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Real Estate Finance: Chapter 8 Loan Terms and Note Payments

Terms in this set (31)

(RAM)

This plan is based on a borrower's ability to capitalize on accumulated equity and is designed to enhance the income of the elderly.

Many senior citizens own their homes free and clear but often face the problem that their incomes are fixed and relatively low.

The reverse annuity mortgage (RAM) allows them to utilize their equities, with the lender paying the borrower a fixed annuity.

The property is pledged as collateral to a lender, who may provide funds to the borrower in one of the following 3 ways:

1. Regular monthly checks to the borrower until a stipulated balance has been achieved with no cash payment of interest involved. The increase in the loan balance each month represents the cash advanced, plus interest on the outstanding balance.

2. An initial lump-sum payment.

3. A line of credit on which checks may be drawn. When the maximum loan amount is reached, the borrower is obligated to start repayment. In some cases this requires the sale of the property.

Under the HUD reverse mortgage program, known as the Home Equity Conversion Mortgage (HECM), the monthly payments continue for as long as the borrowers live in the home with no repayment required until the property is sold.

Any remaining value is distributed to the homeowners or their survivors.

If there is any shortfall, HUD pays the lender.

The size of the reverse mortgage loan is determined by several factors:

1. The age of the borrower (Must be at least 62)
2. The interest rate
3. The value of the property.

There are no asset or income limitations on the HUD RAM.

HUD will insure loans taken out by owners 62-years of age or older and offers 3-mortgage plans:

1. A tenure mortgage, under which the lender makes monthly payments as long as the owner occupies the residence.

2. A term mortgage, under which the payments are made for a specific number of years.

3. A line-of-credit mortgage, under which the owner can draw against the credit as long as the cumulative draws plus accrued interest are less than the principal loan limit.

Ex. Consider Sam and Sarah Jones who are both in their late 70s. They have lived in their home for 35 years and paid off the original mortgage loan many years ago. Unfortunately, Sam's health has been deteriorating over the past 2-years and he is no longer able to tend his rather extensive garden. The garden not only provided Sam with a greater deal of pleasure but it provided an extra source of income during the spring and summer months. Sarah has been famous for years for her scrumptious baked goods. During the long winter months she filled the house with the smells of her breads and muffins, which she delivered to local restaurants in exchange for cash to supplement their Social Security checks.

Although Sam's condition doesn't require him to be hospitalized, he can't work in the garden anymore, nor can he deliver Sarah's baked goods to the restaurants. In fact, Sarah finds that with the additional care Sam needs, she really doesn't have the time (or the energy) to spend long hours in the kitchen baking. The loss of this additional income has made it very difficult for the Joneses. They realize, sadly, they will probably have to sell their home of 35 years and move into a small apartment. Is there a better solution for Sam and Sarah?

Fortunately, Sam noticed an article in the AARP Modern Maturity magazine about the benefits of a reverse annuity mortgage (RAM). He contacted a local lender and learned that under this plan, the Joneses will be able to secure a mortgage on the house where the bank sends them a check every month. The loan will be repaid when the property is eventually sold, the Joneses will have enough cash to meet their monthly expenses, and -- most important -- Sam and Sarah can stay in the home they love!
(Mortgage for Future Advances)

Allows a borrower to secure additional funds from a lender under terms specified in the original mortgage.

Thus, an open-end mortgage can advance funds to a mortgagor on an existing mortgage -- funds that, in many instances, represent the principal already paid by the borrower.

This allows a mortgage to stay alive for a longer period of time and can in some cases save the borrower the time and of the expense of refinancing.

The funds advanced by this process are repaid by either extending the term of the mortgage loan or increasing the monthly payments by the amount appropriate to maintain the original amortization schedule.

The interest rate can also be adjusted accordingly, and appropriate fees can be charged.

Open-end mortgages have become useful financial tools for single-family home loans.

Mortgagors are allowed to borrow funds for personal property purchases made after the original loan is recorded.

These amounts are added to the principal owed, and the payments are increased to accommodate the new balance.

If the personal property becomes part of the loans' collateral, along with the real property, the open-end mortgage is converted into a package mortgage.

Open-end mortgages are often used by farmers to raise funds to meet their seasonal operating expenses.

Similarly, builders use the open-end mortgage for their construction loans in which advances are made periodically while the building is being completed.

Many private loan companies are offering customers an opportunity to draw down on a line of credit backed by the collateral of their home equity.

A basic legal problem associated with open-end financing is one of securing future advances under an already existing debt instrument and, at the same time, preserving its priority against any possible intervening liens.

In most states an obligatory future advance under the terms of an existing mortgage is interpreted as having priority over intervening liens.

For example, an advance made under a construction mortgage that sets forth a specific pattern of draws is interpreted to have priority over a construction (mechanic's) lien that may have been filed in the period prior to the last advance.

Nonobligatory future advances don't have priority over intervening liens, according to most state laws.

The legal security of the advances to be made in the future under an already existing mortgage may not be enforceable against debts incurred by a borrower in the intervening time period.

If the terms of a mortgage don't obligate a mortgage to make specific future advances, the mortgages is well advised to protect the priority of the lien by searching the record for intervening liens prior to making any advances.

Prevailing practice doesn't require a title search, but merely binds a mortgage to any liens of which there has been outside notice.

A few states require a title search and actually reduce the mortgagee to a junior position against any recorded intervening liens.

A search of the records can only be to the advantage of the original mortgagee.

Under the laws of those states that have adopted the Uniform Commercial Code, any personal property security agreements for the purchase of goods that become fixtures on the collateral property have a priority lien over future advances made under an original mortgage.

Suppose a homeowner signs a financing contract with the ABC Appliance Company to purchase and install central air-conditioning system in June, and the agreement is recorded. In December the owners secure an advance on their open-end mortgage to build an addition to their home. Because the central air-conditioning system is now a fixture, the appliance company's lien will take priority over any future advances made by the original mortgagee.

Not all states allow open-end mortgages.

Texas doesn't allow open-end mortgages or line of credit loans for residential properties under their Home Equity Loan Legislation.
To obtain a construction loan, the borrower submits plans and specifications for a building to be constructed on a specific site to a loan officer for analysis.

Based on the total value of the land and the building to be constructed thereon, a lender will make a commitment for a construction loan, usually at the rate of 75% of the property's total value.

Hence a $250,000 project would be eligible for a $187,500 construction loan.

This amount normally would be adequate to cover most, if not all, of the cost of construction, with the $62,500, or 25% equity, representing the value of the free and clear lot.

Construction mortgages usually are secured from financial institutions that normally require that the lot be lien-free in order to preserve the first priority position of the construction loan.

In a case where the lot is encumbered by an existing mortgage or lease, the mortgagee or the landlord must subordinate that interest to the lien of the construction mortgage before the loan can be granted.

Construction loans are available for projects of all sizes, from the smallest home to the largest shopping center, and the basic loan format is similar in each case.

The charges imposed for securing construction loan are usually based on a one-time 1% placement fee paid at the loan's inception, plus interest at about two points above the prime rate charged to AAA-rated borrowers.

Based on a prime rate of 6% and a 2% overcharge, a $187,500 construction loan would be placed for a front-end fee of $1,875 plus 8% interest on the funds disbursed from time to time.

Interest rates and placement fee fluctuate as a function of business cycle, borrowers' credit ratings, and individual situations.