, or exchanging existing
promissory notes secured directly or collaterally by liens on real property (deeds of trust or mortgages). When
MLBs are selling and assigning interests to private investors/lenders in mortgage loans they have funded with
their own capital or through independent credit lines they have obtained for this purpose, MLBs are required
(pursuant to the Corporate Securities Law of 1968 and the Corporations Commissioner’s Regulations
pertaining thereto) to act as the agent and fiduciary of the private investors/lenders.

Real property sales contracts are marketing agreements and security devices/instruments rolled up into one
document. While such contracts are authorized under California law, federal law has preempted applicable state
law thus prohibiting the use of real property sales contracts when the property described therein is encumbered
by deed(s) of trust or mortgage(s) that include due-on-sale or due on further encumbrance clauses (the Federal
Depository Intuitions Act of 1982 also know as the Garn-St. Germain Act.) Further, real property sales
contracts are subject to significant issues regarding the remedies available to the seller/vendor in the event of a
breach or default by the buyer/vendee. For the foregoing reasons, this Chapter focuses on promissory notes and
deeds of trust or mortgages rather than on real property sales contracts. Practitioners should not engage in the
use of real property sales contracts without the prior advice of knowledgeable legal counsel.

Application of Article 5

The passage of Proposition 2 in November 1979 eliminated interest rate limits on real property secured loans
“made or arranged” by real estate brokers (MLBs). The Legislature responded in 1981 and 1982 by extensive
additions to the Real Estate Law, specifically to Articles 5 (governing transactions in deeds of trust primarily
with private investors/lenders) and to Article 7 (governing real property loans in connection with the duties and
obligations owed to borrowers).

Article 5 (Sections 10230 - 10236.6 of the Business and Professions Code) is applicable to arranging the
funding of mortgage loans by private investors/lenders who are non-institutional (other than depository
institutions) and are not themselves licensed as lenders. Article 5 is also applicable to the buying, selling or
exchanging of promissory notes and deeds of trust or mortgages (including interests therein) on behalf of
private investors/lenders.

The provisions of Article 5 also apply to real estate brokers (MLBs) who engage in secured transactions as
principals in buying from, selling to, or exchanging promissory notes and deeds of trust or mortgages with the
public and to MLBs who make agreements with the public for the collection of payments or the performance of
services in connection with promissory notes and deeds of trust or mortgages. The Securities Law integrates
with Article 5 and alters the principal-only role of the MLB when selling to or exchanging promissory notes
and deeds of trust or mortgages with private investors/lenders. As previously mentioned, MLBs engaging in
such transactions are required to be the agents and fiduciaries of the private investors/lenders (Business and
Professions Code Section 10131.3, Corporations Code Sections 25100(e) and 25206, and 10CCR, Chapter 3,
Sections 260.115 and 260.204.1, among others).

Pooling of Loan Funds

Pooling of funds from private investors/lenders’ is prohibited except as authorized through qualification by
exemption or registration of the offering issued through a permit obtained pursuant to the provisions of the
Corporate Securities Law of 1968 and the Corporation Commissioner’s Regulations pertaining thereto. As
previously mentioned, the Securities Law is administered by the DOC. Capital/funds of private
investors/lenders may be accepted for the funding/making of a specific loan or the purchase of a specific
promissory note or interests therein; unless the capital/funds were received through an offering qualified either
by exemption or by registration with the DOC that authorizes such pooling of funds (Business and Professions
Code, Section 10231 and Corporations Code Sections 25019, 25100, 25102, 25102.5 and 25110 et seq., among
others).

When the DOC processes an offering qualified by registration and the applicable requirements have been
satisfied, a permit is issued by the DOC (Corporations Code Section 25110 et seq.). Should the offering be
qualified by exemption, then the DOC is to be noticed pursuant to Corporations Code Section 25102.1 and in
accordance with the related regulations of the Corporations Commissioner. While it is important to comply with
the notice provisions of the Securities Law, the failure to notice the DOC may not in and of itself disqualify the
offering. However, practitioners should be aware that offerings qualified by exemption, pursuant to
Corporations Code Section 25102(f) may be limited to not more than one such offering during a 6-month
period before the start of an additional offering to be qualified under this exemption, i.e., not more than two per
year (10CCR, Chapter 3, Section 260.102.12).

“Multi-lender” or “fractionalized loans” and promissory notes are subject to the Securities Law (as defined).
Article 6 of the Real Estate Law, commencing with Section 10237 of the Business and Professions Code
(discussed later in this Chapter) is qualified by statutory exemption (as defined). MLBs who make or arrange
loans or who engage in the buying, selling, or exchanging of promissory notes with “fractionalized” interests
are issuing securities pursuant to Section 10237 et seq. of the Business and Professions Code and in accordance
with Corporations Code Section 25102.5.

Prior to making or arranging “multi-lender” loans or engaging in the buying, selling or exchanging promissory
notes or “fractionalized” interests therein, the MLB should obtain the advice of knowledgeable securities legal
counsel. Legal advice should also be obtained prior to engaging in any form of pooling of private
investor/lender funds.

A further word of caution should be added - while the buying, selling, or exchanging of promissory notes with
the public is authorized under the Real Estate Law, these activities are subject to the Securities Law and the
MLB’s participation therein may be limited or prohibited when relying on the “multi-lender” statutory
exemption, or in offerings qualified by exemption (Corporations Code Section 25104(a)).

“Threshold” Criteria

Except as otherwise provided in the Real Estate Law, a real estate broker (MLB) pursuant to Business and
Professions Code Section 10232(a) meets the “threshold” criteria if he/she intends or expects in any 12-month
period to perform or provide services regarding any of the following:

“(1.) Negotiate any combination of 10 or more of the following transactions pursuant to
subdivision (d) or (e) of Business and Professions Code, Section 10131 or Section 10131.1 in
an aggregate amount of more than $1,000,000:

(A.) Loans secured directly or collaterally by liens on real property or on business
opportunities as an agent for another or others;

(B.) Sales or exchanges of real property sales contracts or promissory notes secured
directly or collaterally by liens on real property or business opportunities as an agent
for another or others; or

(C.) Sales or exchanges of real property sales contracts or promissory notes secured
directly or collaterally by liens on real property as the owner of those notes or
contracts.

(2.) Make collections of payments in an aggregate amount of $250,000 or more on behalf of
owners of promissory notes secured directly or collaterally by liens on real property, owners
of real property sales contracts, or both.

(3.) Make collections of payments in an aggregate amount of $250,000 or more on behalf of
obligors of promissory notes secured directly or collaterally by liens on real property, lenders
(holders) of real property sales contracts, or both. Persons under common management,
direction, or control in conducting the activities enumerated above shall be considered as one
person for the purpose of applying the above criteria.”

If the lender or promissory note purchaser is a depository institution or a licensed lender (as defined), loans or
sales negotiated in connection therewith by a broker (MLB) or for which the broker (MLB) collects payments,
are not counted in determining whether the broker (MLB) meets the threshold criteria. Further, if the loan or
promissory note transaction occurs under the authority of a securities permit issued by the DOC, such
transactions are also not counted to determine threshold broker status. Pension trusts having a net worth of not
less than $15 million are also excluded from the count to determine threshold broker status. Generally, real
estate brokers (MLBs) dealing with private investors/lenders (whether as individuals or organized as members
or partners of a lawfully authorized entity) and small pension trusts are transactions to be counted to establish
threshold status (Business and Professions Code Section 10232 et seq.).

A threshold broker must notify the DRE in writing within 30 days of satisfying the criteria described in
Business and Professions Code Section 10232 (a) or (b). The notice is intended to advise the DRE the broker
(MLB) meets the threshold criteria and is performing as a threshold broker. Failure to timely inform the DRE in
writing is subject to a penalty of $50 per day up to and including the 30th day after the first day of the
assessment of the penalty and $100 per day thereafter up to a maximum fine of $10,000. The failure to timely
notice the DRE may result in the suspension or revocation of the license of the real estate broker (MLB).

A broker (MLB) who meets the threshold criteria must file with the DRE two annual reports within 90 days
after the end of the broker’s fiscal year and a quarterly trust fund status report within 30 days after each of the
broker’s first three fiscal quarters. The two annual reports are the Annual Report of a Review of Trust Fund
Financial Statements (TAR) and the Mortgage Loan/Trust Deed Annual Report (Business Activities). An
extension for filing the TAR is provided upon request, if the broker’s fiscal year ends between November 30
and the last day of February of the following year.

These required reports are filed under the penalty of perjury, and, if the broker (MLB) fails to timely file the
reports, the Commissioner may cause an examination and report of the MLB’s applicable books and records
and may charge the broker one and one-half times the cost of making the examination and completing the
report. If the broker (MLB) fails to pay the fee as billed, the Commissioner may suspend or deny the renewal of
the MLB’s license (Business and Professions Code Section 10232.2, 10232.25, and 10236.2).

Disclosure Statements

Business Professions Code Sections 10232.4 and 10232.5 require a real estate broker (MLB) to complete and
deliver to private investors/lenders (as defined), or pension trusts that are otherwise not exempt, a disclosure
statement known as the Lender/Purchaser Disclosure Statement setting forth, at a minimum:

1.

The terms of the loan or of the promissory note;

2. Pertinent information about the borrower (identity, occupation, income, credit data, as represented
to the broker by the prospective borrower, or as a result of a separate inquiry of the broker, or
through an inquiry of or a report(s) received from a third party, such as a credit reporting agency);

3. Pertinent information about the intended security property, including the address or other means
of identification, fair market value, age, size, type of construction and description of
improvements obtained from preliminary “title” and appraisal reports;

4. Provisions for loan servicing, including disposition/payment of late charges and prepayment
penalty fees;

5. Pertinent information concerning encumbrances which are currently liens against the security
property or of which the borrower has knowledge or notice and prospective/contemplated liens
which the borrower discloses or are known to the MLB to encumber the security property
presently or subsequent to the completion of the transaction;

6. Detailed information concerning any proposed arrangement under which the prospective lender
(private investor/lender or the trustee of a pension trust or plan, including when the plan is self
directed) will be joint beneficiaries or obligees, along with persons not associated with the private
investors/lenders or the trustees (e.g., engaged with other persons in “multi-lender” transactions);
and,

7. Whether the solicitation is subject to Business and Professions Code Section 10231.2, and if so, a
detailed description of the intended use of the funds being distributed including an explanation of
the nature and extent of the benefits to be directly or indirectly derived by the broker (MLB),
described as self-dealing (Business and Professions Code Section 10238 (e)).

The Lender/Purchaser Disclosure Statement must be delivered before the private investor/lender or purchaser of
a promissory note (or of interests in either the loan or promissory note), as well as a trustee of a pension trust or
a plan (including a self-directed plan) becomes obligated to complete the loan or promissory note purchase
transaction. When the MLB is engaged in self-dealing, this statement must be delivered to the DRE at least 24
hours in advance of receiving the funds from the private investor/lender (as defined above). Further, the issue
of self-dealing by an MLB is subject to the Securities Law and MLBs should not participate in such
transactions without the prior advice of knowledgeable securities legal counsel.

A real estate broker (MLB) who advertises for or solicits capital/funds from the public used for the broker’s
direct or indirect benefit must submit the format of the advertisement and of the disclosure statement to the
DRE for approval prior to such solicitation. Each Lender/Purchaser Disclosure Statement to be issued to the
private investors/lenders (as defined) when the broker (MLB) is self-dealing, must be submitted to the DRE in
advance of receipt of such funds as described above (Business and Professions Code Section 10231.2). The
advertising must also meet the requirements imposed pursuant to the regulations of the Real Estate and
Corporations Commissioners (10CCR, Chapter 6, Section 2848 and 10CCR, Chapter 3, Section 260.302).

The reference in this section to the use of funds from pension trusts or plans is not intended to suggest these
sources may be relied upon by MLBs for the funding of loans or the purchase of promissory notes (or
“fractionalized” interests in either) without the prior advice of knowledgeable legal counsel. Transactions with
ERISA regulated pension plans or with IRAs or SEP-IRAs may be prohibited and subject to significant
penalties imposed by applicable federal law.

Disbursing Funds

Unless a lender has given written instructions knowingly authorizing the broker (MLB) to proceed, the broker
may not disburse loan funds until after recording the deed of trust or mortgage which conveys technical legal
title to the security property to a trustee as a principal source of the repayment of the loan. If the lender has
given the broker (MLB) authority to release funds prior to recordation, the securing deed of trust or mortgage
must be recorded, or delivered to the lender with a written recommendation for immediate recordation within
ten days following disbursement of loan funds (Business and Professions Code Sections 10233.2, 10234,
10234.5 and 10 CCR, Chapter 6, Section 2841.5).

The broker (MLB) is similarly responsible for the execution and recordation of the assignment of a deed of
trust or mortgage when the transaction has been negotiated by the broker (MLB). In addition, the broker is
required to deliver or cause to be delivered conformed copies of the deed of trust or mortgage to the investor or
lender within a reasonable amount of time from the date of recording. MLBs may delegate this responsibility
(subject to written confirmation) to the escrow holder or title insurer escrowing or insuring the loan transaction
(Business and Professions Code Section 10234.5). When the investor or lender is a private investor/lender or a
group of private investors/lenders (as defined), the broker (MLB) should not proceed to disburse funds before
recordation of the security instrument/device.

Table Funding

Table funding by a real estate broker (MLB) is unauthorized and in violation of applicable law (Business and
Professions Code Sections 10233.2, 10234, 10234.5 and 10 CCR, Chapter 6, Section 2841.5). The only
exemption to the table funding prohibition is found in Section 10234(d). This exemption applies when the
lender is a depository institution or a licensed lender (as defined) and when the security property is other than a
dwelling (i.e., a single family unit in a condominium or cooperative, or any parcel containing residential units
numbering four or less). In addition, if the security property is unimproved, no exemption applies.

Generally, a real estate broker (MLB) may not table fund any residential mortgage loan or a loan secured by
unimproved property regardless of the status of the lender. Commercial loans (other than a residential mortgage
or unimproved land) may be table funded with a lender that either is a depository institution or appropriately
licensed under and pursuant to applicable California law.

The concept of table funding has been driven by depository institutions and licensed lenders as a means of
reducing capital reserves (among other objectives) to support the loans in their portfolio that have been funded
and delivered by MLBs (now also known as MLOs). These institutions and lenders are also concerned about
the contingent liability they incur when selling these loans to the secondary market under terms that include an
obligation to repurchase (in the event of breaches of specified representations and warrantees), and in
connection with servicing agreements when the institutions or lenders retain servicing. Loans delivered by
MLBs to depository institutions and licensed lenders that were table funded were characterized as secondary
market transactions to allow different treatment when disclosing the compensation paid to MLBs/MLOs and to
support how the loan is “booked” as an asset in the records of the depository institutions and of the licensed
lenders. While this concept may function in other states, table funding is contrary to applicable California law.

The Real Estate Law (as well as the Finance Lender Law and the Residential Mortgage Lending Act) prohibits
table funding in California with narrow limited exemptions (Business and Professions Code Sections 10233.2,
10234, 10234.5 and 10 CCR, Chapter 6, Section 2841.5; 10CCR, Chapter 3, Section 1460; and Financial Code
Section 50003 (o) and (t)). When an MLB negotiates a loan secured by a deed of trust or mortgage on real
property, the broker is to record or cause to be recorded the security instrument/device in the name of the
beneficiary/lender/mortgagee (or an authorized nominee thereof) who shall not be the licensee or the licensee’s
nominee. This also applies when the MLB sells, endorses, or assigns the promissory note and assigns the deed
of trust or mortgage securing the loan, i.e., the assignee cannot be the licensee or the licensee’s nominee
(Business and Professions Code Sections 10234 and 10234.5 and 10 CCR, Chapter 6, 2841.5).

To avoid unauthorized table funding, the originator of the loan (e.g., an MLB/MLO) must use its “own funds”,
as defined. Further, the originator must approve the loan and must be the named payee on the promissory note
and identified in the deed of trust or mortgage as the named beneficiary/lender/mortgagee. Delegation of
underwriting the loan transaction to a lawfully authorized person is acceptable; however, the creditor/lender
must approve the loan transaction, which approval cannot be delegated under applicable law.

California law generally defines “own funds” to mean the capital of the broker (MLB) or of the creditor/lender
or funds obtained from an independent line of credit as long as the obligations of the line appear as a debt on
the financial statement of the broker (MLB) or of the creditor/lender. The use of “own funds” (as defined) is
required to perform as a creditor/lender in the loan transaction. It is brokering, not lending, to fund loans
relying on the advance commitment to or the actual purchase of the loan at the close of the loan escrow by a
creditor/lender (including when the funds are drawn down for each loan on an individual or loan-by-loan
basis). The use of “own funds” (as defined), loan approval, and naming the creditor/lender as the initial payee
in the promissory note and as the beneficiary/lender/mortgagee in the deed of trust or mortgage will collectively

constitute evidence of the identity of the actual lender (Business and Professions Code Sections 10131.1,
10233.2, 10234, 10234.5 and 10 CCR, Chapter 6, Section 2841.5; 10CCR, Chapter 3, Section 1460; Financial
Code Section 50003 (o) and (t); and 24CFR Parts 3500 et seq.).

Servicing - Broker Advances

A real estate broker (MLB) servicing a promissory note may advance his or her own funds to authorized third
parties to protect the security of the loan being serviced, including an advance to pay debt service on a senior
promissory note and deed of trust or mortgage secured by the same real property. If the MLB does advance
funds for taxes, hazard insurance, or debt service on a senior loan secured by the same real property, the broker
must, within ten (10) days, provide written notice of the advance to the beneficiary/holder of the promissory
note/loan being serviced (Business and Professions Code Section 10233.1).

Retention of Funds

If a broker receives funds from the obligor/borrower in payment of a promissory note, as is ordinarily the case
when servicing the promissory note, the broker may not retain the funds for more than 25 days without written
authorization from the obligee/lender to whom the funds are to be disbursed. The authorization from the
obligee/lender may not provide for payment of interest to the broker on funds retained by the broker (MLB).
Moreover, the agreement between the real estate broker (MLB) and the obligee/lender or obligor/borrower
authorizing the broker to service the instrument must be in writing. This 25 day distribution period also applies
to the receipt of payoff funds due to private investors/lenders (Business and Professions Code Section 10231.1).

As previously mentioned, an MLB may not accept loan funds except for a specific loan transaction or for the
purchase of a specific promissory note or of “fractionalized” interests in either, unless authorized through a
qualified and registered offering resulting in a permit being issued by the DOC (Business and Professions Code
Section 10231 and Corporations Code Section 25000 et seq.).

Advertising

Business and Professions Code Section 10235 describes as unlawful false, misleading, or deceptive advertising
by a real estate licensees (MLBs) engaged in the business of brokering loans or in the sale or assignment of
existing promissory notes and deeds of trust or mortgages. These limitations apply whether the advertising
occurs through printing, display, publishing, or otherwise distributing through print or electronic media; or
telecasting or broadcasting, or in any other manner. An advertisement cannot imply a yield or return on
promissory notes different from the interest rates set forth in the notes themselves, unless the advertisement sets
forth both the actual interest rates and the differences (discounts) between the outstanding principal balance of
the promissory notes and the price at which the notes are being offered for sale.

Article 5 also prohibits real estate licensees (MLBs) from offering or advertising any premium, gift, or other
inducement to a prospective promissory note purchaser or lender (private investors/lenders). The Real Estate
Law was amended to allow for inducements made available to prospective borrowers, provided the
inducements are not intended to steer or direct the perspective consumer/borrower to an unsuitable loan
product. No costs or fees may be added or increased to allow for the inducements (Business and Professions
Code Section 10236.1).

Real estate licensees (MLBs) are not to place an advertisement to be disseminated primarily in this state for
loan transactions or for the sale of promissory notes and deeds of trust or mortgages, unless disclosed within the
printed or oral text is the license number of the licensee under which the loan is to be made or arranged or the
promissory note is to be sold, endorsed, or assigned (Business and Professions Code Section 10235.5).

The Real Estate Commissioner’s Regulations implement the statutory provision against false, misleading or
deceptive advertising in areas of mortgage loan brokerage and in the marketing of promissory notes and deeds
of trust or mortgages. As previously mentioned in this Chapter, MLBs must disclose their license status and the
identity of the regulatory agency in advertisements (regardless of media) concerning contemplated loan
transactions or for the intended purchase and sale or assignments of promissory notes and deeds of trust or
mortgages.

A disclosure of “Real Estate Broker, CA. Dept. of Real Estate” in mortgage loan advertising complies with
applicable law (10CCR, Chapter 6, Sections 2847.3 and 2848). The broker (MLB) license identification
number must also be included in the advertisement (Business and Professions Code Section 10236.4(a) and

(b)). When MLBs engage in transactions subject to the Corporate Securities Law of 1968 and the Corporations
Commissioner’s Regulations pertaining thereto, the advertising regulations of this law must be complied with
(Corporations Code Section 25300, 25301, and 25302, and 10CCR, Chapter 3, Section 260.302).

Commissioner’s Regulations

Real estate licensees active in the mortgage loan business (MLBs) should be familiar with the Real Estate
Commissioner’s Regulations set forth in 10CCR, Chapter 6, commencing with Section 2725. Among the most
important are Sections 2830.1 et seq. (trust fund accounts/handling); 2840 et seq. (approved borrower
disclosure statements and related loan disclosure requirements); 2844 (lending practices for non-traditional
mortgage products); 2845 (interpretative opinion request); 2846 (approved lender/purchaser disclosure
statements); 2846.5 (report of annual trust fund accounts review); 2846.7 and 2846.8 (filing of annual trust
account and quarterly trust fund reports); 2847, 2847.3 and 2848 (advertising requirements, including voluntary
submissions); 2849.01, 2849.1 (annual Business Activities Report format and reporting transactions pending at
close of the MLB’s fiscal year); and 2970 and 2972 (advance fee agreements and related accounting
requirements).

Article 6 – “Multi-Lender” Loans

Claim of Qualification by Exemption Rather than Qualifying by Registration of Securities

For the purposes of this section, the term “purchaser” is intended to identify persons who fund loans (typically
private investors/lenders, as defined) secured directly by real property or “fractionalized” interests therein or
who purchase promissory notes or fractionalized interests therein. The rules discussed under “Article 5”
generally apply to promissory notes secured by deeds of trust or mortgages on real property where the
beneficiary/lender mortgagee is a private investor/lender or promissory note purchaser. However, when the loan
is funded or the promissory note is purchased (including “fractionalized” interests in either) by more than one
private investor/lender (as defined), the loan transaction is known as “multi-lender” which describes the use of
funds from multiple beneficiaries/lenders/mortgagees.

As previously described in this Chapter, these transactions are known as “multi-lender”, “fractionalized” loans,
or “fractionalized” promissory notes. By way of review, Corporations Code Section 25019 describes notes as
securities (unless subject to a specific exemption pursuant to applicable law, including a statutory/regulatory
scheme established for this purpose). “Multi-lender” notes are securities regulated under the Real Estate Law
and the Corporate Securities Law of 1968 and the respective Commissioners’ regulations pertaining thereto.

To offer interests in a loan or a promissory note to more than one private investor/lender (as defined), the
broker (MLB) must either qualify the offering through an exemption or by registration resulting in the receipt
of a permit from the DOC, as defined (Corporations Code Sections 25019, 25100(p), 25102(e), 25102(f),
25102(n), 25102.5, and 25110 et seq. (among others). As previously discussed, the securities specific
exemption for “multi-lender” loan transactions and promissory notes is set forth in Article 6 of the Business and
Professions Code, commencing with Section 10237 and in accordance with Corporations Code Section
25102.5.

Notification to the Department of Real Estate

The real estate broker (MLB) must notify the DRE within 30 days after the first “multi-lender” transaction and
within 30 days of any material change, as defined in applicable law (Business and Professions Code Section
10238(a) and 10CCR, Chapter 6, Section 2846.1). The purpose of the notification is to inform the Real Estate
Commissioner that the broker (MLB) is engaging in “multi-lender” transactions and to inform the
Commissioner of various material facts regarding such broker’s business plan/model.

A broker (MLB) or other person (including entities) lawfully entitled to become the servicing agent for holders
of “fractionalized” promissory notes originated, sold, endorsed, or assigned pursuant to Article 6 must also
provide the DRE with notification no later than 30 days after achieving certain requirements pursuant to
applicable law. These requirements include, servicing loans for which payments are due during any period of
three consecutive months in the aggregate that exceeds $125,000 or the number of private investors/lenders
(including all persons) entitled to receive payments exceeds 120 (Business and Professions Code Section
10238(b)).

Advertising for Private Investors/Lenders

As previously discussed, all advertising soliciting private investors/lenders, note purchasers, or borrowers must
comply with the Real Estate Law and the Corporate Securities Law of 1968 and the respective Commissioner’s
Regulations pertaining thereto (Business and Professions Code 10238(c); 10CCR, Chapter 6, Section 2848; and
10CCR, Chapter 3, Section 260.302).

No expression or implication can be included or made in an advertisement that a contemplated transaction
subject to Article 6 of the Real Estate Law has received any approval by the DRE or the DOC. The same
standard applies to any offering of securities issued by a real estate broker (MLB), whether qualified by
exemption or registration, as defined.

Property Securing the Loan

The real property securing the loan must be located in California and “fractionalized” promissory notes and
deeds of trust or mortgages cannot by their terms be subject to subordination to any subsequently created deed
of trust or mortgage against the same security property. Further, the “fractionalized” promissory notes and
deeds of trust and mortgages may not be promotional notes, as defined (Business and Professions Code Section
10238, 10238(d)(1) and (d)(2) and Corporations Code Section 25000 et seq. and Corporations Commissioner’s
regulations pertaining thereto).

Promotional notes are secured by liens (deeds of trusts or mortgages) on separate parcels of real property in one
subdivision or in contiguous subdivisions (or in units or phases of either). Promotional notes are defined to
mean promissory notes secured by liens on real property executed on unimproved real property, or executed
after construction of an improvement on the security real property, but before the first purchase of the property
as so improved, or executed as a means of financing the first purchase of the property as so improved; that is
subordinate (or by its terms may become subordinate) to any other deed of trust or mortgage on the security
property (as defined).

Real estate brokers (MLBs) may not issue promotional notes, as defined (in a subdivision or contiguous
subdivisions, or in phases or units thereof) without qualifying the offering with the DOC, i.e., registering when
obtaining a permit from the DOC, unless an exclusion from the definition of promotional notes applies to the
transaction. Pursuant to Business and Professions Code Section 10238(d)(1)(2),the definition of promotional
notes does not include:

1. A promissory note and deed of trust or mortgage that was executed in excess of three years prior to
being offered for sale; or,

2. A promissory note secured by a first deed of trust or mortgage on real property in a subdivision (as
defined) that evidences a bona fide loan made in connection with the financing of the usual cost of the
development of a residential, commercial or industrial building, or of buildings to be constructed on
the security property under a written agreement providing for the disbursement of the loan funds as
costs are incurred or in relation to the progress of the work; and further providing, for title insurance
“ensuring” (insuring) the priority of the security instrument/device against mechanics’ and
materialmen’s liens, or regarding the final disbursement of at least 10% of the loan funds after the
expiration of the period for the filing of mechanics’ or materialmen’s liens.

It should be noted that the second exclusion does not extend to security property consisting of unimproved land
or land that is improved with offsite (including backbone) or onsite improvements. The second exclusion
contemplates vertical construction with construction loan agreements entered into describing the manner in
which disbursements are to occur and with title insurance coverage insuring the continued priority of the deeds
of trust or mortgages (security devices/instruments) against mechanic’s and materialmen’s liens (Business and
Professions Code Section 10238(d)(1) and(2) and Corporations Code Section 25000 et seq.; and the respective
Commissioners’ regulations pertaining thereto).

“Fractionalized” promissory notes and deeds of trust or mortgages must be secured directly by real property. No
collateral assignments (hypothecations) of “fractionalized” promissory notes and security devices/instruments
are allowed, i.e., hypothecation through collateral assignments of “fractionalized” notes would cause the loss of
the “quasi-private placement” exemption from qualification of the securities by registration. This and other

deviations from the standards required in the securities specific statutory and regulatory scheme would be
violations of the “quasi-private placement” exemption (Business and Professions Code Section 10237 et seq.
and Corporations Code Section 25102.5).

Practitioners should not engage in promotional notes (as defined) or in hypothecations through collateral
assignments of promissory notes and deeds of trust or mortgages (whether or not “fractionalized”) without the
prior advice of knowledgeable securities legal counsel.

The Broker as Issuer and Related Self-Dealing Limitations

The securities represented by “fractionalized” promissory notes and deeds of trusts or mortgages must be issued
by and sold through a licensed real estate broker (MLB) who is acting in the capacity of an agent or of a
principal in the secured transaction and in the three roles previously described in this Chapter in the context of
the securities being issued (Business and Professions Code Sections 10131.3, 10237 and 10238(e), and the Real
Estate Commissioner’s regulations pertaining thereto; Corporations Code Sections 25019, 25100(e) and 25206,
and the Corporations Commissioner’s regulations pertaining thereto, including 10 CCR, Chapter 3, Section
260.115 and 260.204.1, among others).

No self-dealing (as described in Business and Professions Code Section 10231.2) is allowed, except under two
fact situations described in applicable law, provided the interests of the broker (MLB) or the affiliate of the
broker (if any) is first disclosed to the private investors/lenders, and the disclosure includes under what
circumstances the MLB or the affiliates acquired their interests in the contemplated transaction. The two
exclusions are generally described below:

A transaction in which the broker (MLB) or an affiliate of the broker is acquiring the promissory note and
security devices/instruments or the security property that are under foreclosure (including at the foreclosure
trustee’s sale) of a deed of trust or mortgage for which the broker (MLB) is the servicing agent, or the loan
being foreclosed is evidenced by a promissory note and deed of trust or mortgage that was sold, endorsed,
assigned, or exchanged to the present holder(s) thereof by or through the MLB; or,

A transaction in which the broker or an affiliate of the broker (MLB) is re-selling from inventory the real
property acquired by the holder or holders through foreclosure, provided that the broker (MLB) is the servicing
agent of the loan that was foreclosed or the promissory note and deed of trust or mortgage evidencing and
securing the foreclosed loan was sold, endorsed, assigned, or exchanged by or through the MLB to the holder
or holders thereof.

Applying the language of the two exclusions describing when a broker (MLB) may self-deal in the context of a
“multi-lender” transaction or in any other offering of securities (whether qualified by exemption or registration)
requires the advice of knowledgeable securities legal counsel.

The Purchasers

The note cannot be sold to more than 10 persons, as defined, who must meet certain income or net worth
requirements, i.e., the private investors/lenders must be suitable for the contemplated transaction. The
investment cannot exceed 10% of the net worth of the private investors/lenders (the purchaser’s net worth),
exclusive of home, furnishings, and automobile; or the investment cannot exceed 10% of the adjusted gross
income of the private investors/lenders (the purchaser’s adjusted gross income).

The foregoing thresholds of 10% of the net worth or 10% of the adjusted gross income apply whether the
investment arises from the funding of a “fractionalized” interest in the promissory note and deed of trust or
mortgage, or from the purchase of the promissory note or interests therein as an existing asset. The suitability of
the private investors/lenders must be considered for the specific transaction and the “thresholds” may not be
exclusively relied upon for this purpose (Business and Professions Code Section 10238(f) and the Corporate
Securities Law of 1968 and the Corporations Commissioner’s regulations pertaining thereto).

The Interests

The interests of each private investor/lender (purchaser) in a “fractionalized” loan or promissory note must be
identical in the underlying terms. The terms of the investment representing a “fractionalized” interest in a loan
or promissory note directly secured by a deed of trust or mortgage on real property must be the same among the

private investors/lenders. This includes the interest rate, the servicing fees, and how and to whom the late
charges and prepayment penalty fees are to be distributed, among others.

Notwithstanding the foregoing, private investors/lenders may invest distinguishable amounts resulting in
different percentages of undivided or “fractionalized” interests received in the promissory note and deed of
trust or mortgage (security device/instrument). No stripping of principal or interest amounts (including but not
limited to income streams or yield spreads) may occur and a private investor/lender may not receive any of the
benefits inuring to the beneficiary/lender/mortgagee identified as the initial payee/lender or the endorsee or
assignee thereof in the promissory note and deed of trust or mortgage without receiving and holding a ratable
“fractionalized” interest as the evidence of ownership as the holder or an undivided interest in a promissory
note and deed of trust or mortgage.

Private investors/lenders acquiring interests in promissory notes and deeds of trust or mortgages through
mortgage brokers (MLBs) may not evidence such interests through participation certificates or other forms of
agreements or contracts. Rather, the interest must be evidence by ratable “fractionalized” assignments in the
promissory notes and deeds of trust or mortgages (Corporations Code Section 25100(s).

When a private investor/lender purchases a “fractionalized” interest in an existing promissory note and deed of
trust or mortgage from the holder of the interest, the acquisition price may vary to reflect the market price of the
interest purchased at the time of purchase. This means the benefits inuring to the purchasing private
investor/lender must be identical to the other holders of interests in the “fractionalized” promissory note and
deed of trust or mortgage predicated on a ratable assignment of the undivided interest purchased. For example,
when considering the purchase of an interest in an existing “fractionalized” promissory note and deed of trust
or mortgage, the interest rate of the promissory note, the disposition of late payment charges and prepayment
penalty fees, and the servicing fees must be identical among the private investors/lenders who are the holders
subject to ratable assignment of the foregoing based upon the undivided interests of each holder. The
prohibition regarding principal and interest amounts described in the previous paragraph will still apply
(Business and Professions Code Section 10238(g)).

The applicable law controlling the benefits inuring to private investor/lenders holding “fractionalized” interests
in promissory notes and deeds of trust or mortgage is similar to the meaning applied by the depository
institutions and licensed lenders to the term “pari passu”. However, the distinction between the use of this term
by depository institutions and licensed lenders as compared to MLBs issuing securities to private
investors/lenders is that private investors/lenders do not qualify as investors in transactions where the interests
purchased are participations in the form of certificates or otherwise by agreement or contract in pools of
mortgage loans.

Such investments are limited to depository institutions and other qualified investment buyers (QIBs) who must
meet the predicate qualifications required under Regulation A of Section 4(2) of the Securities and Exchange
Act of 1933 in addition to the Corporate Securities Law of 1968 and the Corporations Commissioner’s
regulations pertaining thereto (15 USC, Chapter 2A, Section 77d and 17 CFR, Chapter II, Section 230.114A,
among others; and Corporations Code Section 25100(s)).

Loan-to-Value Ratios, Appraisals, and Construction and Rehabilitation Loans

Article 6 imposes certain loan-to-value limitations on “fractionalized” loan transactions depending on the type
of the security real property. In some limited circumstances, the statutory loan-to-value limits may be exceeded
if the broker (MLB) deems it to be reasonable and prudent. In such event, the broker (MLB) must include
within the transaction file the written justification for and the evidence in support to exceed the statutory loan-
to-value ratio limits.

Notwithstanding the foregoing, the loan-to-value ratios may not exceed (together with the unpaid principal
balance of any other encumbrance on the security property that is senior to the subject loan) 80% of the current
fair market value of the security real property, as improved, or 50% of the current fair market value of the
unimproved security real property. When the security property is a single family residentially zoned lot or
parcel that has installed offsite improvements (including drainage, curbs, gutters, sidewalks, paved roads, and
utilities as mandated by the local political subdivision having jurisdiction over the lot or parcel), the maximum

loan-to-value ratio is 65% of the current fair market value (Business and Professions Code Section
10238(h)(1)(2)).

The broker (MLB) must advise the private investors/lenders or promissory note purchasers of their right to
receive a copy of an independent appraisal report completed by a qualified appraiser, or the MLB’s evaluation
of the fair market value of the security real property (if the private investors/lenders have first expressly waived
in writing on a case-by-case basis the independent appraisal report). The evaluation of the MLB may not be
delegated to another broker and must include the objective data upon which the MLB relied in offering an
opinion of value, i.e., no “bald” assertions. Further, the MLB must be qualified by knowledge, experience and
training to undertake the valuation of the specific security real property at issue (Business and Professions Code
Sections 10232.4, 10232.5, 10232.6, 10238(h)(3), 10241.3, 11302(b) and 11423).

For vertical construction or rehabilitation loans as authorized by Article 6, the fair market value of the intended
security property must be estimated by an independent appraiser who is properly qualified for the assignment
pursuant to a license or certification issued by the Office of Real Estate Appraisers (OREA). The appraisal
report must be completed in compliance with the Uniform Standards of Professional Appraisal Practice
(USPAP). These standards generally include an “as is” (current) and an “as completed” (future) estimate of fair
market value for the intended security real property.

When the loan being made or arranged relies on a loan-to-value ratio based on the “as completed” or future
value of the security real property, a significant number of safe guards must be operative in the contemplated
loan transaction, including the aforementioned appraisal standards incorporating USPAP and the use of an
appraiser appropriately qualified by license or certification through OREA. Guidance describing the appraisal
process to be accomplished, including the approaches, methods and techniques to be applied by the appraiser in
arriving at an “as completed” or future value is available in the text published by the Appraisal Institute
entitled, “The Appraisal of Real Estate” (13th Edition). The safe guards otherwise include:

1. An independent neutral escrow holder to be used for all deposits and disbursements (e.g., a joint
control agent authorized pursuant to Financial Code Section 17005.1);

2. The loan is to be fully funded, with the entire loan amount deposited in any neutral escrow prior to
recording the deed or deeds of trust or mortgage or mortgages;

3. A comprehensive, detailed, draw schedule is to be used to ensure proper and timely disbursements to
allow for the completion of the project;

4. The disbursement draws from the escrow account are based on inspections by an independent
qualified person who certifies that the work completed to the date of the draw meets the related codes
and applicable standards and that the draws were made in accordance with the construction contract,
including the agreed upon draw schedule incorporated in the Construction Loan Agreement;

5. The independent qualified person authorized to make inspections and certified the work completed
may not be a person who is an employee, agent or affiliate of the broker (MLB) and is to be licensed
as an architect, a structural engineer, or general contractor, or an active local building inspector
performing in his or her official capacity to make such inspections (as authorized by the local building
official);

6. The loan transaction is properly documented, including the holders of the beneficial interests in the
promissory notes and deeds of trust or mortgages evidencing the debt and securing the construction or
rehabilitation loan, agreeing to be governed for actions taken by Civil Code Section 2941.9, and the
documentation shall include a detailed description of the actions that may be taken in event of failure
to complete the project (whether as a result of default, insufficiency of funds or other causes); and,

7. The entire amount of the loan does not exceed $2,500,000 (Business and Professions Code Section
10230(h)(4)).

If the loan is secured by more than one real property, the maximum loan-to-value percentages of each type of
property must be met in accordance with the statutory limits imposed (Business and Professions Code Section
10238(h)(1)(2) and (5)). “Multi-lender” notes if secured by more than one real property in a subdivision (as
defined) require the use of one promissory note and deed of trust or mortgage recorded as a blanket
encumbrance with appropriate release clauses.

Terms of Default and Foreclosure

As previously discussed, the documentation of the transaction must require:

1. A default upon any interest in or in connection with a promissory note and deed of trust or mortgage is
a default on all interests or promissory notes and deeds of trust or mortgages evidencing and securing
the debt(s) or loan(s) for the subject transactions; and,

2. The holders of more than 50% of the beneficial interests (as defined) are entitled to govern the actions
binding all of the holders of the interests in the promissory notes and deeds of trust or mortgages in
accordance with applicable law in the event of default, the pursuit of a foreclosure (whether judicial or
non-judicial), or for other matters that may require direction or approval of the holders.

The majority action standard to be accomplished in what has been described as a majority action affidavit
specifically excludes the real estate broker (MLB) or any affiliate of the broker who has issued or is servicing
the loan transaction for determining the majority (defined to be more than 50% of the holders). This exclusion
extends to an MLB who is servicing the loan who may not be an affiliate of the real estate broker (MLB) that
issued the security (Business and Professions Code Section 10238(i), Civil Code Section 2941.9, and
Corporations Code Section 25013).

Receipt of Funds, Disclosures, Trust Accounts and CPA Review

As previously discussed, the broker (MLB) must present to private investors/lenders a specific loan transaction
or a specific promissory note in which the requested deed of trust or mortgage investment will be made. Prior to
accepting funds from private investors/lenders for a specific transaction (as defined), the MLB must disclose
the relevant material facts and investment risks in connection with the contemplated investment. These
disclosures typically begin with a summary of the terms of the specific loan transaction or of the promissory
note and deed of trust or mortgage in which the funds of the private investors/lenders will be invested.

Should these private investors/lenders express interest in the summarized and described deed of trust or
mortgage investment opportunity (whether to fund a loan or to purchase a promissory note or an interest
therein), a lender/purchaser disclosure statement (as previously discussed in this Chapter) must be completed
and delivered by the MLB before accepting any investment capital/funds. The DRE publishes four
lender/purchaser disclosure statements for use by MLBs for carrying out the disclosure objective. MLBs are not
entitled to construct their own disclosure forms and are required to request permission from the DRE to rely on
forms other than the specific published forms. The request must be made on behalf of at least 25 real estate
brokers (MLBs) who have qualified as “threshold” brokers in accordance with applicable law (Business and
Professions Code Section 10232(e) and 10232.5(a)(b); and 10CCR, Chapter 6, Section 2846).

The Lender/Purchaser Disclosure Statements published by the DRE are intended for use in distinguishable
transactions (as defined) and are numbered 851A, 851B, 851C and 851D. Form 851A is for loan origination
(whether funded by a single private investor or “fractionalized”); form 851B is for the sale of an existing
promissory note and deed of trust or mortgage or a “fractionalized” interest therein that was not originated by
or through the MLB; form 851C is for hypothecations of an existing promissory note and deed of trust or
mortgage (which are prohibited in “multi-lender” transactions); and, 851D is when the deed of trust or
mortgage describes as security for the repayment of the loan more than one real property (cross-
collateralization or blanket encumbrances). The MLB may add addendums to these required Lender/Purchaser
Disclosure Statements to ensure the relevant material facts and investment risks are disclosed fully. If more than
one real property secures the loan, the broker must disclose to the private investors/lenders the risks associated
when securing the loan by multiple properties to the lender or note purchaser (Business and Professions Code
Section 10238(l) and form 851D).

All funds received from private investors/lenders are trust funds and must be handled in accordance with
Business and Professions Code Sections 10145 and the Commissioner’s applicable regulations, 10CCR,
Chapter 6, Section 2830.1 et seq. The MLB who issued the securities or who is performing as the servicing
agent in “multi-lender” transactions must file CPA-prepared quarterly and annual reports (if the payments due
in any 3-month period exceed $125,000 or the number of persons entitled to the payments exceeds 120).

The Article 6 reporting criteria for “multi-lender” transactions differs from the Article 5 reporting criteria when
reporting loan-servicing activities. The Article 6 criteria applies to payments due and the Article 5 criteria
applies to payments collected. The broker (MLB) engaged in “multi-lender” transactions must also submit an
annual report of business activities to the DRE (Business and Professions Code Sections 10238(j), (o), (p)).

Loan Servicing

To service a loan on behalf of the holder or holders, a written servicing agreement is required (Business and
Professions Code Section 10233 and 10238(k)). The servicing agreement is a component of the investment
contract relationship among the private investors/lenders and the MLB. This investment contract relationship is
applicable whether the loans or promissory notes and deeds of trust or mortgages being serviced are “whole
notes” (Corporations Code Section 25100(p)), “multi-lender” notes (Business and Professions Code Section
10237 et seq., and Corporations Code Section 25102.5), an offering qualified by exemption (Corporations Code
Sections 25102(e), (f), (i) or (n)), or an offering qualified by registration (Corporations Code Section 25110 et
seq.).

The tests to apply for the purposes of establishing an “investment contract” include:

1. An investment of money due to;

2. An expectation of profits arising from;

3. A common enterprise; and,

4. Which depends solely on the essential management efforts of a promoter or third party.

The MLB is the promoter or third party whose management efforts are essential in each of the scenarios
described above, unless the “whole note” (loans made by one private investor/lender, as defined) is neither
underwritten nor serviced by the MLB (Securities and Exchange Comm. v. W. J. Howey Co., 328 U.S. 293
(1946) and Securities and Exchange Comm. v. Glenn W. Turner Enterprises, Inc., et al., No., 474 F.2d 476(9th
Cir.1973)). Under the Real Estate Law, loan servicing on behalf of another or others for compensation or
expectation of compensation (regardless of form or time of payment), requires a real estate broker’s license
unless the person or entity is exempt from such licensure (Business and Professions Code Sections 10131(d),
10133, and 10133.1).

The payments received on the promissory notes and deeds of trusts or mortgages or interests therein must be
transmitted pro-rata to the owners or holders of the promissory notes (i.e., ratably according to their respective
interests) within 25 days of receipt of the payments by the servicing agent. The loan-servicing agent (MLB)
must file a request for a notice of default upon any prior encumbrances and promptly notify the promissory note
owners (holders) of any notice of default (Business and Professions Code Sections 10233 and 10238(k)).

Identities of the Purchasers

Upon request, the broker (MLB) as the issuer or the servicing agent must give private investors/lenders
(whether holders of “fractionalized” interests in loans evidenced by promissory notes and secured by deeds of
trust or mortgages or purchasers of promissory notes or interests in either), the names and addresses of the
purchasers of the interests (Business and Professions Code Section 10238(m)). The MLB must keep accurate
records of the names and addresses and other relevant information on private investors/lenders whether
participating in a “multi-lender” transaction (a “quasi-private placement”), another form of private placement
through an offering qualified by exemption, or an offering qualified by registration.

No Option to Purchase

The broker (MLB) cannot have any option right or an agreement that grants a future right to acquire (including
re-purchase) the “fractionalized” interests of the private investors/lenders or to acquire the security real
property, except as authorized by applicable law (Business and Professions Code Section 10238(n)). As
previously discussed, the broker (MLB) may acquire the interests of the private investors/lenders in the context
of a foreclosure or in connection with the security real property after the foreclosure has occurred (Business and
Professions Code Section 10238(e)).

The MLB may acquire the interests of private investors/lenders (as the issuer of the securities or as the
servicing agent), provided the concurrent consent of the private investor/lender is obtained. Pursuant to the
foregoing, the MLB may acquire such interests whether the interests are in “fractionalized” promissory notes
and deeds of trust or mortgages or in the security real property held by the private investor/lender subsequent to
a foreclosure. When the “fractionalized” promissory note and deed of trust or mortgage represents securities
issued pursuant to the “multi-lender” statutory exemption, or is issued through an offering qualified by
exemption (as defined), the interests acquired by the MLB may not be re-sold in violation of applicable law
(Business and Professions Code Section 10238(n) and Corporation Code Section 25104(a)).

Conclusion

Brokers (MLBs) must use an abundance of caution when engaging in “multi-lender” transactions, a statutory
“quasi-private placement” exemption from qualification of the securities granted pursuant to the Real Estate
Law and the Real Estate Commissioner’s Regulations pertaining thereto, and the Corporate Securities Law of
1968 and the Corporations Commissioners regulations pertaining thereto (Business and Professions Code
Section 10237 et seq. and Corporations Code Section 25102.5, among others).

This exemption is securities specific and any violation of the provisions of the exemption from otherwise
qualifying by registration may result in a violation of the Real Estate Law and in a violation of the Corporate
Securities Law of 1968, including the respective Commissioners’ Regulations pertaining to each (Business and
Professions Code Sections 10131.3, 10177(n) and 10237 et seq., and the applicable regulations of the Real
Estate Commissioner, among others; and Corporations Code Sections 25019, 25102.5 and 25206, and the
applicable Regulations of the Corporations Commissioner’s, among others).

Violations of the securities law are subject to criminal prosecution. Therefore, it is prudent and recommended
that MLBs seek the advice of knowledgeable securities legal counsel prior to engaging in “multi-lender”
transactions qualified by statutory exemption, or transactions involving interests in real property (whether
equitable or fee or a mortgage interest) otherwise qualified by exemption or qualified by registration.

PROMISSORY NOTES

The Debt/Loan or Obligations

The promissory note is the evidence of the indebtedness between the borrower and the lender. It is also the
contract that represents the borrower’s promise to pay the lender in accordance with the agreed upon terms.
The promissory note may also evidence future obligations such as in home equity credit line loans or that may
occur pursuant to additional advances authorized in the accompanying security instrument (whether a deed of
trust or mortgage). The promissory note is the prime instrument and if there are conflicts in the provisions of
the note and deed of trust or mortgage, generally the terms of the promissory note are controlling. The deed of
trust or mortgage is the security instrument that makes the real property described therein the security
(collateral) for the debt/loan or obligations that the promissory note evidences.

Negotiable Instruments

A negotiable instrument is a written unconditional promise or order to pay a certain amount of money at a
definite time or on demand. The promissory note, a draft (whether issued by a bank and otherwise), and a check
drawn on a bank are examples of negotiable instruments. Each is subject to the promise to pay to the payee or
to the order of the holder. Bank checks are the most common type of negotiable instrument;drafts (also known
as bills of exchange and trade acceptances) are similar “three-party paper,” except these instruments generally
do not require a bank with Fed check clearing capacity.

Promissory notes constitute “two-party paper.” The maker promises to pay the payee a specified amount of
money on a date certain, upon demand, or in accordance with its terms. There are seven basic kinds of
promissory notes in general use with a deed of trust or mortgage:

1. A straight note calling for payment of interest only during the term of the note, with the principal sum
becoming due and payable on a certain date;

2. An installment note calling for periodic payments on the principal, plus separate periodic payments of
interest made as agreed;

3. An installment note demanding periodic payments of fixed amounts, including interest and principal
(amortized payments) until the loan is fully paid or to a date certain when the principal amount owing
is to be paid in full (a balloon payment);

4. An adjustable rate note with an interest rate that varies depending upon changes in an agreed upon
prescribed standard (a recognized index such as the 11th District Cost Of Funds, U. S. Treasury
Securities, the published Prime or Reference Rate, or the London Interbank Offered Rate);

5. A variable rate note with an interest rate that increases or decreases pursuant to movements in an
identified direction of a prescribed standard (index);

6. A renegotiable note with equal periodic payments of principal and interest being made for a specified
term, e.g., five years at which time the debt or loan is due or is subject to renegotiation/recasting at the
then prevailing interest rate based upon a preset margin in relationship to a recognized and authorized
standard (index); and,

7. A demand note that does not become due until the holder makes demand for its payment.

Negotiable instruments in the form of drafts or checks drawn on a bank are freely transferable in commerce.
They are typically accepted as virtual equivalents of cash, yet the hazards of handling large sums of cash are
avoided. However, to be regarded as a negotiable instrument, the document must conform strictly to the
statutory definition. Thus a negotiable instrument must be:

1. Signed by the maker or drawer;

2. Include an unconditional promise or order to pay a sum certain in U.S. dollars, and no other promise,
order, obligation or power is given the maker or drawer;

3. Payable on demand or at a definite time; and

4. Is payable to the holder or bearer.

Every one of the listed elements must be present if the instrument is to qualify as negotiable. If any one is
missing, the instrument may still be valuable and transferable (assignable) like an ordinary contract. As such,
the transferee or assignee receives no more benefits than held by the transferor. Personal and real defenses that
are available to the borrower/debtor against the payee (lender/assignor) are generally good against the
transferee/assignee, which affects the holder in due course status.

Negotiation

Negotiation is the transfer of an instrument in such form that the transferee becomes a subsequent holder. If the
instrument is payable to order, it is negotiated by delivery and acceptance with any necessary endorsement. If
payable to bearer, it is negotiated by delivery and acceptance.

An exception to the requirement of delivery of the instrument is set forth in Section 10233.2 of the Business
and Professions Code. A real estate broker (MLB) acting as a servicing agent of the note holder or holders may
perfect delivery by retaining possession of the promissory note and the deed of trust or mortgage, including
collateral instruments and documents securing the debt/loan or obligations evidenced by the promissory note
(provided the deed of trust or mortgage or an assignment or assignments of either and of related collateral
documents identifying the lender/beneficiary/mortgagee/assignee is/are recorded in the office of the recorder of

the county in which the security property is located). The promissory note is to be made payable to the
lender/holder or to the assignee(s) or endorsee(s) of the lender/holder.

An endorsement must be written by or on behalf of the holder and on the instrument or on a paper so firmly
affixed thereto so as to become a part thereof. An endorsement on a paper so affixed shall be valid and effective
even though there is sufficient space on the instrument to write the endorsement. When so affixed, the paper is
known as an allonge. An endorsement is effective for negotiation when it conveys the entire instrument or any
unpaid residue. If it purports to do less, it generally operates (with certain exceptions) as a partial assignment.

There are various types of endorsements, including:

1. Blank: the holder simply signs his or her name on the back of the note (Caution: Such an endorsement
should not be made without the advice of legal counsel);

2. Special: the holder executes “pay to the order of (a named transferee)”;

3. Restrictive: the holder restricts future negotiation by inscribing, “pay to the order of
_____________________________State Bank, for deposit only to ______account”; or,

4. Qualified: the holder inscribes the promissory note with the words “without recourse” to the
endorsement, which means if the maker refuses to pay, the endorser will not be liable for the amounts
owed.

Regarding item 4 above, a qualified endorsement does not eliminate the endorser’s contingent liability
concerning certain representations and warrantees included within an agreement between the parties or implied
by law. That is, by negotiating a promissory note by delivery or by endorsing the instrument, the transferor, as a
matter of law, still represents and warrants that: (a) the instrument is genuine and what it purports to be; (b) the
transferor/assignor or endorser has good title to the instrument, that no previous endorsement(s) has or have
occurred by the identified transferor, or that no previous assignment(s) of the same interest by the transferor has
occurred; (c) all prior parties had capacity to contract; and (d) the transferor neither has notice nor knowledge
of any fact or defect that would impair the validity of the instrument or render it valueless.

It is common for the transferor/assignor or endorser of a promissory note to enter into a global agreement with
intended assignees or endorsees regarding the future transfer of promissory notes. These agreements typically
include representations and warrantees made by the transferor upon whom the transferee relies to perform the
representations and warrantees that are distinguishable from an assignment or endorsement without recourse.
Accordingly, the duties and obligations of the transferor pursuant to these agreements would remain operative
irrespective of whether the promissory notes are assigned or endorsed with or without recourse. With
representations and warrantees, it is preferable that the transfer or assignment be made with recourse integrating
the agreement between the transferor and the transferee.

When negotiation is by delivery only, the above warrantees extend only in favor of the immediate transferee.
Negotiability of a promissory note is neither affected by inclusion of a clause adding court costs and reasonable
attorney’s fees in the event litigation becomes necessary to collect nor by inclusion of an acceleration clause
which provides that default in one of a series of payments makes the entire principal amount and any interest
accrued thereon immediately due and payable. These and similar provisions actually make promissory notes
more acceptable to lenders and investors.

Holder in Due Course Defined

A holder in due course is one who has taken a negotiable instrument: (a) for value; (b) in good faith; and (c)
without notice or knowledge that it is overdue or has been dishonored or of any defense against or claim to it on
the part of any person. A holder in due course may be a person who has taken the instrument through a prior
holder in due course, or, for that matter, through a person who was not a holder in due course.

Notice may be obtained in many ways, including defects on the face of the instrument, in the loan documents,
through actual knowledge of dishonor or of a defense, or through the operation of law. Recording of an

instrument does not give notice of a defense or claim in recoupment, or of other claims to the instrument to
prevent the holder from being in due course (Commercial Code Section 3302).

It is possible in the case of negotiable instruments that the transferee may receive more benefits than held by the
transferor. If the holder of the instrument transfers it to a third party who is a bona fide purchaser for value, that
third party enjoys a favored position provided the third party takes the note as a holder in due course (without
notice of defect or dishonor and absent a continual business relationship with the transferor). This holder in due
course status facilitates trade and commerce because persons are more willing to accept such instruments
without careful investigation or thorough due diligence of the maker’s credit worthiness and financial standing
and of the circumstances surrounding creation of the debt/loan or obligations evidenced by the promissory
note/negotiable instrument.

Holder in due course status is limited if the loan transaction is subject to the federal Truth-In-Lending Act
(TILA). Transferees of such loans are liable to the maker if:

■ Violation of the Truth-in-Lending Act is apparent on the face of the disclosure statement or in the loan
documents (e.g., Regulation Z final disclosures show the amount of the broker’s (MLB’s) commission
to be $2,000.00 and the HUD-1 lists the commission as $5,000.00); or,

■ The assignment was voluntary as opposed to involuntary (e.g. court-ordered sale and assignment of
the promissory note/negotiable instrument, unless the order expressly states that the assignee is free of
any claims including TILA that may be brought by the borrower/debtor).

In addition, loans which are subject to 12 CFR Section 226.32 of Regulation Z (TILA) include a broader
assignee liability standard, i.e., assignees of high cost and high fee loans do not benefit from standing as a good
faith purchaser or as a holder in due course.

Holder in due course status may also be limited when private investors/lenders acquire promissory notes
through MLBs who are required to function as their agents and fiduciaries. This is a result of the legal theories
of imputation of liability and of respondeat superior, i.e., the master must respond for the actions or conduct of
the servant performing within the course and scope of the employment, including any applicable notice or
knowledge possessed by the servant. This issue would depend upon the facts, including whether any conduct of
the MLB as the agent and fiduciary was adverse to the interests of the private investors/lenders, or was deemed
to be criminal. Accordingly, legal counsel should be consulted before a conclusion is drawn by practitioners
about holder in due course status, particularly when involving private investors/lenders.

FTC “Holder in Due Course Rule”

State law governing the rights of a holder in due course has been limited by the so-called “holder in due course
rule” of the Federal Trade Commission (16 Code of Federal Regulations, Part 433, Preservation of Consumer’s
Claims and Defenses, 1977). Under this rule, any holder of a consumer credit contract is subject to all claims
and defenses that the consumer could assert against the seller of goods or services obtained under or with the
proceeds from the consumer credit contract.

This rule has limited application in the field of promissory notes secured by deeds of trust or mortgages on real
property. It appears to be applicable in the context of a home improvement contract secured by a deed of trust
or mortgage on the home of the borrower. A typical example would be a siding contract. The normal
promissory note secured by deed of trust or mortgage used to finance the purchase or construction of
improvements on residential or other real property is not subject to the FTC holder in due course rule.

Conflict in Terms of Note and Deed of Trust or Mortgage

Where there is a conflict in the provisions of the promissory note and deed of trust or mortgage, the provisions
of the note will generally control. A deed of trust or mortgage gives no additional validity to an unenforceable
promissory note. However, the assignment or endorsement of the promissory note carries with it the security as
described in the deed of trust or mortgage.

The promissory note and deed of trust or mortgage are to be construed together, and if a deed of trust or
mortgage contains an acceleration clause, exercising it may cause the promissory note to become due, even
though the note contains no such clause. Since July 1, 1972, every California deed of trust or mortgage
describing security property containing 1 to 4 dwelling units that includes a provision accelerating the due date

of the debt/loan or obligation upon the sale, conveyance, alienation, lease, succession, assignment or any other
transfer of the security property (subject to the deed of trust or mortgage) will not be valid, unless the clause is
uniformly set forth in both the promissory note and the deed of trust or mortgage.

SELLER EXTENDING CREDIT

Structuring the “Carry Back”

A seller who receives a substantial portion of the purchase price from the proceeds of a conventional loan
recorded as the senior or first deed of trust or mortgage, plus a down payment from the buyer/borrower that is
acceptable to the conventional lender, may be willing to extend credit to assist in completing the purchase price.
Generally, the buyer/borrower as the trustor/mortgagor of the conventional loan is required by the
beneficiary/lender/mortgagee to pay a down payment equal to at least 5% or as much as 10% of the purchase
price, plus the recurring closing costs or pre-paid expenses.

A seller would typically demand and receive an interest rate higher than that of the first conventional loan.
However, the terms of the seller’s junior loan, including debt service and maturity date, would be subject to the
approval of the beneficiary/lender/mortgagee of the first conventional loan.

When a seller “carries the paper,” the extension of credit is a time differential payment of the purchase price
and not a loan or forbearance. The seller imposes and interest rate/yield as compensation for the delay in
payment. By definition a seller “carry back” is a “purchase money” deed of trust or mortgage. This financing
method may also be used when a seller wants to receive an income spread over a designated period instead of
receiving the entire difference between the balance owing on an existing loan to be assumed and the purchase
price.

Seller “carry backs” are often used in periods of tight money where buyers/borrowers are unable to make the
entire required down payment, whether in the context of financing the purchase through a new conventional
loan or through an assumption of an existing conventional loan. “Carry backs” by sellers are evidenced by
promissory notes secured by deeds of trusts or mortgages recorded in a junior position that may either be held
or sold by assignment or endorsement to a permanent investor/lender, either directly or through use of the
services of a mortgage broker.

These promissory notes may be sold subject to a discount depending upon the risk involved and the material
terms of the transaction. The material loan terms include due date, principal amount, interest rate, borrower
character (including credit worthiness, stability of repayment source, and financial standing), and the market
value of the security property. In addition, clauses and provisions to be considered include due-on-sale, due on
further encumbrance, late charges, prepayment penalty provisions, or customary acceleration clauses. The
foregoing material loan terms, clauses, and provisions will control the amount of discount demanded in the
market place by purchasers of promissory notes evidencing seller “carry backs”.

Disclosures Required

Since July 1, 1983, in transactions that involve a purchase money deed of trust or mortgage secured by 1 to 4
dwelling units with the seller extending credit in the form of a “carry back”, specific disclosures are required to
be given to the seller and the buyer by the “arranger of credit”. An arranger of credit is typically a real estate
broker who has negotiated the sale transaction and the seller’s extension of credit. Certain specific disclosures
must be made by the arranger of credit to both the seller and buyer, including:

■ The identification and a description of the promissory note or other credit documents or security
instruments which are the security for the transaction, including the terms, clauses, and provisions of
each (or a copy of each document or instrument);

■ The terms, conditions, clauses and provisions of each encumbrance which constitutes an existing or
intended lien (whether a deed of trust, mortgage, or otherwise) upon the security property that is or
will be recorded senior to the seller financing being arranged;

■ A warning that if refinancing would be required as a result of the lack of full amortization of the
amounts owing of any existing or proposed liens (deeds of trusts, mortgages, or otherwise), such
refinancing might be difficult or impossible to obtain at that time in the conventional mortgage market;

■ If negative amortization is possible, or the senior loan or the financing being arranged is variable or
adjustable, a disclosure of this fact and an explanation of its potential effect must be given;

■ If the senior loan or the financing being arranged includes a balloon payment or a right of the
lender/creditor/mortgagee or of the seller to require a prepayment of the principal balance (at or after a
stipulated date or on the occurrence of a stipulated event), a disclosure of the date and the amount of
the balloon payment or of the amount that would be due on the exercise of such right must be given in
accordance with Section 2966 of the Civil Code (including no assurance is offered that new financing,
loan extension, or forbearance will be available);

■ A disclosure of the identity, occupation, employment, income and credit data about the prospective
buyer as represented by the arranger of credit or that no representation has been made by the buyer or
the arranger regarding credit worthiness and financial standing, which disclosure is to include that

Section 580b of the Code Of Civil Procedure may limit (in the event of foreclosure) any recovery by
the vendor to the net proceeds of the security property;

■ A statement must be included that the loss payee endorsement has been added to the property
insurance coverage to protect the seller’s interest or instructions have been given to the escrow holder
to accomplish this objective;

■ A statement advising the seller that a request for notice of default under Section 2924b and a request
for notice of delinquency under Section 2924e of the Civil Code has been made and recorded, or that
neither request will be completed or recorded;

■ A statement that an appropriate policy of title insurance has been obtained insuring the interest of the
seller, or that the seller and buyer should consider obtaining such coverage as well as entering into a
tax service contract to be informed if the property taxes and assessments have been timely paid;

■ A disclosure whether the security instruments have been or will be recorded pursuant to Section 27280
of the Government Code, or a statement that the security property may be subject to intervening liens
that may occur after the promissory note has been executed and before any resort to the security
property occurs for payment of the debt/extension of credit (if the security documents or instruments
have not been recorded); and,

■ If the seller financing involves the use of an all-inclusive deed of trust, then a substantial number of
additional disclosures must be given to the seller and buyer. (An all-inclusive deed of trust should not
be used by practitioners without the prior advice of knowledgeable legal counsel.)

The arranger of credit is defined to include the real estate broker representing the buyer in residential
transactions consisting of 1 to 4 units when the seller extends credit in the form of a “carry back”. The arranger
of credit is a fiduciary of the buyer and owes duties to the seller whether performing as a dual agent or in
conjunction with a separate real estate broker representing the seller (Civil Code Section 2957(a)).