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Unit 11 Real Estate Finance

Terms in this set (59)

- An adjustable-rate mortgage, particularly popular when interest rates are high, offers the borrower a chance at lower interest rates if national interest levels drop. When rates across the country rise, however, the borrower may find the rate being raised. ARMs are better if you don't plan on staying in the house for very long.
- ARMs can be a hybrid. Mostly they are hybrids based on the amortization. So an adjustable rate mortgage can be for 30 years, 25, 20, 15, or 10 years. The most popular are the 10/1 ARM, the 7/1 ARM, the 5/1 ARM and the 3/1 ARM. 10/1= is going to have an interest rate that is closer to 30 year fixed but a little bit lower and will have the highest interest rate the ARMs.

The vocabulary of ARMs includes the following:

-Adjustment period. The anniversary on which interest rate and monthly payment adjustments may be made. Most borrowers elect one-year adjustments, but they might be made more frequently or only after three or five years.
-Index. The interest rate on the loan changes following an increase or decrease in a national indicator, or index, of current rates. The most commonly chosen index is the rate paid on one-year U.S. Treasury bills.
-Margin. The borrower pays a specific percentage above the index. That percentage is known as the margin or the spread; the margin or the spread represents the lender's profit when loaning to a borrower. If Treasury bills were selling at 6 percent interest, for example, the borrower with a 2 percent margin over Treasury bills would be charged 8 percent. i.e. We are taking the 5 year Treasury bill and we are going to add a margin onto that interest rate. A typical margin is 2.75%. So if the five year Treasury bill is at 3% and the margin is 2.75% the new interest rate can be 5.75% (that is your margin).
-Cap. The loan agreement may set a cap of, for example, 2 percent on any upward adjustment. If interest rates (as reflected by the index) went up 3 percent by the time of adjustment, the interest rate could be raised only 2 percent. Depending on the particular mortgage, the extra 1 percent might be treated one of three ways:
1.) It could be saved by the lender to be added at the next adjustment period.
2.) It could be absorbed by the lender with no future consequences to the borrower.
3.) )It could be added to the amount borrowed so that the principal would increase instead of decreasing (negative amortization).
- An annual cap typically is 2%. Even if the economic indicator is x and we add the margin to it and the interest can be 5% higher than it is we are going to cap it at an annual 2% increase.
-Ceiling. A ceiling (aka a lifetime cap) is a maximum allowable interest rate. Typically a mortgage may offer a five-point ceiling. If the interest rate started at 8 percent, it could never go beyond 13 percent, no matter what happened to national rates. i.e. A Lifetime Cap is exactly that. It shows how much the interest rate can go up to the life of the loan. A typical lifetime Cap can be 5% or 6% of the start rate. So if they started at 3.25% the first change would be 5.25% at a 2% annual cap with a 5% Lifetime Cap, the highest interest rate can be 8.25%.
-Negative amortization (depreciation). Negative amortization could result from an artificially low initial interest rate. It also could follow a hike in rates larger than a cap allows the lender to impose. Not all mortgage plans include the possibility of negative amortization. Sometimes the lender agrees to absorb any shortfalls. The possibility must always be explored, however, when an ARM is being evaluated. The debt would be increasing, rather than being paid down. i.e. the monthly payment can be a $100/month (or the smallest amount you pay) but the bank keeps tacking on the interest. Instead of owning your original 100,000 you now own $125,000.
-Convertibility. Some ARMs include convertibility; that is, the borrower may choose to change to a fixed-rate mortgage at then-current interest levels. With some plans, any favorable moment may be chosen. More commonly the option is available on the third, fourth, or fifth anniversary of the loan. The borrower may be charged a slightly higher interest rate in return for this option.
-Initial interest rate. With many loan plans the rate during the first year, or the first adjustment period, is set artificially low (discounted) to induce the borrower to enter into the agreement ("teaser" rate). Buyers who plan to be in a home for only a few years may be delighted with such arrangements. Other borrowers, however, may end up with negative amortization and payment shock.
-Assumability. Many ARMs are assumable by a financially qualified next owner of the property, with the lender's approval and the payment of service fees.
To help consumers compare different ARMs, lenders must give anyone considering a specific ARM a uniform disclosure statement that lists and explains indexes, history of past interest rate changes, and other information. A method for calculating the highest possible payment is included. The disclosures must be furnished before the loan applicant has paid any nonrefundable application fee.
3.) Estimate of value-
The real estate must be evaluated by an FHA-approved appraiser. The maximum loan will be a percentage of the appraised value. If the purchase price is higher than the FHA appraisal, the buyer must pay the difference in a higher cash down payment or may decide not to purchase. On Section 203(b) loans, minimum down payment requirements are less than 3 percent.
-FHA borrowers are allowed to finance a portion of their closing costs. The amount is added to the base loan amount.
4.) Repairs-
The FHA requires its borrowers to be notified, before a purchase contract becomes binding, that its appraisers estimate value rather than condition in detail, and that use of a home inspector is recommended. The FHA may, however, stipulate repair requirements that must be completed before it will issue mortgage insurance on a specific property. Certain energy-saving improvements may be financed along with an FHA mortgage.
5.) Assumability-
Older FHA loans may be assumed by the next owner of the property with no change in interest rate, no credit check on the buyer, and only a small charge for paperwork. The assumer could be a nonoccupant/investor. The original borrower is not released from liability, however, unless the new borrower is willing to go through a formal assumption, which involves the lender's approval of credit and income.

For FHA loans made after December 15, 1989, the buyer wishing to assume the mortgage must be a prospective owner/occupant and prove financial qualification; the original borrower is then relieved of liability. Optionally, the new borrower may pass a simple credit check and the property a new appraisal, with the original borrower sharing joint liability for five years after the assumption.
Evaluating Borrower cont'd-
- Lenders like to see a reasonably stable income history, with at least two years' continuous employment or employment in the same line of work. Bonuses, commissions, and seasonal and part-time income are considered with certain time limits and employer verifications. Dividend and interest income, Social Security income, and pension income are included in qualifying the borrower. Projected rental income is accepted in varying amounts. If the borrower's income is marginal, the lender may look at the borrower's education and training to determine whether his or her skills are in demand in the employment marketplace and whether his or her income is likely to increase in the future.
- In judging whether a borrower qualifies to carry the requested loan, lenders analyze the present debts, including any with more than six months (VA and FHA) or ten months (conventional) to run. Lenders sometimes consider potential, as well as actual, balances on credit cards.
- Banks look at the borrower's housing expense (front end ratio) which should not be more than 33% of the gross monthly income. The back end ratio is the housing expenses plus all other payments.
- Borrowers usually must show that they have liquid assets amounting to the cash that will be required at closing without further borrowing. Some mortgage programs, however, allow a willing seller to pay part of the buyer's closing costs (seller concessions). A credit report also will be ordered on the applicant. An applicant who has gone through a bankruptcy may have to wait between one and five years after discharge, depending on the type of loan desired, and show good credit history since the bankruptcy.
-No major purchases or filing bankruptcy right before a closing b/c it can bring your credit score down which can alter your loan amount and interest rates.
-Promissory Note - A signed document containing a written promise to pay a stated sum to a specified person/institution or the bearer at a specified date or on demand.
- Home Equity Line Of Credit (HELOC) - A line of credit extended to a homeowner that uses the borrower's home as collateral.
- Acceleration clause - Term given to the practice of paying off a mortgage loan faster than required by terms of the mortgage agreement.
- Adjustable rate mortgage (ARM) - A mortgage loan with the interest rate on the note periodically adjusted based on an index which reflects the cost to the lender of borrowing on the credit markets.
- Alienation Clause - Allows lender to require the balance of a loan to be paid in full if the collateral is sold (also known as a "due on sale" clause).
- Amortization - The process by which a loan principal decreases over the life of a loan.
- Assignment - The method or manner by which a right or contract is transferred from one person to another.
- Balloon Mortgage - A mortgage which does not amortize over the term of the note, thus leaving a balance due at maturity.
- Blanket Mortgage - A type of loan used to fund the purchase of more than one piece of real property. A blanket mortgage is often used for subdivision financing.
- Bridge Loan - A type of short-term loan, typically taken out for a period of 2 weeks to 3 years.
- Buydown - Obtaining a lower interest rate by paying additional points to the lender.
- Construction Mortgage - A loan secured by real estate which is for the purpose of funding the construction of improvements or building(s) upon the property.
- Conventional Mortgage - A loan secured by real property through the use of a mortgage note.
- Capitalization Rate - The percentage which is the sum of the discount rate, the effective tax rate and the recapture rate representing the relationship between net operating income and present value. Formula: Value = Income / Rate
- Default - The failure to pay back a loan.
- Defeasance clause- A mortgage provision indicating that the borrower will be given the title to the property once all mortgage terms are met.
- Discount Points - A form of pre-paid interest where 1 point equals 1 percent of the loan amount.
- "Due on Sale" Clause - Allows lender to require the balance of a loan to be paid in full if the collateral is sold (also known as an Alienation Clause).
- FHA Mortgage - Backed loans that usually require a lower down payment and may sometimes have a lower interest rate.
- Grace Period - A time past the deadline for an obligation during which a late penalty that would have been imposed is waived.
- Graduated Payment Mortgage - A type of fixed-rate mortgage in which the payment increases gradually from an initial low base level to a desired, final level.
- Home Equity Loan - A loan secured by equity value in the borrower's property.
- Inflation - The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling.
- Interest and Tax Deductibility - Reductions of the income subject to tax, for various items, especially expenses incurred to produce income.
- Lifetime Cap/Ceiling - Some mortgages have interest rate ceilings (or limits) which are similar to, and sometimes referred to as, lifetime caps.
- Loan To Value ratio (LTV) - A financial term used by lenders to express the ratio of a loan to the value of an asset (property) purchased.
- Margin - The amount of interest a bank charges on a loan over the base rate.
- Mortgage Insurance Premium (MIP) - The amount paid by a mortgagor for mortgage insurance, either to a government agency such as the FHA or to a private mortgage insurance (MI) company.
- Mortgage - Legal agreement by which a bank lends money in exchange for taking title of the debtor's property, with the condition that the conveyance of title becomes void upon payment of the debt.
- Mortgagor - the borrower, typically a home owner.
- Mortgagee - The lender or bank who provides a loan to the borrower or homeowner.
- Negative Amortization - Occurs whenever the loan payment for any period is less than the interest charged over that period so that the outstanding balance of the loan increases.
- Package Mortgage - A method of financing in which the loan that finances the purchase of a home also finances the purchase of personal items such as a washer and dryer, refrigerators, stove, and other specified appliances.
- Pledged Account Mortgage (PAM) - Money is placed in a pledged savings account. This fund, plus earned interest, is used to gradually reduce mortgage payments.
- Private Mortgage Insurance (PMI) - Insurance payable to a lender or trustee for a pool of securities that may be required when taking out a mortgage loan.
- Point - A loan fee equal to one percent of the mortgage amount.
- Predatory Lending - The Unfair, deceptive, or fraudulent practices of some lenders during the loan origination process.
- Prepayment Penalty Clause - A clause in a mortgage contract that says if the mortgage is prepaid within a certain time period, a penalty will be assessed. The penalty is usually based on percentage of the remaining mortgage balance or a certain number of months worth of interest.
- Primary Mortgage Market - The market where borrowers and mortgage originators come together to negotiate terms and effectuate mortgage transaction. Mortgage brokers, mortgage bankers, credit unions and banks are all part of the primary mortgage market.
- Secondary Mortgage Market - The market where mortgage loans and servicing rights are bought and sold between mortgage originators, mortgage aggregators (securitizers) and investors. The secondary mortgage market is extremely large and liquid.
- Promissory Note - A signed document containing a written promise to pay a stated sum to a specified person/institution or the bearer at a specified date or on demand.
- Red-Lining - The refusal to lend money within a specific area for various reasons. This practice is illegal.
- Regulation Z - The Truth in Lending Act of 1968 is United States federal law designated to promote the informed use of consumer credit, by requiring disclosures about its terms and cost to standardize the manner in which costs associated with borrowing are calculated and disclosed.
- Release Clause- A clause found in a blanket mortgage which gives the owner of the property the privilege of paying off a portion of the mortgage indebtedness, and thus freeing a portion of the property from the mortgage.
- Real Estate Settlement Procedures Act (RESPA) - A consumer protection statute, first passed in 1974. The purpose of RESPA are
1) To help consumers become better shoppers for settlement services and
2) To eliminate kickbacks and referral fees that unnecessarily increase the costs of certain settlement services.
- Reverse Annuity Mortgage - A form of mortgage in which the lender makes periodic payments to the borrower using the borrower's equity in the home as satisfaction of mortgage.
- Sale-and-Leaseback - A transaction where one sells an asset and leases it back for the long-term; therefore, one continues to be able to use the asset but no longer owns it.
- Satisfaction of Mortgage - A document acknowledging the payment of a mortgage debt.
- Shared Equity Mortgage - Joint ownership of real estate by both lenders and property dwellers. When the property is eventually sold, the owners share in the proceeds, or equity. In the meantime the property occupants benefit from interest and property tax write-offs.
- State of New York Mortgage Association (SONYMA) - A mortgage program that assists first-time homebuyers with the purchase of a home in New York State.
- Straight Mortgage/Term Mortgage - A non-amortizing mortgage under which the principal is paid in its entirety upon the maturity date.
- Usury - On a loan, claiming a rate of interest greater than that permitted by law.
- VA Mortgage - A mortgage loan designed to offer long-term financing to eligible American veteran or their surviving spouses (provided they do not remarry). The basic intention of the VA direct home loan program is to supply home financing to eligible veterans in areas where private financing is not generally available and to help veterans purchase properties with no down payment.
- Wrap-around Mortgage - A form of secondary financing for the purchase of real property. The seller extends to the buyer a junior mortgage which wraps around the existing in addition to any superior mortgages already secured by the property.