RFINANCE4: Lenders
However, the law also states that a borrower whose equity equals 20% of the purchase price or appraised value may request that the lender cancel the PMI.
Lenders have a duty to inform all borrowers of their right to terminate the PMI.
Conventional loans also have their disadvantages.
Typically conventional loans require higher down payments than government-backed loans require. Some conventional loans carry prepayment penalties, while government-backed loans do not.
In a sense, a loan can be considered a
"partnership" between the lender and the person getting the loan. On the borrower end, it's obvious that the advantage lies in obtaining the funds to complete the home purchase. On the lender end, the advantage lies in obtaining income in the form of the interest and finance charges on the loan. So in the eyes of the lender, the loan is an investment.
Section 203(b)-Mortgage Insurance for One-Family to Four-Family Homes
Although there are many different programs available under FHA insured financing, the most popular is the FHA 203(b) that covers loans on one-to-four-unit owner-occupied dwellings. This fixed-rate loan often works well for first time home buyers because it allows individuals to finance up to 97 percent of their home loan, which helps to keep down payments and closing costs at a minimum. The 203(b) home loan is also the only loan in which 100 percent of the closing costs can be a gift from a relative, non-profit, or government agency.
Certificate of Reasonable Value (CRV)
An approved VA appraiser must issue a Certificate of Reasonable Value (CRV) showing the value of the property to be equal to or greater than the sales price. The CRV is valid for six months on existing property and 12 months on new construction. The DVA will never issue a certificate that shows the value to be greater than the sales price. For example, if a home is selling for $300,000 and the appraisal comes in at $325,000, the CRV will be $300,000. On the other hand, if the sales price is $300,000 and the appraisal is $275,000, the CRV will be $275,000. The veteran may proceed with the purchase if the sales price exceeds the CRV, but he or she will be required to pay the difference in cash. The source of the cash must be approved by the VA. If the CRV is not equal to or greater than the sales price, the veteran may withdraw from the contract.
Section 251-Adjustable Rate Mortgage
As we said earlier, FHA's most popular home loan is the 203(b) loan. However, there are also many other programs available based on the 203(b) that have additional features. One of these is the Section 251 Adjustable Rate Mortgage program, which provides insurance for adjustable rate mortgages. When interest rates are high, adjustable rate mortgages keep the initial interest rate on a mortgage low, which allows borrowers to qualify for the financing they need. The Section 251 program works well with the other widely-used FHA single-family products we've already discussed: 203(b), 203(k) and 234(c). Even though the Section 251 program helps to keep mortgage interest rates and payments low, they may change over the life of the loan. The maximum amount of fluctuation in the interest rate in any given year cannot exceed 1 percentage point. And over the life of the loan, the interest rate cannot increase more than 5 percent from the initial rate. The terms of the adjustable rate mortgage will be disclosed to the borrower at the time of application. Should the interest rate increase, the borrower will be informed at least 25 days before any changes are made to the total monthly payment. As an additional benefit of the Section 251 program, an adjustable rate mortgage can be "streamline refinanced" to a fixed rate mortgage at any time. Streamline refinancing means that the documentation and underwriting is greatly reduced, but closing costs still apply. Aside from the adjustable rate aspect of the Section 251 loan, it is very similar to an FHA-insured, single-family loan. Because FHA insurance allows borrowers to finance up to 96.5 percent of the value of their home through their mortgage, down payments can be as little as 3.5 percent of the total value of the home.
Summary/Review
There are basically two categories of loans available to buyers in the marketplace - conventional loans and government-backed loans. Government-backed loans include those loans offered by: The Federal Housing Administration (FHA) The Department of Veterans Affairs (DVA) - sometimes simply referred to as VA The California Department of Veterans Affairs (Cal-Vet) Other state, county or city-backed subsidized loan programs Conventional loans have several advantages over government-backed loans. Processing a conventional loan usually takes less time. Loan approval from a conventional lender can take 30 days or less, while approval on a government-backed loan seldom, if ever, can be done in less than 30 days. Conventional loans typically have fewer forms, and processing can be more flexible than government-backed loans. There is usually no legal limit on loan amounts with conventional loans; however, government-backed loans have dollar limits that vary by agency. In the event of a loan refusal, borrowers have other lenders that they can make application to. There is only one of each government agency type, so if the loan is refused by a particular agency, there are no alternative lenders available. Conventional lenders are much more flexible. Many offer a variety of loans with attractive provisions. Conventional loans also have their disadvantages. Typically conventional loans require higher down payments than government-backed loans require. Some conventional loans carry prepayment penalties, while government-backed loans do not. The conventional loan is the most common type of loan and is generally viewed as the most secure. Most conventional loans require the borrower to make a down payment of 20% or more, making the loan 80% or less of the property's sale price. Conventional loans are typically uninsured. The mortgage itself provides the only security for the loan. To protect its interests, the lender relies on the appraisal of the property and the borrower's ability to repay the loan, as indicated by the borrower's credit reports. Most conventional loans have traditionally been designed as fixed-rate loans. With this common type of mortgage program, the monthly payments for interest and principal never change. Property taxes and homeowners insurance may increase, but generally the monthly payments will be very stable. Fixed rate mortgages are available for 30 years, 20 years, 15 years and even 10 years. Even though most conventional loans require the borrower to make a down payment of 20% or more, a borrower can get a conventional loan with a lower down payment by insuring the loan through a private mortgage insurance program (PMI). A popular way to avoid having to pay private mortgage insurance is through the use of what's known as 80-10-10 financing. What this means is that the institutional lender provides the traditional 80-percent first mortgage. Then the borrower gets a 10-percent second mortgage and makes a 10-percent cash down payment. Government-backed loans include those loans offered by: The Federal Housing Administration (FHA) The Department of Veterans Affairs (DVA) - sometimes simply referred to as VA The California Department of Veterans Affairs (Cal-Vet) Other state, county or city-backed subsidized loan programs The FHA provides low-down-payment loans to qualified buyers. The Department of Housing and Urban Development (HUD) oversees the FHA. The loans FHA provides are high loan-to-value ratio loans, so FHA insures the loans in order to make them available to higher risk individuals. Although there are many different programs available under FHA insured financing, the most popular is the FHA 203(b) that covers loans on one-to-four-unit owner-occupied dwellings. This fixed-rate loan often works well for first time home buyers because it allows individuals to finance up to 97 percent of their home loan, which helps to keep down payments and closing costs at a minimum. The 203(b) home loan is also the only loan in which 100 percent of the closing costs can be a gift from a relative, non-profit, or government agency. Other popular FHA programs include: Section 234(c)-Mortgage Insurance for Condominium Units Section 245(a)-Growing Equity Mortgage Section 203(k)-Rehabilitation Home Loan The Section 251 - Adjustable Rate Mortgage program provides insurance for adjustable rate mortgages. This program works well with the other widely-used FHA single-family products: 203(b), 203(k) and 234(c). In an effort to make it possible for veterans returning from World War II to purchase a home, the Veterans Administration (VA), now the Department of Veterans Affairs (DVA), offered the opportunity for veterans to purchase a home with no money down. In order to make this loan acceptable to lenders, the DVA agreed to guarantee the top portion of the loan. Since lenders were now protected in the event of a default by the borrower, lenders agreed to loan four times the current DVA Entitlement. The veteran must provide a Certificate of Eligibility showing the amount of entitlement available. The entitlement is the maximum number of dollars that DVA will pay if the lender suffers a loss. The DVA also requires the veteran to pay a funding fee, which is a percentage of the loan amount charged for the privilege of obtaining a VA loan. This fund is used for administrative costs and to offset losses incurred in cases of default by the borrower. It is very similar in function to FHA mortgage insurance premiums. An approved VA appraiser must issue a Certificate of Reasonable Value (CRV) showing the value of the property to be equal to or greater than the sales price. VA loans were freely assumable prior to March 1988. Since then, a purchaser who desires to assume an existing VA loan must qualify with the original lender. The veteran should request a release of liability from the purchaser that will relieve the veteran from any further liability for the loan. The veteran would remain personally liable for any deficiency if he or she does not obtain the release. California provides another alternative in the form of a special assistance program for farm and home purchases. The California Department of Veterans Affairs (CDVA), Division of Farm and Home Loans administers the program and the loans are referred to as Cal-Vet loans. Unlike the insured FHA loan or the guaranteed VA loan, the Cal-Vet loan is actually a land contract. When a veteran is approved for a Cal-Vet loan, the state purchases the property and resells it to the veteran using a contract of sale. The state retains the title to the property until the loan is paid off, after which California will issue a grant deed to transfer legal title to the veteran. CDVA will purchase only approved single-family residences (including condominiums, units in planned unit developments, and mobile homes) in California which meet the needs of the veteran as a dwelling place for his or her family. The property must be structurally sound and provide safe and sanitary living conditions. The main advantages of the Cal-Vet loan are its relatively low interest rate; the availability of inexpensive life, fire and hazard insurance; and low closing costs. The biggest disadvantages are few, if any, chances to refinance and potential shortage of funds to make the loans. The California Housing Finance Agency (CalHFA) program offers below-market interest rate first mortgage programs and a variety of down payment assistance programs to eligible first-time homebuyers. In order to qualify for a CalHFA loan, a borrower must meet certain requirements. Eligible properties must be priced at or below the county-by-county limits established by CalHFA for new or existing homes. By definition, a junior loan is a mortgage (second mortgage or second trust deed) that is "subordinate in right or lien priority" to an existing mortgage on the same property. Junior loans contain more risk that first loans. For this reason, they will typically carry a higher interest rate. Just like first trust deeds, junior loans require the execution of a promissory note that spells out the terms and conditions of the loan. The property description for a junior loan will be the same as the description contained in the existing first note. The subordinate position of the secondary loan puts the lien holder of the junior loan in a high-risk position. If a foreclosure on the first note results, the first note holder may sell the property to recover as much as he can, leaving the junior lien holder "holding the bag" with effectively no compensation, since the allocation of any proceeds from the sale would be to the "senior" lien holder first, followed by any junior lien holders. Most junior loans are used in low-down-payment situations. Sometimes after a period of three to five years, a borrower will merge the junior note with the existing first note by increasing the first loan by an amount that will allow the junior loan to be paid off. Another and probably more common type of junior loan is the home equity loan. The Tax reform Act of 1986 eliminated the interest deduction for consumer finance, but kept the interest deduction on home loans. So many homeowners choose to take out home equity loans and earmark the funds for a myriad of uses, from home improvements to automobile purchases to vacations to education to medical expenses. Most of these home equity loans have a term of five years. When the loans come due, the borrowers typically choose to refinance their property, obtaining a new first deed of trust to pay off the junior loan.
Some lenders are particularly active in the junior loan business. Because:
1) the loans are short term 2) the lender has better control of the interest rates 3) the lender can keep tabs on the value of the property and the credit of the borrowers.
Most first lenders are protected by a
20 percent cash down payment on a conventional loan or by insurance or a guarantee on a government-backed loan. Junior lenders, on the other hand, have no such protection. Since the second lender is usually financing the difference between the sale price of the property and the total of the first loan and the borrower's cash down payment, this second lender is assuming the full risk for the top portion of the property's value without any insurance or guarantee program as back-up. A junior lender may want to minimize the risk by requiring a larger down payment.
These limits are:
65 percent for land acquisition 75 percent for land development 80 percent for multi-family and commercial real estate 85 percent for one-to-four family residences
The junior loan financing instrument can contain clauses that will help protect the junior lien holder's position. These clauses include:
A provision that grants the junior lender the right to pay property taxes, insurance premiums and other charges if the borrower is not making these payments. A clause that allows the junior lender to pay funds for taxes and insurance into an escrow account and make any payments on the first loan to offset a possible default. A provision that includes a requirement that the borrower guarantee that he or she will be personally liable for any deficiencies in the case of a default and foreclosure. A clause prohibiting the borrower from amending any of the terms of the first note without the written consent of the junior lender. A cross-defaulting clause which provides that a default on the first note will automatically trigger a default on the junior note.
In order to qualify for a CalHFA loan, a borrower must meet certain requirements:
Be a first-time homebuyer. (CalHFA considers persons first-time homebuyers if they have not owned and occupied their own home during the last 3 years.) Have an annual household/family income within CalHFA's income limits for the family size and county in which the home is located. Purchase a home that is within CalHFA's sales price limits for the family size and county in which the home is located. Live in the home the borrower is purchasing for the entire term of the loan or until the home is sold or refinanced. Meet credit, income and loan requirements of the CalHFA lender and the mortgage insurer. Be a citizen or other national of the United States or a qualified alien. Eligible properties must be priced at or below the county-by-county limits established by CalHFA for new or existing homes.
Here are some other facts about the Cal-Vet loans:
CDVA offers below market interest rates. Cal-Vet loans usually have a variable interest rate, which historically has not changed much and is not tied to an index. VA-guaranteed loans require no down payment and non-VA loans require only 3% down. Cal-Vet charges a one percent loan origination fee plus a loan guarantee fee. If a veteran makes a down payment of 20 per cent or more, the loan guarantee fee is waived. There is no prepayment penalty for paying off the loan early. Loan terms are typically 30 years. Loan maximums are very generous and are adjusted annually. Secondary financing is allowed at the time of purchase. However, the two loans together cannot exceed 98 percent of the Cal-Vet appraisal. Home and loan protection plans are included. In addition, all Cal-Vet borrowers under age 62 must carry life insurance and that premium must be included with the monthly mortgage premium. The veteran or a qualifying-dependent member of his or her family must occupy the property. Cal-Vet also includes construction and rehabilitation loans.
Veteran Eligibility: The veteran must provide a
Certificate of Eligibility showing the amount of entitlement available. The entitlement is the maximum number of dollars that DVA will pay if the lender suffers a loss. The following veterans are eligible, based on time spent in the service: Active-duty veterans discharged during WWII or later, without the status of "dishonorable." Active-duty veterans with at least 90 consecutive days of service during major conflict. Peacetime veterans and active duty personnel with at least 180 days of consecutive service. Enlisted veterans whose service began after 1980 or officers whose service began after 1981 and who have served at least 2 years. National Guard and Selected Reserve members who have served for 6 years (Note: Eligibility for members of the Selected Reserve expired on September 30, 2007.) Certain unmarried spouses of veterans who were deemed missing in action or prisoners of war, who died in action or died due to a service-related accident, or who have served as a US public health officer may also be eligible. The veteran must plan to occupy the property. In order to use both incomes for a couple to qualify, they must either be married or both have VA eligibility. Otherwise, DVA will only guarantee half of the amount of entitlement. A veteran may use VA-guaranteed financing for any of the following situations: To buy a home. To buy a townhouse or condominium unit in a project that has been approved by VA. To build a home. To repair, alter or improve a home. To simultaneously purchase and improve a home. To improve a home through installment of a solar heating and/or cooling system or other energy efficient improvements. To refinance an existing home loan. To refinance an existing VA loan to reduce the interest rate and add energy efficiency improvements. To buy a manufactured (mobile) home and/or lot. To buy and improve a lot on which to place a manufactured home which you already own and occupy. To refinance a manufactured home loan in order to acquire a lot.
Check Your Understanding-Answers:
Explain the difference between "points" and "discount points" on a loan. Points are a one-time service charge to the borrower for making the loan. Points represent prepaid interest, and the lender charges them to get additional income on the loan. Points are paid at closing and are usually equal to 1 percent of the loan amount. Discount points are designed to offset any losses the lender might suffer when selling the loan to the secondary mortgage market. Discount points are a means of raising the effective interest rate of the loan. The rule of thumb is 1/8 percent for each discount point. List two advantages of conventional loans over government-backed loans. (See other correct answers on Screen 3.) Processing a conventional loan usually takes less time. Loan approval from a conventional lender can take 30 days or less, while approval on a government-backed loan seldom, if ever, can be done in less than 30 days. There is usually no legal limit on loan amounts with conventional loans; however, government-backed loans have dollar limits that vary by agency. What are four ways that fixed-rate loans can be structured? Fully amortized loan Term loan Growing equity mortgage Graduated payment mortgage What does federal law say about the termination of private mortgage insurance? Federal law requires that any loans originated after July 1999 must have the PMI terminated after the borrower has accumulated 22% of equity in the property (loan-to-value ratio is 78%) and is current with all loan payments. However, the law also states that a borrower whose equity equals 20% of the purchase price or appraised value may request that the lender cancel the PMI.
Section 234(c)-Mortgage Insurance for Condominium Units
FHA Condominium Loans are designed to encourage lenders to offer affordable mortgage credit to those who have non-conventional forms of ownership. The Section 234(c) program insures a loan for 30 years to purchase a unit in a condominium building. The building must have at least four dwelling units and can be made up of detached and semidetached units, row houses, walkups or an elevator structure.
Check Your Understanding-Answers
FHA and VA loans differ from conventional loans in what important way? FHA and VA do not loan funds directly. FHA insures loans and VA guarantees loans, but the loans themselves are made by approved, qualified lenders. What kind of insurance does FHA require borrowers to pay? As of 2006, the borrower must pay two insurance premiums. The first is the "upfront" Mortgage Insurance Premium (MIP) which is a percentage of the loan amount. The borrower can pay this one-time premium at closing or the charge could be financed with the loan. The second premium, called Mutual Mortgage Insurance (MMI) is a monthly premium that is paid with the monthly principal, interest, taxes and insurance payment. MMI premiums may be dropped when the remaining loan balance is 80 percent loan-to-value ratio or less. Name four popular FHA loan programs. Section 203(b)-Mortgage Insurance for One-Family to Four-Family Homes Section 234(c)-Mortgage Insurance for Condominium Units Section 245(a)-Growing Equity Mortgage Section 203(k)-Rehabilitation Home Loan What is a Certificate of Reasonable Value and what is it used for? A Certificate of Reasonable Value (CRV) shows the value of a property in relation to its sales price. It is issued by an approved VA appraiser when a veteran is seeking a DVA loan.
The following items are important to know about FHA loans:
FHA loans can be either fixed-rate 10- to 30-year loans or one-year adjustable loans. The maximum loan term is 30 years or 75 percent of the remaining economic life of the property, whichever is less. Down payments are low. However, the borrower must have cash for a down payment and closing costs. These items cannot be added to the sales price and become part of the loan repayment. The maximum loan fee is 1 percent of the loan amount and is typically paid by the buyer.
Here are additional facts to know about FHA loans:
FHA requires that the monthly amounts the borrower pays toward taxes, insurance and MMI be deposited into an escrow or impound account. The lender can charge points and either the borrower or the seller (or both) can pay them. Note: Both interest rates and discount points are fully negotiable between borrower and lender. Loans are assumable, but the rules for assumptions vary depending upon when the loan originated, the type of property, and the specific FHA program under which the original loan was given. The mortgaged real estate must be appraised by an approved FHA appraiser. These appraisals are called "conditional commitments and are good for six months on existing property and one year on new construction. There is no maximum on what the purchase price of the property can be. The borrower can pay more than the appraisal; but the loan will be based on the appraisal amount or the agreed upon sales price, whichever is less. The property must meet the FHA standards for type and construction. FHA also has standards about the quality of the neighborhood. These loans are available for one-to-four family residences and some condominium units. The borrower must occupy the property. FHA requires evidence from a recognized structural pest inspection company that an existing property has no pest infestation. FHA loans are also available to help residents or investors repair or rehabilitate single-family properties. There are no prepayment penalties on FHA loans on one-to-four-family residences. However, the borrower must give 30 days written notice to pay a loan in full before it is due. There is no due-on-sale clause. Original terms of the loan stay the same and cannot change because of a sale.
The PMI payments will terminate once the loan has been repaid to a certain level. Federal law requires that any loans originated after July 1999 must have the PMI terminated after the borrower:
Has accumulated 22% of equity in the property (loan-to-value ratio is 78%). Is current with all loan payments
Where does the second mortgage come from? It commonly comes from one of two sources.
Home seller - Some sellers would be happy to offer secondary financing, either as a way to secure the sale or because they want to get income from the loan. These sellers often offer lower interest rates as well. Seller carryback mortgages are usually short-term balloon notes that are due and payable three to five years after origination. Institutional lender - Surprisingly, a borrower can sometimes get a second mortgage from the same lender who is providing the first mortgage. Sometimes the loan is structured as a home equity loan; other times it may be a conventional second mortgage. It may or may not be a balloon note. If it is fully-amortized, it's usually structured as a 15-year mortgage. Even though this financing is referred to as 80-10-10, if the borrower absolutely cannot afford a 10-percent down payment but could afford 5 percent down, the loan could be structured as 80-15-5. Remember, though, that since the down payment is less, the lender's risk is higher, so the borrower would probably be required to pay higher loan fees and a higher interest rate for 80-15-5 financing than he or she would pay for 80-10-10 financing.
Check Your Understanding:
How is a Cal-Vet loan different from an FHA or VA loan, and how is the loan handled? Unlike the insured FHA loan or the guaranteed VA loan, the Cal-Vet loan is actually a land contract. When a veteran is approved for a Cal-Vet loan, the state purchases the property and resells it to the veteran using a contract of sale. The state retains the title to the property until the loan is paid off, after which California will issue a grant deed to transfer legal title to the veteran. What kinds of programs are offered by the California Housing Finance Agency? The California Housing Finance Agency program offers below-market interest rate first mortgage programs and a variety of down payment assistance programs to eligible first-time homebuyers. What is the relationship of a junior loan to a senior or first loan? A junior loan is "subordinate in right or lien priority" to an existing mortgage on the same property. What are two ways a junior lender can protect itself from default? (See other correct answers on screen 29.) By adding clauses to the financing instrument, such as: A provision that grants the junior lender the right to pay property taxes, insurance premiums and other charges if the borrower is not making these payments. A clause that allows the junior lender to pay funds for taxes and insurance into an escrow account and make any payments on the first loan to offset a possible default.
Private mortgage insurance premiums vary, but there are usually two types of payment plans.
In one plan, a single premium is charged to cover the lender's risk. In the second, more common plan, an initial premium is charged at closing and then an annual premium is charged and added to the monthly mortgage payment until the lender's risk is reduced.
Conventional loans have several advantages over government-backed loans.
Loan approval from a conventional lender can take 30 days or less( approval on a government-backed loan seldom, if ever, can be done in less than 30 days) fewer forms and processing can be more flexible than government-backed loans. There is usually no legal limit on loan amounts with conventional loans; however, government-backed loans have dollar limits that vary by agency. In the event of a loan refusal, borrowers have other lenders that they can make application to. There is only one of each government agency type, so if the loan is refused by a particular agency, there are no alternative lenders available. Conventional lenders are much more flexible. Many offer a variety of loans with attractive provisions.
In order to increase their investment, lenders often charge other fees when the borrower gets the loan. The borrower could pay all or some of these charges.
Loan origination fees - This fee is typically 1 percent of the loan amount, although it could be higher. It covers the lender's cost for generating the loan. Points - This is a one-time service charge to the borrower for making the loan. Points represent prepaid interest and the lender charges them to get additional income on the loan. Points are paid at closing and are usually equal to 1 percent of the loan amount. Two (2) points on a $75,000 loan would be $1,500 ($75,000 x .01 x 2 points). Discount Points - These charges are designed to offset any losses the lender might suffer when selling the loan to the secondary mortgage market. Discount points are a means of raising the effective interest rate of the loan. The rule of thumb is 1/8 percent for each discount point. So a charge of 4 points would increase a 7 ¼ percent mortgage to a 7 ¾ percent yield. 4 points x 1/8 percent = 4/8 = ½ percent 7 ¼ + ½ = 7 ¾
The FHA qualifies potential borrowers based on two ratios and the borrowers must qualify under both of these ratios.
Mortgage Payment Expense to Effective Income The lender will take the total mortgage payment (principal and interest, escrow deposits for taxes, hazard insurance, mortgage insurance premium, homeowners' dues, etc.) and divide that amount by the borrower's gross monthly income. The maximum ratio to qualify is 31%. The lender will add up the total mortgage payment (principal and interest, escrow deposits for taxes, hazard insurance, mortgage insurance premium, homeowners' dues, etc.) and all recurring monthly revolving and installment debt (car loans, personal loans, student loans, credit cards, etc.). Then, the lender will divide that amount by the borrower's gross monthly income. The maximum ratio to qualify is 43%. Note: The above indicators do not exclusively determine whether or not a candidate will qualify for an FHA loan. The FHA will consider other factors, including credit history and job stability.
Other property eligibility requirements include:
Newly constructed or existing (previously-owned) home Single family residence (detached) Five acre maximum An attached residence (a half-plex that is not part of a planned unit development (PUD) or condominium) A detached unit within a PUD A condominium or attached unit in a PUD For more information on the CalHFA program, visit their website at http://www.calhfa.ca.gov/.
Section 245(a)-Growing Equity Mortgage
Section 245(a) enables those who currently have a limited income but expect their monthly earnings to increase to purchase a home with the help of a Growing Equity Mortgage. With this program, payments start small and increase gradually over time. As the mortgage payments grow, the additional payment is applied toward the principal on the loan, thus reducing the mortgage term. Growing Equity Mortgages also allow homeowners who are interested in further reducing the term of their mortgage to apply scheduled increases in their monthly payments to the outstanding principal balance.
During the early amortization period, a large percentage of the monthly payment is used for paying the interest. As the loan is paid down, more of the monthly payment is applied to principal. Fixed-rate loans can also be structured in other ways.
Term loans - This requires interest-only payments for some period with a balloon payment at some specified future date. Growing equity mortgage (GEM) - This allows the borrower to pay additional principal each month to pay off the loan faster. Graduated payment mortgage (GPM) - With this type of loan, the payment starts out low and then gradually rises. This is also referred to as a negative amortization loan, because the initial low monthly payments are not enough to pay the mortgage interest that accrues each month. So the amount in unpaid interest is added onto the principal amount of the mortgage. The most common fixed-rate loans are 30-year mortgages, because the payment is stable and there is always the opportunity to pay the balance down or refinance for a better rate at a later date. Recently, 15-year mortgages have become popular as borrowers realize that the interest savings is significant over the 30-year loan.
Section 203(k)-Rehabilitation Home Loan
The FHA 203(k) loan provides funds for both the purchase and the rehabilitation of a house through one mortgage. The value of the property is determined by whichever is less: The value before rehab plus the cost of rehab 110 percent of the appraised value after rehab The maximum loan must stay within the mortgage limit for the particular geographic area. A portion of the loan goes to pay the seller at settlement. The remaining funds are retained in escrow and distributed as the rehabilitation work is completed, similar to "draws" on a construction loan. Most of the rules and restrictions for the FHA 203(b) loan also apply for a 203(k) loan. The property may be a single-family, detached townhouse or a condominium unit located in an FHA or VA-approved condominium. The following are some additional guidelines: The home must be at least one year old. The home must require a minimum of $5,000 in rehabilitation cost. During six months of rehab, the borrower pays only taxes and insurance. Potential additional fees include supplemental origination fee, fee for preparation of architectural documents and review of rehabilitation plan, and a higher appraisal fee. No upfront mortgage premium is required. These loan funds can be used for: Structural alterations Modernization of functioning systems Elimination of health and/or safety hazards Changes to improve appearance or eliminate obsolescence Replacement of roof, gutters, downspouts Addition or replacement of floors and/or floor treatments Major landscape work and site improvements Accessibility improvements or additions for a disabled person Energy conservation improvement HUD requires that basic energy efficiency and structural standards be met under this program. Luxury items or improvements that are a not a permanent addition to the property are not eligible. A handbook entitled "Rehab a Home with HUD's 203(k)" is available from HUD by mail.
The Federal Housing Administration (FHA) was established in 1934 during the great depression to stimulate the housing market in the United States.
The FHA provides low-down-payment loans to qualified buyers. The Department of Housing and Urban Development (HUD) oversees the FHA. The loans FHA provides are high loan-to-value ratio loans, so FHA insures the loans in order to make them available to higher risk individuals. Important Note: FHA does not build homes or loan money directly. They insure loans made by approved lending institutions, including qualified mortgage companies, savings and loan associations and commercial banks. FHA-insured loans protect lenders against any loss they would suffer from a borrower's default.
Conventional loans are the most common loan type available and most homes are financed through uninsured or insured conventional loans. However, the government stills play a role in providing loans for property purchases. As we said earlier, government-backed loans include those loans offered by:
The Federal Housing Administration (FHA) The Department of Veterans Affairs (DVA) - sometimes simply referred to as VA The California Department of Veterans Affairs (Cal-Vet) Other state, county or city-backed subsidized loan programs
Government-backed loans include those loans offered by:
The Federal Housing Administration (FHA) The Department of Veterans Affairs (DVA) - sometimes simply referred to as VA The California Department of Veterans Affairs (Cal-Vet) Other state, county or city-backed subsidized loan programs When a borrower is faced with a financing decision, he or she must determine which type of loan best meets his or her needs. The borrower must compare the advantages and disadvantages of the two types of loans.
As of 2006, the borrower must pay two insurance premiums:
The first is the "upfront" Mortgage Insurance Premium (MIP) which is a percentage of the loan amount. The borrower can pay this one-time premium at closing or the charge could be financed with the loan. This premium could be paid by some other party, such as the seller. The second premium, called Mutual Mortgage Insurance (MMI) is a monthly premium that is paid with the monthly principal, interest, taxes and insurance payment. This is often referred to as PITI + MMI. MMI premiums may be dropped when the remaining loan balance is 80 percent loan-to-value ratio or less.
Funding Fee Exemptions
The following persons are exempt from paying the funding fee: Veterans receiving VA compensation for service-connected disabilities. Veterans who would be entitled to receive compensation for service-connected disabilities if they did not receive retirement pay. Surviving spouses of veterans who died in service or from service-connected disabilities (whether or not such surviving spouses are veterans with their own entitlement and whether or not they are using their own entitlement on the loan). Please note that the VA has the final say on who is exempt.
Fixed-rate fully amortized loans have two distinct features:
The interest rate remains fixed for the life of the loan. The payments remain level for the life of the loan and are structured to repay the loan at the end of the loan term.
Advantages and Disadvantages
The main advantages of the Cal-Vet loan are its relatively low interest rate; the availability of inexpensive life, fire and hazard insurance; and low closing costs. The biggest disadvantages are few, if any, chances to refinance and potential shortage of funds to make the loans. For more details about Cal-Vet loans, visit their website at http://www.cdva.ca.gov/.
These are some other rules that apply to VA-guaranteed loans.
The maximum VA home loan term is 30 years and 32 days. However, the loan term cannot exceed the remaining economic life of the property. The DVA does not require a down payment. There is no maximum loan amount. However, as we mentioned earlier, DVA guarantees only a portion of the loan, so most lenders will limit the amount they are willing to lend on DVA loans. Interest rate and discount points are negotiable between the lender and the veteran borrower. The loan origination fee cannot exceed 1 percent of the loan amount. DVA requires only monthly principal and interest payments. Even though they do not require taxes and insurance to be included, DVA recommends that they be included. The loan may be prepaid without penalty. DVA requires a structural pest report from a recognized inspection company. If repairs are indicated, the work must be done and certified by both the veteran and an inspector. Funding Fee The funding fee is a percentage of the loan amount charged for the privilege of obtaining a VA loan. This fund is used for administrative costs and to offset losses incurred in cases of default by the borrower. It is very similar in function to FHA mortgage insurance premiums. The veteran can pay the fee up front or choose to finance it as part of the loan, as long as it does not increase the loan amount beyond the maximum allowed. If so, it must be paid separately by either the veteran or the seller.
Maximum Loan Amounts
The maximum loan amount allowed varies by geographic area based on a percentage of median house prices for the area with a ceiling calculated as a percentage of the current Conforming Loan limits. Federal legislation increases or decreases the percentage of the current Fannie Mae/ Freddie Mac loan limit used for the FHA maximum high cost area calculation. For example in 1998 the percentage used was 87% while in 2012 it was 125%. This results in much higher maximum loan limits for high-cost areas. In California, the maximum loan amount varies by county. Maximum loan amounts for each geographic area may be found on the Internet at: www.fha.com/lending_limits.cfm. Currently the purchaser must provide a minimum 3.5% of the sales price toward the down payment. The 3.5% may be from the purchaser's own funds, a family gift or a grant.
Conventional loans are typically uninsured.
The mortgage itself provides the only security for the loan. To protect its interests, the lender relies on the appraisal of the property and the borrower's ability to repay the loan, as indicated by the borrower's credit reports. Note: When writing conventional loans, many lenders follow the underwriting standards that are provided by Freddie Mac and Fannie Mae, so that they can sell their loans in the secondary mortgage market.
Seller Contribution:
The seller can pay all of the VA purchaser's closing costs, including all discount points. This can have a big impact on the amount of cash a veteran must pay out of pocket in order to complete the purchase.
Table
Type Vet Down Pay 1st Time Use Subsequent Use Loans from 1/1/04 - 9/30/11 Reg Military None 2.15% 3.30%* 5%-10% 1.50% 1.50% 10% or more 1.25% 1.25% Reserves/National Guard None 2.40% 3.30%* 5%-10% 1.75% 1.75% 10% or more
Assumptions:
VA loans were freely assumable prior to March 1988. Since then, a purchaser who desires to assume an existing VA loan must qualify with the original lender. The veteran should request a release of liability from the purchaser that will relieve the veteran from any further liability for the loan. The veteran would remain personally liable for any deficiency if he or she does not obtain the release. If another veteran wishes to assume the original loan and is willing to substitute his or her eligibility, the original veteran may have a restoration of eligibility. The entitlement is restored at the current amount, not at the amount when the original purchase was made.
Some lenders actively seek home equity loan business by offering a variety of incentives to encourage buyers to get a loan. These incentives include:
Waiver of the first month's interest charge Zero placement fee Zero origination fee Guaranteed renewals
A popular way to avoid having to pay private mortgage insurance is through the use of what's known as 80-10-10 financing.
What this means is that the institutional lender provides the traditional 80-percent first mortgage. Then the borrower gets a 10-percent second mortgage and makes a 10-percent cash down payment.
The California Housing Finance Agency (CalHFA) program offers:
below-market interest rate first mortgage programs and a variety of down payment assistance programs to eligible first-time homebuyers.
There are basically two categories of loans available to buyers in the marketplace:
conventional loans and government-backed loans.
The conventional loan is the most common type of loan and is generally viewed as the most secure. Most conventional loans require the borrower to make a
down payment of 20% or more, making the loan 80% or less of the property's sale price. As we mentioned in an earlier unit, the Federal Deposit Insurance Corporation, the Federal Reserve Board, the Office of the Comptroller of the Currency and the Office of Thrift Supervision regulate banks and savings associations. These agencies have issued lending standards that suggest what the upper limits on conventional loan-to-value ratios should be.
Most of these home equity loans have a term of
five years. When the loans come due, the borrowers typically choose to refinance their property, obtaining a new first deed of trust to pay off the junior loan.
Most conventional loans have traditionally been designed as
fixed-rate loans. With this common type of mortgage program, the monthly payments for interest and principal never change. Property taxes and homeowners insurance may increase, but generally the monthly payments will be very stable.
As we said on an earlier screen, most conventional loans require the borrower to make a down payment of 20% or more, making the loan 80% or less of the property's sale price. However, a borrower can get a conventional loan with a lower down payment by
insuring the loan through a private mortgage insurance program (PMI). A lower down payment means a higher loan-to-value ratio. Lenders need to minimize their risk, so they require additional security in the form of insurance. The lender purchases the insurance, which typically protects the upper portion of the loan, from a private mortgage insurance company. The lender passes the cost to the borrower by charging a fee at closing plus an additional monthly fee while the insurance is in force. Using this process, a borrower may be able to get a loan for up to 97% (or even 100%) of the appraised value of the property.
Most junior loans are used in
l ow-down-payment situations. Sometimes after a period of three to five years, a borrower will merge the junior note with the existing first note by increasing the first loan by an amount that will allow the junior loan to be paid off. Interest Rates As we have said, most junior loans carry high interest rates to offset the junior lender's risk. However, this is more a function of who the lender is. Most traditional lenders are in the business of maximizing profits by charging as much interest as the law allows and the borrower is willing to pay. On the other hand, private sellers who carry junior loans often charge rates that are at or below the market rates. This happens because most sellers carry junior loans so that they can actually complete the sale. Their goal is the sale of the property, not the yield on the loan.
Unlike the insured FHA loan or the guaranteed VA loan, the Cal-Vet loan is actually a
land contract. When a veteran is approved for a Cal-Vet loan, the state purchases the property and resells it to the veteran using a contract of sale. The state retains the title to the property until the loan is paid off, after which California will issue a grant deed to transfer legal title to the veteran.
Junior loans are also commonly used by
land developers to pay for improvements such as streets, sidewalks, sewers and other utilities. When the lender loan funds for these improvements, the lender accepts a lien on all the property being developed. This lien would be in a secondary position to that of the original loan for the land itself. As the developer completes construction of subdivided plots and sells them to qualified buyers, the improvement liens would be replaced by the conventional or guaranteed loans of the individual buyers.
Define the term loan-to-value ratio:
means the ratio of debt to the value of the property. When talking about mortgages, the value is the sale price or the appraised value, whichever is less. If the loan-to-value ratio is low, that means the borrower is paying a higher down payment on the property. Lenders like this, since the higher the down payment, the lower the risk for the lender.
By definition, a junior loan is a
mortgage (second mortgage or second trust deed) that is "subordinate in right or lien priority" to an existing mortgage on the same property. more risk so typically a higher interest rate. In most circumstances, a buyer secures a first mortgage from a lender for the major percentage of the property's purchase price. The buyer usually covers the remainder of the price with a cash down payment. When the buyer doesn't have the cash to cover the down payment, he may ask the seller to carry a portion of the sale price in the form of a junior loan. Alternatively, the buyer could approach a savings and loan association or a commercial bank for the second deed of trust. (See our earlier discussion on 80-10-10 mortgages.)
In an effort to make it possible for veterans returning from World War II to purchase a home, the Veterans Administration (VA), now the Department of Veterans Affairs (DVA),
offered the opportunity for veterans to purchase a home with no money down. (Note: We will be using the acronyms DVA and VA interchangeably in this course.) In order to make this loan acceptable to lenders, the DVA agreed to guarantee the top portion of the loan. Since lenders were now protected in the event of a default by the borrower, lenders agreed to loan four times the current DVA Entitlement. The basic entitlement of a DVA loan is $36,000; although some loans are eligible for up to $60,000 if they are over $144,000. The DVA-guaranteed amount is calculated as 25 percent of the current Freddie Mac conforming loan limit for a single family home. Each year, if the Freddie Mac conforming loan amount increases, the DVA guarantee to a lender also increases. As of January 2007, the Freddie Mac conforming loan was $417,000, so the maximum guarantee would be $104,250. $417,000 x .25 = $104,250 Most lenders require that a combination of the guarantee entitlement and any cash down payment must equal at least 25 percent of the reasonable value or sales price of the property, whichever is less. Note: In certain cases, a veteran may have a partial entitlement if the amount to be guaranteed has increased since the first time the veteran used his eligibility.
What will CDVA will purchase?
only approved single-family residences (including condominiums, units in planned unit developments, and mobile homes) in California which meet the needs of the veteran as a dwelling place for his or her family. The property must be structurally sound and provide safe and sanitary living conditions. The property must also comply with a specific set of standards. If the veteran selects a property that fails to meet one or more of the CDVA standards, the veteran may still be able to obtain a Cal-Vet loan by negotiating with the seller to correct the problem conditions as part of the sales agreement.
California provides another alternative in the form of a special assistance program for farm and home purchases. The California Department of Veterans Affairs (CDVA), Division of Farm and Home Loans, administers the
program and the loans are referred to as Cal-Vet loans. These loans are available to California residents who have met the veteran requirements. Eligibility requirements have been expanded to the point that almost any veteran who wants to purchase a home in California would be eligible.
Just like first trust deeds, junior loans require
the execution of a promissory note that spells out the terms and conditions of the loan. The property description for a junior loan will be the same as the description contained in the existing first note.
The subordinate position of the secondary loan puts the lien holder of the junior loan in a high-risk position. If a foreclosure on the first note results,
the first note holder may sell the property to recover as much as he can, leaving the junior lien holder "holding the bag" with effectively no compensation, since the allocation of any proceeds from the sale would be to the "senior" lien holder first, followed by any junior lien holders. Sometimes in a default situation, the first note holder will allow the junior lender to make up the delinquent payments. Then the junior lender will foreclose on the property.
Another and probably more common type of junior loan is
the home equity loan. As we mentioned earlier, the Tax reform Act of 1986 eliminated the interest deduction for consumer finance, but kept the interest deduction on home loans. So many homeowners choose to take out home equity loans and earmark the funds for a myriad of uses, from home improvements to automobile purchases to vacations to education to medical expenses.
In California, borrowers can utilize what's called the zero premium settlement plan:
which means that the borrower can choose to finance the entire PMI premium and not pay a lump sum initial premium at closing.
Fixed rate mortgages are available for 30 years, 20 years, 15 years and even 10 years. There are also "biweekly" mortgages,
which shorten the loan by calling for half the monthly payment every two weeks. (Since there are 52 weeks in a year, the borrower makes 26 payments, or 13 "months" worth, every year.)