VAN ED TX- REAL ESTATE FINANCE Unit 2

Construction loan

Provides the funds necessary for the construction of a real estate project. Referred to as "interim" or short-term financing. Full amount of the loan is not paid by the lender to the borrower at the time of execution, but rather in installments, as specified parts of the project are completed. When the construction is complete, the construction loan will be converted to permanent financing. If the construction loan does not have a conversion option, the borrower will refinance into a new first mortgage.

Real Estate Investment Trust (REIT)

REITs make loans, secured by real property, which provide financing for large commercial projects such as second-home developments, apartment complexes, shopping malls and office buildings. REITs are owned by stockholders and enjoy certain federal tax advantages.

Limited Partnerships

Limited partnerships are formed to make a substantial real estate investment that would be beyond the means of any of the individual investors. The limited partners pay for the expenses of the partnership and receive any profits. They are not responsible for any partnership losses beyond the amount of their individual investment, provided they take no part in management of the affairs of the partnership. A partnership is not taxed as an entity.

Purchase money mortgage

Loan in which the borrower does not receive cash, but the right to make payments. Proceeds of the loan go to purchase the property.

Hard money mortgage

Mortgage given in return for cash, such as a second mortgage or home equity loan (opposite of Purchase Money Mortgage). Also, 'cash out refinance' is a Hard Money Mortgage.

Graduated payment mortgage

Most graduated payment loans have a fixed interest rate for 30 years. The initial payment is lower to help a borrower qualify for a larger home. The payments typically increase by no more than 7.5% per year for up to five years. Because the minimum payment does not pay the entire monthly interest, the unpaid interest is added to the loan balance, resulting is a loan that is larger than the original balance. This is called negative amortization, which occurs whenever the minimum required payment does not cover monthly interest.

Federal National Mortgage Assn. (FNMA)

"Fannie Mae", was created in 1938 as a corporation completely owned by the federal government to provide a secondary market for residential mortgages and to stabilize mortgage markets. - They bought "packages" of loans (originally FHA, later VA, and now any kind) from local lenders who needed funds and sold the mortgages to investors with plentiful funds. - They also originally handled housing assistance programs and first-mortgage management. - An Act of Congress in 1968 transformed Fannie Mae into a " private corporation with a public purpose," a profit-making organization that is listed on the New York Stock Exchange. - As a private corporation it may also purchase conventional mortgages, currently a major portion of its business. - Fannie Mae buys mortgages regularly from all primary lending institutions. - They sell interest-bearing securities (backed by specific pools of mortgages it holds) to investors. - They also ell stock that is available to private investors. - Fannie Mae is the single largest holder of home mortgages. FNMA does not make loans directly to borrowers. They purchase whole loans from mortgage companies or mortgage bankers. Because of their size, the underwriting guidelines established by Fannie Mae are generally adopted as the industry standard. These guidelines are constantly changing, so make sure to check with your mortgage professional for current requirements. Some of the more common standards are as follows: - Loan Size: Fannie Mae sets the maximum loan size they will purchase. The current loan limit is $417,000 for single- family homes. Loans larger than this limit are referred to as 'Jumbo Loans". The limits are increased in high -cost areas, such as California and Hawaii, and for multi-unit properties. - Loan to Value (LTV) and Combined Loan to Value (CLTV) limits: Minimum down payment and loan to value limits are also set by FNMA. LTV and CLTV are based on either the sales price or appraised value, whichever is lower. Loans for more than 80% of the purchase price require mortgage insurance. - Additional costs for investment properties: Rates and/or fees for investment or non- owner occupied homes are higher. Minimum standards for condominium projects, These include, but are not limited to: - Owner-occupied ratio. - Number of units owned by the same person. All amenities completed and functioning. - No commercial space. - No Condotels (short-term rentals such as vacation rentals), or condominiums with required rental pools. - Home Owners Association Control: FNMA required the common areas and amenities to be in control of the homeowners association control for at least one year. - Minimum insurance requirements: FNMA requires acceptable hazard insurance, flood insurance when needed, and liability insurance for the common areas. - Minimum income requirements: The borrower's income must be sufficient to pay the housing expense, along with their other monthly obligations. - Credit Quality: FNMA will use both the credit score and the debt obligations to judge the creditworthiness of a borrower. Other factors used include previous bankruptcies, judgments, collections, and pending lawsuits. - Source of Funds: Most borrowers need to provide all or part of their down payment from their own funds. Gifts, sale of assets, and other loans are considered. - Market Value: FNMA uses an appraisal to establish the market value of the property. The appraisal will also note deficiencies in the property and whether it meets the minimum standards required by FNMA. - FNMA is the largest provider of conventional loans. When a lender refers to a 'Conventional' loan, they are talking about loans that will be, or are eligible to be, sold to FNMA. - FNMA's electronic underwriting program is called "Desktop Underwriting" or DU.

Federal Agricultural Mortgage Corporation (FAMC)

"Farmer Mac", as it is known, was created by Congress with the Agricultural Credit Act. Farmer Mac was created to establish a secondary market for the sale of agricultural real estate and rural housing loans. - Farmer Mac operates today in much the same way as Fannie Mae and Freddie Mac. It is Stockholder-owned and Federally chartered, and all - Farmer Mac was created by the Agricultural Credit Act of 1987, which added a new Title VIII to the Farm Credit Act of 1971 and Farmer Mac's statutory authority has been amended three times since: - In 1996 to streamline the operating structure to be more competitive (allowing Farmer Mac to buy loans directly from lenders and issue guaranteed securities representing 100% of the principal of the purchased loans, modifying capital requirements and other changes; - In 1991 to clarify Farmer Mac's authority to purchase its guaranteed securities, establish the Farm Credit Administration's Office of Secondary Market Oversight as Farmer Mac's financial regulator and set minimum regulatory capital requirements for Farmer Mac; and - In 1990 to create the Farmer Mac II program at the request of the USDA

Federal Home Loan Mortgage Corporation (FHLMC)

"Freddie Mac" was created by Congress in 1970, primarily to establish a reliable secondary market for the sale of conventional mortgages by and for Savings & Loans. - An agency of the Federal Home Loan Bank (FHLB) System, Freddie Mac's stock is held primarily by savings and loan associations, and most of the loans are purchased from Savings and Loans. Other financial institutions, including banks and mortgage companies, are eligible to sell mortgages to Freddie Mac. - Freddie Mac sells mortgage-participation certificates (PCs) and guaranteed-mortgage certificates (GMCs). - PCs and GMCs are securities that represent an undivided interest in specific pools of mortgages. - Freddie Mac guarantees payment of principal and interest to purchasers. - Freddie Mac adopts most of the underwriting requirements and loan limits established by Fannie Mae. There are some minor differences that may be beneficial for some buyers, so make sure to check with your mortgage professional for current Freddie Mac guidelines. - Freddie Mac will also purchase loans from Banks, Savings and Loans, and Mortgage Companies. - The electronic underwriting system used by Freddie Mac is "Loan Prospector" or LP.

Government National Mortgage Assn. (GNMA)

"Ginnie Mae" was created in 1968 when Fannie Mae was converted to a private corporation. It is an agency of the Department of Housing and Urban Development (HUD). - This agency purchases only government- backed or insured loans (VA and FHA) - In addition, it handle housing assistance programs and loan management functions formerly handled by Fannie Mae; it may be considered the government agency that guarantees Fannie Mae securities.

Pension Funds and Insurance Companies

- Pension funds and insurance companies have recently had such growth that they have been looking for new outlets for their investments. They manage huge sums of money, and traditionally have invested in ultra-conservative instruments, such as government bonds. However, the booming economy of the 1990's, and corresponding budget surpluses for the federal government, left a shortage of treasury securities for these companies to buy. They had to find other secure investments, such as mortgages, to invest their assets. The higher yields available with Mortgage Backed Securities were also a plus. The typical mortgage- backed security will carry an interest rate of 1.00% or more above the government security. - Pension funds and insurance companies will also provide direct funding for larger commercial and development loans, but will rarely loan for individual home mortgages. Pension funds are regulated by the Employee Retirement Income Security Act (1974).

Real Estate Mortgage Investment Conduit (REMIC)

A Real Estate Mortgage Investment Conduit (REMIC) is an entity that holds pools of mortgages and mortgage backed securities. A REMIC is a multiclass, mortgage backed security where cash flows are allocated to individual investors and bond holders. The underlying mortgages and securities are separated into different classes according to maturity, type, interest rate, etc. These "classifications" will have various rates of return based on maturity and risk. - They are treated like a partnership for Federal Income Tax purposes where the income is passed directly to the investor(s). - REMICs are sometimes referred to as CMOs, or Collateralized Mortgage Obligations. The Tax Reform Act of 1986 introduced REMICs to the market, which enabled great flexibility in structuring bond classes with varying maturities and risk profiles within a single transaction. Freddie Mac began issuing REMICs in March 1988 and issued the first REMIC backed by Gold PCs in October 1990. Gold PCs are the cornerstone product of Freddie Mac's mortgage-backed securities program. Fixedincome investors in the United States and abroad place a high value on the quality and liquidity of Gold PCs. Freddie Mac's innovative structured products such as REMICs continue to increase demand for Gold PCs and enable investors to better manage their portfolios.

Bi-weekly Loan

A bi-weekly loan has payments due every two weeks. This loan requires a payment of one-half of the normal payment every other week. There are two advantages to this loan. First, the payments can be set to coincide with a normal paycheck cycle. The second advantage is the typical 30-year loan will pay off in approximately 20 years, saving thousands in interest. However, the only reason this saves interest is because a year is 52 weeks, not 48 weeks. Making one-half of a monthly payment every other week results in making 26 payments, equivalent to 13 monthly payments. You can accomplish the same thing by making 13 payments each year instead of 12. This accelerated pre-payment will pay off a normal 30- year loan in about 20 years. The disadvantage of this loan is that it requires automatic payments, and there is usually a fee charged up-front to set this up.

Buy-Down Loan

A buy-down loan is a tool to provide lower payments for the first two or three years. If the current interest rate is 8.00%, the lender can provide a 2-1 buy down where the first year payments are based on 6.00%, and the second year payments are based on 7.00%. The cost of the buy-down is the actual difference in payments. For example, a $200,000 loan at 8% has a monthly payment of $1457.67, while the payment for 6.00% is $1199.15, and the payment for 7.00% is $1330.68. The first year payment will be reduced by $268.47, and the second year payment will be reduced by $136.89. The cost for this buy- down is $3358.53 ($268.47 x 12 plus $136.89 x 12). Buy-down loans may help borrowers qualify in some circumstances, but they are mostly a sales tool provided by new- home builders. Because the buy- down cost is the actual difference in payments, the loan doesn't save the borrower any money.

Hybrid ARM

A hybrid ARM is a combination of a fixed rate and an adjustable rate mortgage. Typically the hybrid ARM will have a fixed payment and interest rate for a specific time period-- usually three, five, seven, or ten years-- and then convert to an adjustable rate after that. For example, a 5/1 ARM has an initial fixed rate and payment for five years, but beginning in year six the rate and payment will adjust yearly. - Most hybrid ARMs are not assumable during the initial fixed rate term, but may be assumable when the loan becomes adjustable.

Rental pool

A leasing arrangement in which owners, as a condition of purchase, agree to have their units available for rental as determined by the management. Owners then share in profits and losses of all the rental apartments in the pool according to proportionate interests. (This prevents - Seasonal variations and - Management favoritism or bribery

Real Estate Mortgate Trust (REMT)

A real estate mortgage trust is a type of real estate investment trust (REIT) that buys and sells the mortgages on real property rather than the real property itself. These trusts loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage backed securities. Their revenues are generated by both interest and fees on the mortgages. - REMT's make investments in mortgage-backed securities, mortgage loans, and other real estate-related loans and securities. These can be for residential mortgage-backed securities and residential mortgages, or commercial real estate loans.

Bridge loan

A short-term loan that uses the equity in an existing property that is to be sold. A bridge loan allows a buyer to close on a newly purchased property without selling their existing home. The bridge loan will be paid off with the buyer's proceeds from the sale of a previous property. Most financing involving bridge loans require the borrower to qualify for all three payments: the new house payment, the existing house payment, and the bridge loan payment.

Home equity mortgage

A subsequent and junior lien to the original mortgage for repairs, improvement, or other worthy reason. Secured by the equity (unencumbered value) in the property. It is one of the few remaining IRS income tax deductions, but there are some conditions. First, only the interest paid on loans up to $100,000 is deductible. Second, the interest on any amount exceeding the initial purchase price is not deductible (unless it is for education, medical, or home improvement).

Straight (term) loan

A term loan is a loan that carries no payment, but the entire balance (principal plus accrued interest) is due at the end of the term. Term loans usually are for one year or less.

Adjustable Rate Mortgage (ARM)

Adjustable rate mortgages were devised in the 1980's to help Savings and Loans cope with the rapidly changing interest rate environment. The business model for Savings & Loans in the 1960's and 1970's, using short- term deposits to fund long- term loans, no longer worked, and led to the failure of many institutions. Adjustable loans were created to prevent this situation from repeating itself. As the interest rates on deposits increased, the interest rates on the mortgages they provided increased. The upside of this change is that it allowed homeowners to save thousands of dollars on their mortgage, if they were only planning on owning the home for a short time. Why pay rates associated with a 30- year loan when you plan to sell in three years? Also, the average loan is paid off in seven to ten years because of the sale or refinancing of the property. If a borrower is willing to share the risk of interest rates going up, the lender is willing to give a lower rate than the rate offered for 30-year amortized loans. The loan type that shares the risk is called the ARM (adjustable rate mortgage) loan. It is made up of the following parts: - Initial Rate: Most adjustable loans have a fixed interest rate and payment for a specific time period. This can be as short as one month, or as long as 10 years. The initial rate can be different than the fully indexed accrual rate, and thus is more of a "come-on" rate. When shopping ARM loans, always ask your lender what the payment would be based on the Fully Indexed Accrual Rate. This is a better gauge of the true cost of the mortgage. - Fully Indexed Accrual Rate (FIAR): The actual rate obtained by adding the required margin to the rate of current index used for the specific loan. - Margin: A fixed number that is added to the index. This is the spread between the index and the note rate. - Index: The base market indicator that is used to determine the interest rate. The most common indices are: - London Interbank Offered Rate (LIBOR) - 1-Year Treasury Bill - Cost of Funds Index (COFI) - Monthly Treasury Average (MTA) - Constant Maturity Treasury (CMT) - Caps: The maximum allowable change in the interest rate at the intervals when the rate can be adjusted. The caps protect the borrower from extreme rate changes. The mortgage originator can use the caps to inform the borrower of the worst-case scenario associated with any ARM program. - Life of loan cap: The maximum interest rate allowed for the entire term of the loan. - First adjustment cap: The maximum the interest rate can change (either up or down) after the initial period. Note: Hybrid ARMS with initial fixed rates of three years or longer often have a first adjustment cap larger than the periodic cap. - Periodic adjustment cap: The maximum interest rate change allowed for any adjustment, other than the first adjustment. Most loans have either annual, bi-annual, or monthly adjustments. - Payment cap: A limit on how much a payment can change, typically 7.5% per year. A payment cap is used in place of an interest rate cap. Loans with only payment caps (without an interest rate cap) can lead to negative amortization. - Adjustable rate mortgages are re-amortized at each adjustment. The current balance, interest rate, and remaining term are used to determine the new payment. A large principal reduction will result in a lower payment at the next adjustment. - Adjustable loans are usually assumable by a qualified buyer. The buyer must meet minimum credit and income guideline.

Participation mortgage

Allows the lender to "participate" in the income (commercial) or appreciation (residential or commercial) of a property in exchange for a lower interest rate.

Installment Land Contract

Also called a land contract, conditional sales contract, or contract for deed, this method places the title to the property in escrow to be delivered to the buyer at some future time only when the buyer fulfills all or an agreed- upon part of the contract. - The buyer will receive legal title only when the escrow agent delivers the deed after an agreed- upon portion of the purchase price has been paid. - The buyer possesses the property while paying for it and has a real property interest called equitable title. - The seller has naked legal title and a personal property interest in the contract. If the buyer defaults, the escrow agent returns the deed to the seller. - If the defaulting buyer refuses to give up the property, the seller must foreclose through the courts. - The installment land contract performs several functions: - Sales contract: when signed by the parties at the closing, the property is considered sold - Financing method: there is no promissory note - Security device: there is no mortgage or trust deed - Right to possess with a future right to title (as distinct from a lease that does not give future title right) - The installment land contract, while not very common, is still a viable financing option, particularly in a "tight-money" economy. - There is no Rule F form, so buyer or seller must retain an attorney to draft an ILC.

Open end Mortgage

Any loan permitting the mortgagor to borrow additional money under the original note/security instrument. This may extend the repayment period at the same monthly payment amount. Home Equity Lines of Credit (HELOCs) are open-ended mortgages; they allow prepayment of some or all of the principal, while retaining the option of re-borrowing up to the credit limit.

Bonds

Bonds play an important role in mortgage financing, and are the reason lenders can offer long term fixed rate loans. Mortgage loans are packaged into pools (usually over $1,000,000) and are sold as bonds. The underlying real estate serves as collateral, and the return to the investor is the interest paid by the mortgagor. - Fannie Mae and Freddie Mac, because of their unique government affiliation (they are Government Sponsored Enterprises) sell bonds through the US Treasury window. This gives Fannie Mae and Freddie Mac more favorable interest rates, which is why they purchase a majority of mortgages. - Banks and other financial institutions sell Mortgage Backed Securities (MBSs). These bonds help finance loans and/or properties that don't fit into the Fannie Mae or Freddie Mac guidelines. These include, but are not limited to, jumbo loans, non-warrantable condominiums, apartment homes, etc. - Many times states, cities, and counties will offer tax-exempt bonds to assist low and moderate income buyers. Because of the tax free status, these bonds have lower interest rates that can be passed on to borrowers with below market financing, down payment assistance, etc. These loans have maximum income limits which will vary based on the city or county of their residence and purchase.

Commercial Banks

Commercial Banks are the largest of all lenders with the greatest total cash resources involved in the financing of real estate, and are either federally (nationally) or state chartered. - Nationally-chartered banks are members of the Federal Reserve System (FRS) and the Federal Deposit Insurance Corporation (FDIC). - FRS members (approximately 1/3 of all commercial banks) control the majority of total bank assets and are regulated by the Federal Reserve Board. - FDIC provides insurance on depositors' accounts up to a maximum of $250,000 for each account. - The word "national" must appear in their name or the letters "N.A. (national association) after the title. - State chartered banks are regulated by various agencies; FDIC and FRS membership is optional. - Commercial banks carry on their books time deposits (savings accounts), demand deposits (checking accounts), certificates of deposits (CD), and money market accounts. - Most real estate activity is in short- term financing, particularly construction loans, bridge loans, and home equity loans. They also provide warehousing lines for Mortgage Bankers. - Commercial banks rarely finance fixed rate loans for residential purchases. They prefer a high degree of liquidity, so they prefer short- term loans and adjustable rate mortgages. However, they are a great source for second mortgages, including Home Equity Lines of Credit (HELOC's), construction loans, and bridge loans. - These banks may sometimes represent other institutional investors, assuming the function of mortgage company or mortgage banker, by brokering the investor's money to borrowers for a fee paid by the investor (loan correspondent). - In small communities and rural areas, commercial banks represent the main source of all money, including mortgage money for farm loans.

Syndications and Securities

Due to the legal complexity of these financing methods, a real estate broker dealing in syndications and securities should obtain the guidance of a specialized attorney. Generally, a security exists when a person invests money in a common enterprise with the expectation of profit based on the essential managerial efforts of a third party. Obviously this definition covers not only stocks or mutual funds, but also real estate investments in some cases, such as: - General and limited partnership interests - Joint venture interests - Timeshares and condominium interests - Real estate investment trusts (REITs) Federal Requirements - If advertising real estate for sale across state lines (interstate), dealers must register the real estate with the REC and with the Security and Exchange Commission (SEC). - Brokers or dealers of these securities must also be registered with the SEC and must be a member of the National Association of Securities Dealers (NASD). Condominiums as Securities - Regulatory commissions consider condominium unit sales to be the sale of a security when: - The developer is the exclusive sale or rental agent, AND - A rental pool is a requirement or condition of the sale. - Even if a rental pool is not required, a condominium may be considered a security if the benefit of depreciation as a tax deduction is used as an inducement to purchase. - Provisions for non-profit management services or non-profit common element use fees (e.g., golf course or swimming pool fees) do not trigger the registration requirement.

REIT (The Real Estate Investment Trust Act)

Enacted to provide more capital to satisfy the growing demand for long-term investment money by attracting individual small investors. - They were formed under the Act in 1960. The purpose was to allow smaller investors an opportunity to invest in commercial real estate. They are tax-free entities as long as they pass 90% or more of their earnings on to the shareholders. There are three types of trusts, an equity trust that invests in commercial real estate, a mortgage trust that invests in mortgages, and a hybrid trust that does both. The larger ones are listed on the New York Stock Exchange. - Individuals buy stock in the real estate investment trust (REIT), an unincorporated association. - The REIT must have at least 100 shareholders. - No 5- share holders may hold more than 50% of the stock. - REITs are exempt from income taxes provided: - At least 95% of the profit is distributed each year as dividends. (The dividends are taxable to the individual investor.) - The income is derived from real property investments. - There are two types of REITs: - Equity Trusts: - Invest in income properties (e.g., large apartment complexes). - Derive profit primarily from the operation of their income-producing properties. - Mortgage Trusts: - Invest in or make mortgage loans. - Derive profit primarily from mortgage interest

Package Mortgage

Finances both realty and personal property (e.g., appliances, drapes, air conditioner) in one loan. All described items of personal property are part of the lender's security. This is also called a Chattel Mortgage.

Mortgage Backed Security (MBS)

Many commercial banks, brokerage houses, and large mortgage companies issue their own securities, backed by mortgages, which are sold on the secondary market. These securities provide funds for mortgages that may not meet the underwriting guidelines imposed by Fannie Mae and Freddie Mac. As the lending industry became more competitive, lenders realized there were many financially viable and secure loans that did not fit the parameters set by Fannie Mae. Mortgage Companies wanted to increase their market share, and their subsequent profits, so they devised mortgage instruments to fill various niches. These include, but are not limited to: - Loan Size: The increase in home values across the country has made many homes too expensive for FNMA financing. These loans are called jumbo loans. Most jumbo loans meet the same credit and income guidelines that have been established by FNMA. - Alternative Income Guidelines: Many borrowers may not have verifiable income. Often, with good credit and down payment, lenders will provide loans without proving income. These may be stated income loans, where the borrowers state their employment and income, no- ratio loans where the job is listed without any reference to income, or no- doc loans, where there is no mention of employment or income. These are referred to as 'Alt A' loans, 'limited doc' loans, or 'no doc' loans. - Lower Credit Standards: Some lenders will provide high risk loans to customers who have poor, or no, credit. These loans carry a higher interest rate, usually based on degree of bad credit. The interest rate increases as the quality of the credit decreases. These loans are referred to as non-conforming loans, sub-prime loans, or B & C loans. - Unique Properties: Many properties are ineligible for FNMA financing because they are unique. These include vacation condominiums that don't meet FNMA guidelines (called non-warrantable condominiums), gentleman farms, mixed used properties, acreages, etc. - Mortgage backed securities are sold in the secondary market to various investors; these include pension funds, insurance companies, banks, foreign governments, and individual investors. The issuer will include warrants (guarantees) regarding the loan quality and credit standards of the particular security. These may include, but are not limited to, minimum credit scores, maximum loan size, property type, etc. All loans in an individual pool must meet the minimum standards warranted by the issuer. For this reason, many of these loan programs have unique underwriting standards that cannot be waived because of the warranties provided with the pool. - The interest rates offered on these securities will vary, based on the credit quality of the loans pledged as collateral for the security. Filling the pool with loans made to borrowers with low credit scores or questionable income sources will have a higher risk of default, thus a higher interest rate. This goes back to the risk vs. reward on investment decisions covered in Section I.

Mortgage Banker

Mortgage Bankers, like Mortgage Companies, also loan their own money. However, they usually sell the servicing rights along with the mortgage. The value of this servicing, called the Servicing Release Premium (SRP), becomes income for the Mortgage Banker. This is how a Mortgage Banker (or Broker) can earn money on a transaction, even if the borrower doesn't pay points or origination fees. Mortgage Bankers can sell loans individually or in pools. - Warehousing: Since Mortgage Bankers fund their own loans, they need a source of money to fund these loans. Most Mortgage Bankers will have a Warehouse Line, which is a line of credit from a bank to provide funds for the loan closing. - A Warehouse Bank is a commercial bank that extends a line of credit to a mortgage banker. The mortgage banker deposits (warehouses) loans in the commercial bank, and then borrows against this collateral to fund new loans. The loans serving as security are "warehoused" at the bank and later sold to secondary market investors. - Mortgage Bankers have the advantage to choose the best program and rates from a wide variety of investors. Also, since they loan their own money, they control the entire lending process, including taking the application, processing and underwriting the loan, and providing documents and funds for the closing. - The disadvantage of using a mortgage banker is all their loans, including servicing, are sold immediately after closing. A borrower will not know who the end investor will be until after closing.

Mortgage Broker

Mortgage Brokers have no money of their own to loan, but broker loans to many different banks or mortgage companies. Each loan is funded directly by the investor purchasing the loans. - Mortgage Brokers, like Mortgage Bankers, have the advantage to shop many companies to get the lowest rates. - The disadvantage of a mortgage broker is that they rely on the investor for underwriting, closing, and funding the loans. For pre-qualification, ABC Mortgage may write the pre-approval letter, but the actual loan will be from XYZ Financial. The mortgage broker, after taking the pre-qualification information, finds a lender who will accept the buyer. They will package this loan and send it to the investor for underwriting and approval. Since the approval and the funds for closing come from the investor, the real estate professional should make sure the interest rate guarantee (lock) and the loan approval letter come from the investor, not just the broker. The typical mortgage broker will not be in a position to fund the loan if the investor turns it down.

Mortgage Companies

Mortgage Companies loan their own money, and then usually sell the loan to recapture their original money, plus a small profit. Mortgage companies typically sell the loans to Fannie Mae or Freddie Mac, who put together Mortgage Backed Securities (MBS's) which are sold on "Wall Street" as investments grade securities. The mortgage company will continue to "service" the loan (collect payments, and disburse the taxes and insurance) and distribute the interest to the purchasers of the loan. Many of the larger mortgage companies may also issue their own mortgage- backed securities to allow mortgage types and terms not available through Fannie Mae or Freddie Mac. - Mortgage- Backed Securities are securities that backed the value of the mortgaged real estate pledged as security for the loan. These instruments are sold on WallStreet to individual investors. - The advantage of using a mortgage company is they will provide all the mortgage services from loan application to closing. They will also service the loan, which involves collecting the monthly payments and disbursing the taxes and insurance payments, as needed. A borrower will send their payments to the same company they originally applied with. - The disadvantage of using a Mortgage Company is they usually offer only their own programs, and do not have other investors to choose from to obtain the best programs or rates. Also, since loan servicing can be transferred or sold at any time, the customer has no guarantee that they will continue to deal with the original lender.

Savings and Loans

Savings and Loans are also direct lenders. They generally loan money from their depositors' accounts (savings and checking accounts, certificates of deposits, money market funds, etc) and service the loan. They prefer to offer adjustable loans because their deposits are subject to changes in the interest rates. - Most Savings & Loans are federally chartered by the Federal Home Loan Bank Board. - Accounts are insured up to $100,000 by the Federal Savings & Loan Insurance Corporation (FSLIC). - Prior to 1980, most of the real estate financing in this country was provided by Savings and Loans. They collected money from their customers through savings accounts, checking accounts, and certificates of deposits. They would then loan this money (usually with fixed rates loans) to finance real estate purchases. This worked well while the economy and interest rates were stable. The spike in interest rates of the 1970's led to higher interest rates being paid on the savings and checking accounts, while the revenue from their fixed- rate mortgages they provided remained constant. Losing a little money on most loans led to a collapse of many Savings and Loans in the 1980's. Since that time, Savings and Loans have reinvented themselves, using their deposits to provide adjustable rate mortgages (ARM's), Home Equity Lines of Credit, and short term loans such as construction loans and bridge loans. - To avoid interest rate risk, any fixed rate loans offered by Savings and Loans are sold in the secondary market.

Blanket mortgage

Secured by more than one property (e.g., all the lots of a subdivision). A blanket loan usually contains a partial-release clause (or non-disturbance), allowing release of a specific lot upon payment of a specified sum, without disturbing financing on the remaining properties.

Negative Amortization Loan

Sometimes lenders find it beneficial to allow the borrowers to pay less then they actually owe each month. When the minimum required payment doesn't pay the current interest charge, the amount that is not paid is added to the principal, thus creating negative amortization. The principal balance increases with each payment instead of decreasing. Negative amortization can show up in both Graduated Payment Loans and Adjustable Rate Mortgages with payment caps, but not interest rate caps. A payment cap does not prevent large fluctuations in interest rates; it only prevents large fluctuations in payments. The required payment may not pay all the interest due, so the unpaid interest is added to the principal balance. - Most negatively amortized loans have a cap of 125%. In other words, if the principal balance reaches 125% of the original loan, the loan is usually re-amortized and the payments are increased to cover the minimum interest due.

Piggyback Loan

When a borrower takes out two (first and second) mortgages on the same property. Typically, the first mortgage will be at 75% to 80% or the purchase price or appraised value to avoid mortgage insurance. The second mortgage will be used to pay all or part of the down payment. The combined loan amounts, in relation to the sales price, become the Combined Loan to Value (CLTV). Loan to Value (LTV) and Combined Loan to Value (CLTV) are based on purchase price or appraised value, whichever is lower.

Option ARM

The Option ARM is a type of a loan that combines the attributes of the Adjustable Rate Mortgage, the Graduated Payment Loan, and the Negative Amortizing Loan in one package. An Option ARM is a monthly adjustable loan where the initial payment is based on an artificially low interest rate. This initial interest rate may only be in effect for the first month or two, and then the note rate will adjust to market. However, the required minimum payment based on the initial rate will remain the same for the first year. Each month, the borrower will be given four 'payment options'. The first option is to make the minimum payment based on the low initial interest rate, the second option is to pay only the monthly interest due, the third option is to make the payment required to amortize and pay off the loan in thirty years, and the fourth payment option will amortize and pay off the loan in 15 years. Depending on market conditions, minimum payment required for the first option may not cover the monthly interest, resulting in negative amortization. If the first option is chosen, minimum payment will remain the same for the first year. Each succeeding year the monthly payment will not increase by more than 7.5%. However, if the interest rate increases are extreme, and the principal balance reaches 125% of the initial loan amount, the minimum payment will immediately increase to avoid any additional negative amortization. The only cap or protection with an option ARM is a lifetime cap, usually about 10%. Because there are no annual interest rate caps, a borrower may be faced with increasing payments, increasing loan balances (negative amortization) or both. These potential problems can be very confusing to a borrower, and they should be explained thoroughly by both the Realtor and the mortgage lender to help the borrower avoid future problems.

All-inclusive deed of trust

The all-inclusive deed of trust or wraparound mortgage is an alternative to the installment land contract, involving less risk with more advantage to both buyer and seller. - The term "wrap-around" describes the lien arrangement. - The seller carries back a second trust deed that wraps around the seller's existing trust deed. - The amount of the second trust deed is equal to the total of the senior lien(s) plus the seller's equity. - A wraparound mortgage cannot be done without lender approval if the senior lien(s) contain a due-on-sale clause. - Seller remains totally liable for the original note. - Like an installment land contract, the buyer takes title "subject to" the loan of record',meaning not personally liable for the original loan (although loss of the home is no small liability). - Use of wraparound is wise only if you know the seller can afford to continue to pay on the first lien if the buyer defaults. - If the seller defaults, the buyer should have the right to make payments directly to the holder of the original note. - For title purposes, the wraparound is treated as a second lien. The title insurance policy will have two exceptions: (a) one for the first loan and (b) a second for the wraparound. - Because of its complexity, a wraparound note and deed should be prepared by an attorney or a specialist in this type of financing.

1031 Real Estate Exchange

This is a way to sell an investment property and use the proceeds to procure another investment property without paying the capital gains tax on the property sold. 1031 refers to the IRS statute allowing this type of transaction. This is sometimes called a Starker Real Estate Exchange from the investor who successfully sued the IRS that led to this provision. This provision states that as long as an investor does not take possession of the proceeds from the sale, and invests all of the funds into a new investment property, there is no tax liability. The seller will hire an exchange company to take possession of the money and hold it until it is needed for the new purchase. - The exchange must be real property for real property. It cannot involve personal property. For instance, a person cannot exchange a rental property for a business. - The ownership must stay the same. Joe Smith cannot sell a property and use the proceeds to buy a property for Joe and Mary Smith. - After a property is sold, the seller has 45 days to identify a property, and 180 days to close the purchase. - The purchase price for the new property must be equal to or greater than the net proceeds from the sale. Any proceeds not used for the purchase will be subject to taxes. - 1031 exchanges are very complicated, and everyone needs to rely on a professional 1031 exchange company. Tiny pitfalls may make the entire exchange illegal, and could cost the buyer thousands in taxes.

Balloon Loan

This is considered a partially amortized loan. The payments are based on a full term, usually 30 years, but the entire balance is due sooner, usually at the end of five, seven, or ten years. This allows a borrower to have a lower interest rate, therefore a lower payment, because they do not need the security of a 30- year loan. This type of loan is favored by individuals who expect to own the home for a short time.

Fixed-Rate Loan

This is the most common real estate financing vehicle. This loan will have a fixed interest rate and fixed and equal payments for the entire term of the loan. The payments are usually collected monthly, but they can be collected bi-weekly, quarterly, or yearly. The payments include both principal and interest. By making equal payments over a period of time, the amount owed (principal) is eventually paid off. This is considered a budget loan because the borrower is never faced with one big payment due. - The loan will have a fixed term. The normal term is thirty years, but terms between ten and forty years are not uncommon. - With a fully amortized fixed- rate loan, the payment is fixed for the life of the loan. Additional principal pre-payments will shorten the remaining term of the loan, but not reduce the minimum payment. - Fixed Rate Mortgages are almost never assumable.

Credit Unions

While the majority of loans made by credit unions are consumer loans (cars, furniture, appliances) to their own members, larger credit unions do provide members with long- term mortgage money. The State Banking Commissioner regulates credit unions. - Credit Unions are a good source of funds for second mortgages, home equity loans and lines of credit, and bridge loans. - At times, they may operate as Mortgage Bankers by offering fixed- rate mortgage loans to be sold in the secondary market. - Credit Unions can make loans with as little as 5% down. Most mortgage insurance companies provide lower MI insurance rates because credit unions typically have a lower incidence of foreclosure. - Modern Credit Unions are non-profit member owned financial services institutions. For this reason they often offer better rates, terms, and fees.

Budget loan

With a budget loan, the payment includes payments into an escrow account for the taxes and insurance. This is called PITI, which refers to a payment that includes principal (P) reduction, interest (I), taxes (T), and insurance (I). Besides payment of Principal and Interest each period, PITI requires the borrower to pay into a lender's escrow account each month of 1/12th of the annual Taxes and I/12th of the homeowners' Insurance premium. The lender then makes these payments from the escrow fund when due. In the case of PITIM, M stands for Mortgage insurance premium when required by a lender or the FHA. Most lenders like to collect payments that include PITI. There are two reasons for this. First, the lenders hold money in escrow without having to pay interest on it. They can actually use this money to make other loans to earn additional interest. Second, they know that the required property taxes and insurance are paid on time. - If an owner did not pay his taxes, the county government could place a lien on the property, and eventually sell the property to collect the taxes owed. A property tax lien has first priority over all other liens. If an owner does not keep hazard insurance on his property current, the building could burn down and the value of the property lost. In order to protect their collateral, many lenders collect from the borrower the money needed to pay the annual taxes and insurance premiums as part of the monthly payment. The lender will then make those payments for the borrower each year when they are due. Many loans require the lender to escrow for taxes and insurance. All government loans (VA or FHA) require escrows. Most lenders also require escrows for conventional loans when the down payment (or equity) is less than 20%. Escrows are required if all or part of the down payment comes from secondary financing. The escrow requirements are based on Combined Loan to Value (CLTV)> - If a property is in a flood hazard area, and the lender requires escrows for taxes and insurance, the lender is also required to escrow for flood insurance. - If a loan requires mortgage insurance, the premium for this insurance also must be escrowed for.

Interest Only Loan (I/O)

With an interest-only loan, the required payment covers only the monthly interest due. This gives the borrower the option of having lower initial payments so they can qualify for a larger loan. The disadvantage is that there is no principal reduction, so the borrower is not building equity. The typical loan with an interest-only option will have an interest-only term of up to ten years, and then become a normally amortizing loan for the remaining twenty years. Fixed rate loans will have fixed interest payments, while the interest payments for adjustable loans may change based on adjustment terms. - Another advantage of the interest-only loan is that principal reductions will reduce the required minimum payment. A customer can use the interest only option if they intend to make a large principal payment, and would like payments to decrease accordingly. This is only true until the I/O period ends. Once the loan starts to amortize, the payments are fixed.