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Unit 11 Real Estate Finance
Terms in this set (59)
Short Term/Temporary Loans
The homeowner who is selling one residence and buying another may find it necessary to buy the new home before the closing date on the present one. In that situation a temporary loan, variously called a bridge loan, a swing loan, or interim financing, may be arranged. This is generally viewed as a personal loan, not a mortgage loan.
- is a loan that somebody will get (a person or an entity will get) in order to buy real estate or use the equity in the real estate to obtain financing. A mortgage is only related to real estate but it can be a residential, commercial, for an investment property or primary residence, a second home, or for construction, as long as it has to do with real property.
- aka a lien against the real estate which you are using for the security. So the mortgage is a security instrument. It gets recorded in the County's Clerk Office where the real estate is located
- The note is the personal guarantee, or the promise to pay back the money over and above the value of the real estate
- The borrower = mortgagor; lender = mortgagee
Obligations of the borrower
- They are obligated to pay back the mortgage.
- They are obligated to keep the property in good condition. There is a clause within the body of the mortgage which says you need to keep this property in good condition, i.e. you cannot have rusty old cars in the front yard or let a hole in the roof continue without repair. By doing this, you're lowering the value of the real estate which would be an issue if the bank had to foreclose.
- They also must keep the title "as is". If you buy a property in your own name (John Smith) you must keep it in the name of John Smith. If you sold it to John Smith Inc. you are in essence changing the title or ownership of the property and that would kick in the "due on sale clause".
Rights of the borrower
- They have the right to occupy the real estate.
- The borrower also has the right to pay off the mortgage at any time before the due date.
- They don't have to keep it for the full amortization. This might also kick in a prepayment penalty which has changed over the years
- The lender has the right to foreclose if the borrower defaults. Default means you are 90 days or greater late on your mortgage payments
- The lender has the right to take possession of the real estate as a result of the borrower's default of the mortgage.
- The lender, has the right to assign the mortgage itself to another lender.
All the buyers that are named in the contract are also named on the deed, meaning all the buyers on the deed own the real estate. If one or more of those buyers has bad credit and the other has good credit, the lender will go with the buyer(s) with good credit to get the mortgage and only that person(s) the lender decides to go with will sign the promissory note. Therefore, if the property goes into default, only those people on the note will be responsible for making those payments. Not all the buyers are required to sign the note.
- In the case of a default, the bank has the right to accelerate the payoff of the mortgage.
'Due on sale' clause
- means that if you sell the real estate or change the name on the title by selling it to someone else, the mortgage is due. Home equity loans also need to be paid off when property is sold.
- if people buy real estate in their own names and then transfer it to a trust, or into a corporation, or an LLC, or they will add somebody else to it, all of these actions will kick in that 'dues on sale' clause and the mortgage needs to be paid off.
Principal, Interest, Taxes, & Insurance
- (PITI)- A mortgage consists of the principal and interest on the principal.
- Escrow- The taxes and insurance are put into an escrow. Most people have the option if they want to escrow or not. Most lenders will allow the borrower to escrow which means that you are paying for taxes and insurance along with your principal and interest. They have the option whether they want to include the taxes and insurance or whether they want to pay it on their own. There are some lenders out there that will charge an extra fee. It is typically 1/4% of the loan amount if the person wants to pay their own taxes and insurance.
- People choose to pay T&I on their own if they want to do a lump sum but some attorneys advise that 1st time home buyers pay that with the P&I so as not to worry about it.
- If you're buying a condo or co-op, the fees that will be included in the monthly housing expenses are the common charges (condo) fee or the maintenance (co-op) fee. If you're paying for PMI (mortgage insurance) w/ an FHA loan, or flood insurance or have a 2nd mortgage, all these costs will be included in the mthly housing expense. Other expenses that can come up with home ownership are boiler or driveway repairs, or repainting the house. This is why buyers need to have a reserve.
- If buyers want to pay extra each month on their mortgage, they should consult with a loan officer in the benefits of that. If they want to refinance later on and they pay extra each mth, it may not pay to refinance.
Participation Loans or Shared-Equity Mortgages
The purchaser receives help with the down payment, a low interest rate, or assistance with monthly payments from a partner. The "partner" may be a lending institution, the seller, or a relative. The partner usually receives:
-a share of the profit when the property is sold;
-a share of any refinancing proceeds; or
-a share of profits derived from the income stream on an income-producing property.
The lender receives any proceeds in the form of deferred interest.
includes not only the real estate (real property) but also personal property such as appliances and furniture on the premises. In recent years this kind of loan has been used to finance furnished condominium units
used by borrowers to obtain additional funds to improve property. The borrower "opens" the mortgage to increase the debt after the debt has been reduced by payments over a period of time.
They work like credit cards. The borrower/card holder may use the proceeds up to a prescribed limit. So long as the balance is paid down, the borrower/cardholder need not reapply for additional funds up to the prescribed limit.
an open mortgage is one that may be repaid in full at any time without any prepayment penalty by the lender.
covers more than one parcel or lot and are often used to finance subdivision developments. When one parcel or lot is sold, the borrower makes a partial payment to release it from the overall mortgage.
A mortgage clause that permits part of the mortgaged property to be released from the lien; is an essential element and requirement for the subdivider. Without it, the subdivider may be successful in subdividing a larger parcel into many lots; however, without the release of the lien held by the lender, the subdivider will be unable to sell any of the lots.
frequently are used to refinance or finance a purchase when an existing mortgage is to be retained. A wraparound mortgage is always a second mortgage. The buyer gives a large mortgage to the seller (the second recorded position), who will collect payments on the new loan, usually at a higher interest rate, and continue to make payments on the old loan (the first recorded position).
Graduated Payment mortgage aka pledge account mortgage
a mortgage in which the monthly payment for principal and interest graduates by a certain percentage each year for a specific number of years and then levels off for the remaining term of the mortgage. There are five different versions of the plan available in the FHA-245 program. The most popular is Plan III, in which payments increase at the rate of 7½ percent per year for five years.
-FHA-245 program is especially attractive to persons who may be just starting their careers and anticipate increases in their incomes and who want to obtain a home mortgage with a lower initial monthly installment obligation than would be available under a level payment plan. This plan helps borrowers qualify for loans by basing repayment schedules on salary expectations and anticipated home price appreciation. Because FHA underwriting guidelines are based on the first year's monthly requirement for principal and interest amortization, persons using FHA-245 can qualify for larger loan amounts than would ordinarily be available under other forms of financing.
-3 unique features of this plan:
1.) The size of the individual payments is less than it would be under a fixed-payment loan.
2.) Negative amortization occurs during the initial years.
3.) The face amount of the note is greater than the funds disbursed at closing.
reverse annuity mortgage or reverse mortgage
allows senior citizens on fixed incomes to tap the equity buildup in their homes without having to sell. When savings, pensions, and Social Security are not enough income for the homeowner to live on, this type of mortgage can be useful. The homeowner receives a monthly check, a lump sum, a line of credit against which to draw, or a combination of these.
-Among the better reverse mortgage plans is that backed by the Department of Housing and Urban Development (HUD), which requires counseling so that the borrower understands exactly what is involved. HUD's is called a home equity conversion mortgage.
purchase money mortgage
is any loan that enables the purchase of real estate, as opposed to a second mortgage for further borrowing or a refinance mortgage that is used to pay off the original one. It's for the situation in which a seller lends the buyer money to complete the purchase. The seller "takes back financing" and acts as the lender. A purchase-money mortgage may cover a portion of the purchase price or may be a first mortgage to finance the entire price.
(A mortgage issued to the borrower by the seller of the home as part of the purchase transaction. This is usually done in situations where the buyer cannot qualify for a mortgage through traditional lending channels. This is also known as seller/owner financing. A purchase-money mortgage might be offered by the seller as incentive to purchase a property. This can be used in situations where the buyer is assuming the seller's mortgage, and the difference between the balance on the assumed mortgage and the sales price of the property is made up with seller financing.)
A purchase-money mortgage held by the seller is exempt from usury limitations on interest rate. If seller financing is at an artificially low interest rate, however, the IRS assumes a higher rate (imputed interest). The seller must charge at least 9% or a rate equal to the applicable federal rate (AFR), whichever is lower. A seller who charges less will be taxed as if income were received at the required rate. An exception is made for certain transfers of vacant land within a family.
construction loans aka building loan agreements
made to finance the construction of improvements on real estate. These are always short-term loans. Depending on the type of project, terms range from 12-24 months. A construction loan can be difficult to secure unless the applicant works through a recognized builder or contractor. Payments are made on a scheduled basis to the general contractor or owner for work that has been completed since the previous payment. The lender usually inspects the work before each payment. Every time work is done, call the bank: "Hi I need another $50,000, this is what we did" (you might need to show receipts). The title company is going to run a continuance to make sure there are no liens from contractors and an appraiser is going to go out there and make sure that the work is really done, and the bank is going to distribute the money. This kind of mortgage loan generally bears a higher interest rate because of risks assumed by the lender. The borrower arranges for a permanent mortgage loan (also known as an end, or takeout, loan) when the work is completed and they receive a certificate of occupancy.
- Three types:
- Construction- for either a builder or a buyer, or a person that owns a lot that wants to build property on that lot
- Rehab- I already own my home and I want to take out $100,000 to do an addition, $ is distributed over a period of time to do the construction
- Purchase-rehab - Where one buys a house zoned for only a 2 family and they want to expand it into a 4 family property
real estate can be purchased under a land contract. Real estate is often sold on contract when mortgage financing is not available or is too expensive or when the purchaser does not have a sufficient down payment. It should be noted that banks do not extend loans in the form of mortgages on unimproved land. Under the terms of a land contract, the buyer assumes ownership of the property so long as he meets the terms of the contract. The payment goes directly to the seller rather than a third-party lender. You may qualify for a land contract with little or even poor credit. That decision lies in the hands of the seller, who solely decides to whom he wishes to sell the land.
sale and leaseback agreement
A financial transaction in which an owner sells his or her improved property and, as part of the same transaction, signs a long-term lease to remain in possession of the premises. The land and building used by the seller are sold to an investor, such as an insurance company. The investor then leases back the real estate to the seller, who continues to conduct business on the property as a tenant. This enables a business firm that has money invested in a plant to free that money for working capital.
home equity loan
- A form of second mortgage, homeowners whose property has appreciated in value may borrow up to new loan-to-value (LTV) ratios or, in one popular version, establish a line of credit that is based on the equity position in their home, borrowing against it as they choose. Some sellers do not realize that their home equity line of credit is really a second mortgage and must be paid off when they sell, as any other nonassumable mortgage must be. Your loan-to-value ratio is another way of expressing how much you still owe on your current mortgage. Ex: You currently have a loan balance of $140,000. Your home currently appraises for $200,000. So your loan-to-value equation would look like this:
$140,000 ÷ $200,000 = .70
-In order to calculate the equity portion eligible for loan, one would apply the following steps:
1.) Derive the appraised value of the property at time of loan
2.) Multiply the figure from step one by the loan-to-value ratio at which a lender agrees to provide funds
3.) Subtract any outstanding existing mortgage balance(s)
In formula form it would appear as
(Appraised property value × Loan-to-value ratio) - Any existing mortgages = Equity amount
home equity loans cont'd/HELOCs
- A second mortgage is always going to be in second position, is always going to be a fixed rate, and is always going to be similar to a first mortgage in that you make your principal and interest payments
- HELOCs are usually interest only payments for the first 10 or 20 yrs but the borrower can use the line of credit, pay it back and then use it again.
- A line of credit can also be a first mortgage. You can use a line of credit if you already own a home and want to pull some equity out of the home (i.e. to do some work on the home). Or you can use a line of credit to buy a house. That could be your only mortgage. They were very popular before the crash. A lot of people had home equity loans, they used the entire line of credit, the value of their home dropped and they were "under water". A lot of banks that did home equity loans took huge losses after the values were reduced so a lot of banks don't really offer second mortgages anymore or home equity loans anymore. MOst are sold in secondary markets.
Interest-Only and Optional-Payment Mortgages
-interest only loans are not very popular and in order to deter people from doing interest only loans, lenders charge an extra fee.
- Loans which build no equity are almost the equivalent of renting the property. In high-cost areas where the average buyer cannot afford normal monthly payments or people who receive big bonuses can put some of that towards a huge payment on principal, some lenders offer interest-only mortgages, with monthly payments covering only the interest due and no debt reduction. Some even offer "choose-your-own-payment-this-month" mortgages. With those, payments might not even cover interest. The way it works is for the 1st 10 yrs of a 30 yr loan, for ex., you only pay the interest and then after that, you are reqd to start paying off the principal. So a mortgage would go from $800/mth to $2000/mth.
- Interest-only loans may turn out to be bad financial decisions if housing prices drop, causing those borrowers to carry a mortgage larger than the value of the house (being 'upside-down') which in turn will make it impossible to refinance the house into a fixed-rate mortgage.
Methods of Finance
-Conventional loans are those arranged entirely between borrower and lending institution, i.e. Fannie, Freddie
-Nonconventional or government-backed loans include those insured by the Federal Housing Administration (FHA) or guaranteed by the VA, or Sallie Mae. With both types the actual loan comes from a local lending institution.
-Loans directly from the government include State of New York Mortgage Agency (SONYMA) mortgages and Rural Economic and Community Development Administration (formerly Farmer's Home Administration) (FmHA) loans.
-Private loans are those made by individuals, often the seller of the property or a relative of the buyer.
- lending institutions set their own standards, governed always by banking regulations. These loans are based on the amount. A conventional loan may be useful where a short processing time is needed or where an unusual house or unusual buyer is involved. Conventional loans are also popular when interest rates for mortgage loans are low. Conventional mortgages may be fixed rate, adjustable rate, or a combination of plans. Most fixed-rate conventional mortgages (with some exceptions) are not assumable by a subsequent buyer of the property; some adjustable-rate mortgages are assumable, but only when the buyer can prove financial qualification.
- right now the loan amount is called Conventional Conforming. For a single family home it goes up to maximum loan amount $417,000.
Fixed rate loans
- With a fixed rate loan the interest rate is fixed for the life of the loan, therefore, your principal and interest payment will be the same every single month from the first month to the last month. You can do a fixed rate loan for different amortization terms which will be how long your loan is. So your loan can be a 30 year, 25, 20, 15, 0r 10 yr fixed rate.
- Has the least amount of risk
- A 10yr fixed will have the lowest interest rate
Private mortgage insurance
conventional loans call for higher down payments (lower LTV ratio) than government-backed mortgages. With any down payment below 20 percent, a conventional loan in New York State must be accompanied by private mortgage insurance (PMI). The borrower pays a yearly premium—or, optionally, a lump sum at closing—for insurance that protects the lender in case of loss after a foreclosure. New York State law requires that the lender discontinue collecting PMI premiums when the loan has been paid down to 75 percent of the value of the property as appraised at the time of purchase. For conventional mortgage loans placed after July 29, 1999, the federal government requires that lenders drop PMI coverage at the borrower's request when equity reaches 20 percent and that coverage be dropped automatically when it reaches 22 percent.
Adjustable rate mortgages
- 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.
FHA, which operates under HUD, does not lend money itself. Rather, it INSURES mortgage loans made by approved lending institutions. It does not insure the property, but it does insure the lender against loss. These loans allow for very low down payments, usually at 3%.
- FHAs also do high balanced loans but they don't do Jumbos
The most widely used FHA mortgage is known as 203(b) and may be placed on one- to four-family residences. The following are among the requirements set up by the FHA before it will insure a loan.
The loan is available only to an owner/occupant, someone who intends to live in the property as a primary residence. (Investors may sometimes buy HUD foreclosures with 25 percent down.)
2.) Mortgage insurance premium-
In addition to paying interest, the borrower is charged a lump sum of 1.5 percent of the loan as a mortgage insurance premium (MIP). This amount is payable in cash at the closing or may be financed for the term of the loan. If the loan is subsequently paid off within the early years of the loan, some refund of unused premium is due the borrower from HUD.
-For an FHA loan placed after 2000, the FHA will drop MIP payments when the principal balance has been reduced to 78 percent of original purchase price, but only after the first five years.
-On FHA loans made since July 1991, borrowers are charged the initial lump-sum premium at closing and also 0.05 percent MIP (mortgage insurance premium) per month as interest for a number of years, depending on the size of the down payment.
FHA loans cont'd
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.
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.
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.
FHA loans cont'd
The FHA offers a "streamline" refinancing for its loans, with minimal closing costs.
7.) Other FHA programs-
Among other FHA programs, which may or may not be handled by a particular local lender at any given time, are ARMs and special plans intended for veterans, for rehabilitation of housing being purchased, and for no-down-payment purchase of modest homes. Other FHA programs are sometimes available to finance mobile homes, manufactured housing, and condominiums. For first-time purchasers, the FHA offers special discounts for teachers, firefighters, and police officers buying HUD-foreclosed houses in "revitalization zones," and for first-time buyers who complete a course in financial management.
The program known as FHA 203(k) allows money to be borrowed to cover both the purchase and the rehabilitation of a house in need of substantial repair.
VA GUARANTEED loans
The VA can GUARANTEE lending institutions against loss on mortgage loans to eligible veterans. Because the VA guarantees part of the loan, no down payment is required (though individual lenders may sometimes ask for a small down payment). The primary difference between the FHA and VA programs is that the VA can loan an eligible borrower 100 percent financing. Even an FHA loan requires the borrower to make an initial investment/down payment. It is used to guarantee the top 25 percent of the loan, so in practice that amount could cover a loan of up to $417,000. VA loans are intended only for owner-occupied property that is owned by veterans, or veterans and their spouses, and may be placed on one- to four-family residences. While the guarantee comes from the federal government, the loan itself is made by a local lending institution. The veteran pays a funding fee directly to the VA at closing. The amount of the funding fee depends on the size of the down payment:
-Nothing down or less than 5 percent: 2 percent
-Down payment between 5 and 10 percent: 1.5 percent
-10 percent or more down payment: 1.25 percent
-Assumptions of VA loans: 0.5 percent
Those eligible through national guard/reservist service pay an extra 0.75 percent in funding fee.
VA loans cont'd
To qualify, a veteran must have a discharge that is "other than dishonorable" and the required length of service:
-For those in the National Guard or the reserves, six years' service
-For those who enlisted before September 7, 1980, at least 90 days' continuous active service since September 16, 1940 (or 90 days' service during a war)
-For those who first enlisted after September 7, 1980, two years' active duty
-Reservists called up for at least 90 days during the Persian Gulf War, whether or not they went overseas
The veteran who applies for a VA loan must furnish a certificate of eligibility
VA loans cont'd
Veterans who have used some or all of their eligibility to guarantee one loan sometimes can place another VA mortgage. Eligibility may still be available if
-the first loan used only part of the guarantee;
-the original VA loan has been paid off and the home sold;
-the original VA loan was formally assumed by another veteran; or
-the applicant is the widow or widower of a veteran who died of a service-connected disability and has not remarried.
Qualified veterans' home loan entitlement will be restored one time only if the veteran has repaid the prior VA loan in full but has not disposed of the property securing that loan. If veterans wish to use their VA entitlement again, they must dispose of all property previously financed with a VA loan, including the property not disposed of under the "one time only" provision.
VA loans cont'd
Any VA mortgage loan made before March 1, 1988, may be assumed by the next owner of the property, who need not be a veteran and need not prove qualification to the lender or the VA. For loans made after March 1, 1988, the assumer (who need not be a veteran) must prove creditworthiness, and the original borrower is free of future liability.
VA loans may be refinanced with a streamline process for a fee of 0.5 percent.
Government Backing via the Secondary Market
- A market for the purchase and sale of existing mortgages, i.e. HELOCs, 2nd mortgages, designed to provide greater liquidity of mortgages.
-Lenders in the primary mortgage market originate loans directly to borrowers. Other primary lenders may sell packages of loans to large investors in what is known as the secondary mortgage market. A lender may wish to sell a number of loans when it needs more money to meet the mortgage demands in its area.
- A major source of secondary mortgage market activity is warehousing agencies, which purchase mortgage loans and assemble them into large packages of loans for resale to investors such as insurance companies and pension funds. The major warehousing agencies are Fannie Mae, Ginnie Mae, and Freddie Mac.
Govt Backing cont'd
-Fannie Mae (FNMA)-
a privately owned corporation. It raises funds to purchase loans by selling government-guaranteed FNMA bonds. Originally, FNMA started out as a governmental agency. Mortgage bankers are actively involved with FNMA, originating loans and selling them to FNMA while retaining the servicing functions. FNMA is the nation's largest purchaser of mortgage. When Fannie Mae talks, lenders listen. Because FNMA eventually purchases one mortgage out of every ten, it has great influence on lending policies. When Fannie Mae announces that it will buy a certain type of loan, local lending institutions often change their own regulations to meet the requirements.
Govt Backing cont'd
-Ginnie Mae (GNMA)-
formerly called the Government National Mortgage Association. The Ginnie Mae pass-through certificate lets small investors buy a share in a pool of mortgages that provides for a monthly "pass-through" of principal and interest payments directly to the certificate holder.
provides a secondary market for mortgage loans. Freddie Mac buys mortgages, pools them, and sells bonds with the mortgages as security.
Most lenders use a standardized mortgage application and other forms that are accepted by Freddie Mac and Fannie Mae.
- When Fannie Mae and Freddie Mac announce that they will buy loans only up to a certain size ($417,000 for one-family homes), many local lenders set that as their own limit. Loans higher than Fannie Mae's or Freddie Mac's maximum loan limit are known as nonconforming loans. A nonconforming loan usually carries a slightly higher rate of interest.
- A loan that goes from $417,000 to $625,500 is called a non-jumbo loan, or a high balance loan.
- Anything over $625,500 uses a 'Jumbo' loan.
The 'Jumbo loans' are not purchased by Fannie Mae or Freddie. Typically are sold on the secondary market to a REIT or some sort of Equity Company, or Wall Street firm, or another bank. But they don't always follow the guidelines for the conventional as well as the high balanced loans.
- Nonconforming mortgages (portfolio loans) do not have to meet uniform underwriting standards and can be flexible in their guidelines. The borrower with an unusual credit situation or a unique house may need a nonconforming loan.
The federal government regulates the lending practices of mortgage lenders through the Truth-in-Lending Act, Equal Credit Opportunity Act (ECOA), and Real Estate Settlement Procedures Act (RESPA).
The Truth-in-Lending Act, enforced through Regulation Z (that is, the Truth-in-Lending Act as it applies to the advertisement of credit terms), requires that credit institutions inform the borrower of the true cost of obtaining credit so that the borrower can compare the costs of various lenders and avoid the uninformed use of credit. All real estate transactions made for personal or agricultural purposes are covered. The regulation does not apply to business or commercial loans.
It requires that the customer be fully informed of all finance charges, as well as the true annual interest rate, before a transaction is consummated. In the case of a mortgage loan made to finance the purchase of a dwelling, the lender must compute and disclose the annual percentage rate (APR) in a written Truth-in-Lending statement provided to the mortgagor.
Three-day right of rescission
Lenders close on the loan, but need to withhold the funds from the borrower until the 3 day rescission period has passed. In extreme situations the lender might agree to waive that period for the borrower, but there can be serious consequences for the lender. Borrowers have the right to change their minds about the loan in 3 days with no questions asked by giving written notice to the lender before the 3 days are up.
Regulation Z cont'd
Regulation Z provides strict regulation of real estate advertisements that include mortgage financing terms. General phrases like "liberal terms available" may be used, but if specifics are given they must comply with this act. The APR must also be stated.
Specific credit terms, known as triggering terms—such as the down payment, monthly payment, dollar amount of the finance charge, or term of the loan—may not be advertised unless the following information is set forth as well: cash price; required down payment; number, amounts, and due dates of all payments; and APR. The total of all payments to be made over the term of the mortgage must also be specified unless the advertised credit refers to a first mortgage to finance acquisition of a dwelling. The expression "low down payment" would not be a triggering term.
Regulation Z provides substantial penalties for noncompliance, ranging from a fine of $5,000 to $10,000 for each day the misleading advertising continues to a year's imprisonment. Licensees are cautioned and advised not to violate any of the provisions of Regulation Z.
Federal Equal Credit Opportunity Act
The federal Equal Credit Opportunity Act (ECOA) prohibits lenders and others who grant or arrange credit to consumers from discriminating against credit applicants. Lenders must inform all rejected credit applicants in writing of the principal reasons why credit was denied or terminated.
The National Affordable Housing Act requires that borrowers be presented with a statement of their rights if their loan servicing (the process by which a mortgage bank or subservicing firm collects the installment payment of interest and principal due from the borrower) is transferred. The borrower must be notified at least 15 days before the date of transfer and provided with a toll-free or collect-call telephone number of the new servicer. Servicers are also required to acknowledge borrowers' inquiries within 20 days, and act on them within 60 days.
The Real Estate Settlement Procedures Act (RESPA) requires that lenders inform both buyers and sellers in advance of all fees for the settlement of a residential mortgage loan.
Lender's Criteria For Granting A Loan
All mortgage lenders require that prospective borrowers file an application for credit that provides the lender with basic information. A prospective borrower must submit personal information including age, family status, employment, earnings, assets, and financial obligations. Details of the real estate that will be the security for the loan also must be provided, including legal description, improvements, and taxes. For loans on income property or those made to corporations, additional information is required, such as financial and operating statements, schedules of leases and tenants, and balance sheets. Self-employed applicants will be asked to show two years' income tax returns. Anyone employed by a family member will be asked to show a current pay stub and the most recent tax return.
- Criteria is based on the property and the borrower:
Evaluating the Property-
- The value of the property is an important element of the lender's underwriting process. The amount of the loan is based on the sales price of the property or appraised value, whichever is less. The lender then applies its LTV ratio to this figure. For example, suppose the property's sales price is $150,000, its appraised value is $152,000, and the buyer is applying for a 90 percent loan (which means he or she is making a 10 percent down payment). To determine the maximum loan amount, the lender would multiply $150,000 (the lesser of the sales price and appraised value) by 90 percent. The maximum loan amount would be $135,000. (The borrower would have to make a $15,000 down payment.)
To determine the appraised value of the property, the lender will order that an appraisal be performed. When valuing the property, the appraiser will take into consideration such elements as the property's location, its size and square footage, the number of bedrooms and bathrooms, the size of the lot, and the condition of the property. If the property is a condominium or cooperative unit, the appraiser also will look at the project as a whole and examine the condominium declarations and bylaws filed with the attorney general or the cooperative's proprietary lease and bylaws.
- It's important to get an appraiser that is familiar with the area or is from the area so as not to get a too low/high appraisal value
Evaluating the Potential Borrower-
- Because a credit report will be part of the application process, homebuyers are well advised to check their own reports early in the homebuying process to allow time for clearing up any errors. The three main reporting agencies are: Equifax, Experian, TransUnion
-Of course, a lender would much rather have its borrowers pay off their mortgage loans as agreed. If the applicant does not appear financially able to handle the mortgage payments comfortably or if the applicant's continued employment is doubtful, the loan application may be rejected. In recent years, however, some lenders offer special programs, perhaps at higher interest rates, to applicants with less-than-perfect credit scores. The Fannie Mae Foundation offers free pamphlets on understanding, evaluating, and repairing credit history.
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.
Through the process known as underwriting, the lender analyzes the application information. Verification forms are sent to the applicant's employers, financial institutions, and lenders. These forms are returned to the lender and examined to make sure the information on the loan application is correct. The lender also studies the credit reports and the appraisal of the property before deciding whether to grant the loan.
Lender's criteria for granting a loan:
Evaluating the property
Evaluating the borrower
The widely used FICO score ranges from 300 to 850, with most people scoring in the 600s and 700s. A score of 750 might bring the offer of a low interest rate; below 620 it could be difficult to mortgage property at all.
FICO analyzes the subject's payment (on-time) record for 35 percent of the score. Current borrowing and credit limits account for 30 percent. Length of credit history (the longer the better) makes up 15 percent, and the rest evaluates types of credit used, number of recent accounts, credit cards, installment loans, and the like.
-Most mortgage lenders will ignore a bankruptcy when four years have passed since the discharge (not the filing).
The lender's acceptance is written in the form of a loan commitment, which creates a contract to make a loan and sets forth the details. This loan commitment must be signed by the borrower and returned to the lender within a specific time period.
Borrowers can go through the mortgage application process before they start house-hunting. Application and credit report fees are due, but the result can be a lender's statement that the applicant is qualified to borrow up to a certain maximum amount. The buyer with mortgage preapproval is particularly welcome to sellers and may be in a stronger bargaining position.
A few lenders have been known to make mortgage loans to unqualified borrowers regardless of repayment ability. Such loans often end with the property lost in foreclosure.
Predatory loans are usually at high rates of interest and carry large closing costs. Predatory lenders often urge borrowers to refinance again and again (flipping) to clear past debt, each time increasing the financial burden.
New York State has enacted laws against predatory lending, defined as loans at an interest rate eight or more percentage points over the yield on comparable Treasury notes. Predatory closing costs are defined as anything over 5 percent of the amount being borrowed. The law also addresses the problems of unreasonable balloon payment arrangements.
Lending practices over recent years have led to a financial credit market crisis. This crisis has been termed by government and the media as the "subprime" loan crisis. In 2007, news began to surface as to lending practices targeted to less-than-qualified borrowers because of an unprecedented rise in nonperforming loans and foreclosures. Some of this practice involved adjustable-rate mortgages that were due for rate adjustments. Other loans consisted of hidden fees, high interest rates, and closing costs. In many cases (currently under investigation by federal authorities), loans were originated with "money back at closing" to a buyer (also known as seller concessions). At closing, the buyer paid substantial portions of the money received to vendors involved in the transaction. Payment was made in the form of fees. These practices have led to federal investigations concerning potential banking fraud.
-Qualifying ratios: housing expense ratio and total monthly obligations ratio
-With each mortgage plan offered, the lender has certain qualifying ratios that will be applied to each borrower. A typical ratio for a conventional loan if the buyer has only moderately good credit is 28/36; the borrower will be allowed to spend up to 28 percent of gross monthly income for housing expenses (PITI—principal, interest, taxes, and insurance) and up to 36 percent of income for both housing expenses and other payments on long-term debts. The applicant must qualify under both ratios before the loan will be approved (front end and back end ratios).
For EXAMPLE, suppose a prospective buyer earns $3,000 a month. She pays $350 a month on long-term debts, including a car loan and credit card balances. If a lender applies the qualifying ratios to her income, the results will be as follows:
28 percent of $3,000 is $840. This is the maximum monthly payment for the loan amount she will qualify for under the housing expense-to-income ratio.
36 percent of $3,000 is $1,080; $1,080 minus $350 (monthly long-term payments) equals $730. This is the maximum monthly payment for the loan amount she will qualify for under the total expenses-to-income ratio.
Because a borrower must qualify under both ratios, the highest monthly loan payment this borrower would qualify for is $730.
Other loan programs can have different ratios. For example, to qualify for an FHA loan, applicants can spend no more than 31 percent of their gross monthly income on housing expenses and no more than 43 percent of their gross monthly income on both housing expenses and payments on long-term debts.
To qualify for a VA loan, applicants must spend no more than 41 percent of their gross income on both housing expenses and long-term debt payments and must also meet the VA's cash flow guidelines (called residual income requirements).
-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.
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