Chapter 13 - Real Estate

Types of Mortgage Lenders

• Savings Association

• Commercial Banks

• Credit Unions

• Life Insurance Companies (LICs)

• Mortgage Bankers

Three types of mortgage loans

FHA, VA, and Conventional

Loan for single-family owner-occupied homes that guarantees the first 25% of losses in the event of a foreclosure or default, reproducing the lender’s risk

VA loan; Loans are originated through a VA approved lender and guarantee amounts vary based on the borrower’s position and tenure of service, up to the maximum amount

Document that shows a veteran’s eligibility and amount of guarantee for the VA mortgage loan program

Certificate of eligibility (obtained through the VA); To be eligible, the veteran must have served a specified minimum amount of time and be honorably discharged

Maximum total obligations ratio for a VA guaranteed mortgage loan

41% (The VA does not use the housing expense ratio)

Purpose of the FHA 203(b) guaranteed loan program

Provide basic mortgage insurance for the purchase or refinance of owner-occupied one-to-four family properties

The type of loan that is insured, protecting the lender from loss in the event of foreclosure

FHA loan; The loan is funded by a lending institution

Purpose of the FHA insured loan program

Promote home ownership for low- and moderate income families by lowering loan costs while encouraging lenders to make loans to creditworthy borrowers who cannot meet conventional loan requirements

Minimum down payment required for FHA loans

3.5% of the home’s purchase price or appraised value

Maximum loan-to-value (LTV) ratio for an FHA insured mortgage loan

96.5%

Maximum housing expense ratio for an FHA insured mortgage loan

31%

Maximum total obligations ratio for a FHA insured loan

43%

FHA mortgage insurance that is paid once, at closing

Up-front mortgage insurance premium (UFMIP); typically, 1.75% of the mortgage amount

FHA mortgage insurance premium that is paid monthly for the life of the loan

Annual mortgage insurance premium (AMIP); 0.85% of the annual outstanding loan balance divided up into 12 monthly payments

Unique aspect of an FHA mortgage loan

FHA insures the lender 100%; In the event of default, the lender is reimbursed for losses

Purpose of the FHA 203(k) insured loan program

Insures loans where homebuyers can finance both the purchase of one-to-four family dwelling and cost of its rehabilitation through a single long-term fixed or adjustable rate mortgage

Purpose of the FHA 234(c) insured loan program

Insures a loan for 30 years specifically for the purchase of a single-unit condominium

Purpose of the FHA 251 insured loan program

Insures loans with adjustable rate financing based on FHA/HUD approved market indexes

Conventional loan

Loan that is not insured or guaranteed by an agency of the government

Loan type that is typically most difficult to obtain

Conventional (These loans typically carry a higher interest rate and require a higher down payment; they also carry a higher risk for the lender)

Insurance typically required for conventional mortgage loans when the loan amount exceeds 80% of the property value

Private mortgage insurance (PMI); With PMI, a borrower may typically obtain a loan up to 95% of the property value

Condition for automatic cancellation of PMI with a conventional mortgage loan

PMI will be cancelled when the loan-to-value (LTV) ratio is 78% or less of the proeprty’s original value

Usury

Charging an unlawfully high interest rate

Term mortgage (also called a straight-term mortgage)

Loan repayment method that provides for payments of interest only during the term of the loan with the amount borrowed repaid in a lump sum at the end of the term

Amortized mortgage

Loan repayment method with scheduled periodic payments consisting of a portion that applies to interest and a portion that applies to principal

Fully amortizing

Amortized mortgage when the payments are enough to repay the interest and loan amount in full over the life of the loan

Partially amortizing

Amortized mortgage when the payments are not enough to repay the interest and loan amount in full over the loan term

Negative amortization

Amortization that occurs when loan payments fail to cover the interest due and the remaining amount of unpaid interest is added to the loan’s principal

Balloon payment

Lump sum payment of any remaining principal amount at the end of a term mortgage or partially amortized loan

Adjustable rate mortgage (ARM)

Loan repayment method in which the interest rate fluctuates over the term of the loan based on a nationally recognized index, such as the T-bill

Index and Margin

Key elements of an adjustable rate mortgage (ARM) that determine the loan payment

Index; The loan rate can change (up and down) based on changes to the index

Foundation rate for an adjustable rate mortgage (ARM) that is based on U.S Treasury Securities

Margin; The margin added to the index determines the note rate that the borrower will pay on the loan. This remains constant for the loan term

Percentage that is added to the index rate by the lender for an adjustable rate mortgage (ARM) for profit and to cover costs

Teaser rate; Intended to encourage borrowers to obtain an ARM instead of a fixed-rate loan

Initial rate stated in a promissory note for an ARM that is lower than the fully indexed rate

Three-year ARM

Adjustable rate mortgage with an adjustment period of 36-months

Five-year ARM

The term that refers to an adjustable rate mortgage with and adjustment period of 60-months

Periodic cap (or periodic cap rate)

Maximum interest rate change at any one time for an ARM

Payment cap; Example: A one-year ARM with a payment cap of 2% for any one adjustment period

Maximum limit for any single adjustment to the payment amount of an ARM

Lifetime cap; Example: A one-year ARM with a lifetime cap of 6%

Maximum interest rate that can be charged over the life of an ARM

Negative amortization; The unpaid monthly interest is deferred and added to the principal balance

ARM interest rates increase; payment cap limits the monthly payment that does not cover the interest portion of the monthly payment

Biweekly mortgage; This is essentially the same as making 26 payments each year, or 13 full monthly payments, paying the loan off earlier and saving substantial interest

Loan repayment method that requires that one-half of the mortgage payment be paid every two weeks instead of one payment per month

Blanket mortgage; Used by builders and developers when constructing several properties in the same area

Mortgage that pledges two or more parcels as security for a loan with a release clause that allows the borrower to pay a specified amount to release single lots to be sold to buyers

Home equity loan

Single lump sum loan secured by a homeowner’s equity creating a lien on the property

Home equity line of credit (HELOC); This is very different from a home equity loan

Loan with a revolving line of credit and adjustable interest rate allowing a homeowner to borrow against the home’s equity

Reverse mortgage

Loan allowing homeowners age 62 and older to take a lump sum or a monthly advance on a line of credit based on the equity in their home

Purchase money mortgage (PMM);

Loan obtained by a buyer from the seller to purchase real property (seller financing)

Package mortgage

Loan including real and personal property, such as major appliances and furniture, as security for a loan

Chattel mortgage

Loan that includes only personal property as security for the loan

Intermediation; Deposits put more money into the monetary system that can be used for lending

Flow of deposits into a lending institution, making more funds available for lending purposes

Disintermediation; Withdrawals take money out of the monetary system, reducing the money available for lending (making money tighter)

Depositors withdraw funds from low interest rate accounts, transfer the funds to alternate higher interest investments

Effect of mortgage interest rates when intermediation occurs

Interest rates decrease with intermediation since more money is available for lending

Effect on mortgage interest rates when disintermediation occurs

Interest rates increase with disintermediation since less money is available for lending

Federal Reserve System

Central bank of the United States that sets monetary policy, lends money to member banks, and regulates the cost and availability of credit

Three methods (tools) used by the federal reserve board of Governors to regulate the money supply

1. Reserve requirement

2. Discount rate

3. Open market operations

Federal Reserve action that changes the reserve requirement

Increasing or decreasing the percentage of depositor’s money that cannot be used for lending purposes, resulting in increased or decreased interest rates for borrowers.

Effect on interest rates when the Federal Reserve raises the reserve requirements

More money must be reserved. making less money available for lending, causing interest rates to increase

The impact on interest rates when the Federal Reserve decreases the reserve requirements

Less money must be reserved, making more money available for lending, causing interest rates to decrease

The Federal Reserve action associated with changes to the discount rate

Increasing or decreasing the discount (interest) rate for member banks to borrow money; resulting in increased or decreased rates for borrowers

Effect on interest rates when the Federal Reserve increases the discount rate to members

Increasing the discount rate to member banks is passed on to lenders, resulting in higher interest rates to borrowers

Effect on interest rates when the Federal Reserve decreases the discount rate to member banks

Decreasing the discount rate to member banks, when passed on to lenders, results in lower interest rates to borrowers

Federal Reserve actions associated with open market operations

Purchasing or selling government securities on the open market, altering the amount of money in the monetary system, which affects interest rates for lending

Impact on interest rates when the Federal Reserve purchases government securities on the open market

Purchasing government securities puts more money into the monetary system (intermediation), making more money available for loans, resulting in lower interest rates

Impact on interest rates when the Federal Reserve sells government securities on the open market

Selling government securities takes money out of the monetary system (disintermediation), making less money available for loans, resulting in higher interest rates

Most abrupt method for the Federal Reserve to control the supply of money

Raising or lowering the reserve requirement

Least effective method for the Federal Reserve to control the cost of money

Increasing or decreasing the discount rate

Most effective method for the Federal Reserve to control the cost of money

Purchasing or selling government securities on the open market

Mortgage market where loans are originated

Primary mortgage market; Consists of individuals and business that need or want to borrow money and the various sources for those loans

Mortgage lenders in the primary mortgage market

• Savings associations

• Commercial banks

• Credit Unions

• Life insurance companies

• Real estate investment trusts

• Mortgage bankers

Largest source of funds in the primary mortgage market for financing both apartment and commercial properties

Life insurance companies (LICs)

Primary lending source used primarily for short-term construction loans for large projects

Commercial banks; Funds come from checking accounts and time deposits in savings accounts

Primary lending source used by private investment groups to purchase real estate for investments

Real estate investment trusts (REITs); REITs receive special tax treatment under Federal income tax laws

Individuals who accept residential loan applications or offers to negotiate terms of a residential mortgage loan for compensation

Mortgage loan originator (MLO); MLOs do not make loans

Mortgage broker

Licensed individual who employs mortgage loan originators (MLOs) to conduct loan originator activities

Mortgage market where loans originated in the primary market are packaged and sold to provide a constant source of funds for real estate transactions

Secondary mortgage market; When the loans are sold, the loan amounts in the primary market are replaced, allowing a continuous source of funds for lending

Principal lenders in the secondary mortgage market

• Fannie Mae (FNMA)

• Freddie Mac (FHLMC)

• Ginnie Mae (GNMA)

Fannie May (FNMA, Federal National Mortgage Association)

Oldest and largest participant in the secondary mortgage market that purchases FHA, VA, and conventional loans

Ginnie Mae (GNMA, Government National Mortgage Association); Operating within HUD, Ginnie Mae also provides a secondary market for VA and FHA loans

Government-owned participant that operates solely in the secondary mortgage market, primarily with the purchase of federally subsidized residential mortgages originated by local lenders

Freddie Mac (FHLMC, Federal Home Loan Mortgage Corporation)

Stockholder-owned secondary mortgage market participant that primarily purchases conventional loans and sells mortgage backed securities and mortgage loans to investors

Common types of mortgage fraud

• Foreclosure rescue schemes

• Borrower identity theft

• Reverse mortgage scams

• Straw borrowers

• Appraisal fraud

• No document “no doc” loans

Activities considered possible signs of mortgage fraud (“red flags”)

• unsolicited offers

• Upfront fees

• Requests for payments to foreclosure service

• Requests for quitclaim deed

• Names added or deleted from contract

• Requests to sign incomplete documents

• Inflated appraisals or contract prices

Requirements of the Real Estate Settlement Procedures Act (RESPA)