Chapter 11: Real Estate Financing Pt 1

Rights of Lenders: Deficiency Judgement

If the sale of the collateral property through foreclosure sale does not raise enough to cover the entire loan amount, accrued interest, and other costs, the lender may be able to obtain a deficiency judgment against the property owner. This is a court-ordered personal judgment against the debtor that creates a general, involuntary lien against all real and personal property. In North Carolina, a seller who finances the sale by taking a mortgage and note is prohibited from using a deficiency judgment to recover a deficit.

Private Mortgage Insurance: Cancellation

Once the increased risk of borrower default is gone (when the loan-to-value ratio is reduced to 80% or less because the borrower's payments have reduced the principal balance on the loan), private mortgage insurance has fulfilled its purpose. In the past, many lenders didn't cancel PMI even when the risk was reduced. The Homeowners Protection Act of 1998 (HPA) requires lenders to automatically cancel PMI when a home has been paid down to 78% of its original value, assuming the borrower is not delinquent. The law also says that lenders must drop PMI coverage at a borrower's request when the loan has been paid down to 80% or less of the home's value and mortgage payments are current. The Homeowners Protection Act has some exceptions, such as for multi-family units, non-owner-occupied homes, mortgages on second homes, and second mortgages. As is often the case, though, the law sets a minimum, but the market moves the bar higher. For example, Fannie Mae and Freddie Mac will consider the present value of the home, not just the original value as required by the law. This effectively cancels PMI more quickly, assuming the home appreciates. Most lenders also now follow these guidelines. Some PMI insurers consider the risks of insuring loans in markets with declining property values. While every company has its own standards, the result could be that a loan—and therefore the transaction—is put in jeopardy. For example, if an insurer refuses to offer mortgage insurance, the borrower would need a 20% down payment. Alternatively, an insurer may raise the PMI premiums in those markets, making the loan too expensive.

Due-on-Sale Clause

A due-on-sale clause, also called an alienation clause, gives the lender certain stated rights when there is a transfer of ownership. Alienation refers to the transfer of property by any means. This is designed to limit the debtor's right to transfer the property without permission of the lender. Upon sale, or even a transfer of significant interest in the property, lenders may have the right to accelerate the debt, change the interest rate, or charge an assumption fee.

Mortgage Defined

A mortgage is the conveyance of an interest in real property to a lender as security for the payment of a promissory note. A mortgage is a type of security instrument where the borrower (the mortgagor) pledges property to the lender (the mortgagee) as collateral for the debt, creating a voluntary lien on the property, but the mortgagor holds legal title to the property.

Other FHA-Insured Mortgage Loan Programs

Additional popular FHA-insured mortgage loan programs, include: FHA 243(c). A basic fixed-rate loan for a condominium. FHA 251. An adjustable-rate (ARM) loan. FHA 203K. A loan structured to allow the buyer to purchase the home and borrow enough money for the purchase price, plus renovation expenses.

Amortization and Debt Service

Amortization is the reduction of the balance of the loan by paying back some of the principal owed on a regular basis. Amortizing loans have payments applied to principal and interest. A fully amortizing loan is one for which the total payments over the life of a loan pay off the entire balance of principal and interest due at the end of the term. This is also known as self-liquidating. The amount of money required in a given period of time to pay for principal and interest is referred to as debt service. Traditional conventional loans are typically long-term, fully amortizing, fixed-rate real estate loans. Negative amortization occurs anytime the monthly payment is not sufficient to cover the accrued interest from the previous month. Negative amortization will be discussed in more detail later in the course.

Rights of Lenders: Right to Transfer

An alienation clause in a contract gives the lender certain stated rights when there is a transfer of ownership in the property. It may also be referred to as a due on sale clause. It is designed to limit the debtor's right to transfer property without the creditor's permission. Depending on the actual wording of the clause (that's why lawyers are important) alienation may be triggered by a transfer of title, transfer of a significant interest in the property, or even abandonment of the property.

Unit Summary

As part of a mortgage or deed of trust, a borrower is guaranteed certain rights. Borrowers have the right of possession, meaning they have the right to use the property, during the loan The defeasance clause in a mortgage or deed of trust gives the borrower the right to redeem title to a property once the loan debt has been paid. The statutory right of reinstatement is a way for borrowers to cure the default by bringing the loan current—including all accumulated costs and fees—within a specified time period after they receive a notice of foreclosure or after the notice was recorded. This right to redeem the property prior to the foreclosure sale is called the equitable right of redemption. If a borrower defaults on a loan, the lender has the right to begin foreclosure proceedings. Non-judicial foreclosure (in title theory states) does not go through the courts. It is authorized by a power of sale clause in the deed of trust or note. Judicial foreclosure (in lien theory states) requires a court proceeding. The lender accelerates the debt and gives notice of foreclosure, demanding the outstanding loan balance. The notice of foreclosure is recorded in the public record. The borrower may bring the loan current within a specific time after the notice of foreclosure (statutory right of reinstatement), otherwise, the lender will schedule the foreclosure sale. The public is notified about the sale (public auction) via advertising. The highest bidder receives a sheriff's deed, which does not include any warranties. Proceeds from a foreclosure sale are used to first pay sales expenses and then to pay off liens in the order in which they were filed, although real property taxes are always paid first. A deficiency judgment is a court-ordered judgment that creates a lien against their personal and real property to pay for the loan amount and other costs not covered by the foreclosure sale proceeds. With a short sale, the lender agrees to accept less than the loan balance when the property is sold. The listing agent coordinates a short sale package to be submitted to the lender's loss mitigation department.

Rights of Borrower: Right of Possession

As part of a mortgage or deed of trust, a borrower is guaranteed certain rights. For example, borrowers have the right of possession, meaning they have the right to use the property during the term of the loan. The defeasance clause in a mortgage or deed of trust gives the borrower the right to redeem title to a property once the loan debt has been paid.

Mortgages

As previously defined, a mortgage is the conveyance of an interest in real property to a lender as security for the payment of a promissory note. A mortgage is a type of security instrument where the borrower (the mortgagor) pledges property to the lender (the mortgagee) as collateral for the debt, creating a voluntary lien on the property, but the mortgagor holds legal title to the property. Once the loan is repaid, the promissory note is canceled. Generally speaking, mortgages are the primary security instrument used in lien theory states. When a borrower defaults on a mortgage, the lender may commence a judicial foreclosure action, which is a lawsuit filed by a lender or other creditor to foreclose on a mortgage or other lien. Such action may result in a court-ordered sheriff's sale of the property to repay the debt. (We will compare various types of foreclosure actions in another unit in this chapter.) The term "mortgage" is commonly used incorrectly to refer to the actual loan rather than the legal instrument that pledges the property for the loan. Brokers are expected to know the difference and the technical difference between a mortgage and a deed of trust, which is described next.

VA-Guaranteed Loans: Qualifying Standards

As with FHA-insured loans, VA qualifying standards are more liberal than you find with conventional loans. A loan that is guaranteed by the Department of Veterans Affairs does not apply a payment-to-income ratio as a qualifying component. Instead, it looks at residual income, which is the amount of income a borrower has left after subtracting taxes, housing, and recurring debt obligations. The VA has regional guidelines to estimate the average cost of utilities based on the size of the house. Those costs are included as part of the debt obligations. A veteran's residual income must meet the VA's minimum requirements, which are available from the Department of Veterans Affairs. When qualifying borrowers for a VA loan, lenders do consider a borrower's total debt-to-income ratio, which cannot exceed 41% of their gross monthly income.

Essential Elements of Mortgage Note

As with all binding contracts, for a mortgage note to be a legal and valid promise to pay a mortgage loan debt, it must include at a minimum: Names of borrowers Property address Interest rate Late charge amount Amount of loan Term (number of years)

VA-Guaranteed Loans: No Down Payment

Because VA mortgage loans can be for the full reasonable value of the property, generally, no down payment is required by the VA. However, under the following circumstances a down payment is required: If the purchase price exceeds the reasonable value of the property, a down payment in an amount of the difference between the purchase price and reasonable value must be made in cash from the borrower's own resources. VA requires a down payment on all graduated payment mortgages. A graduated payment mortgage is a loan in which monthly payments start at a lower amount and increase periodically over the life of the loan. If the veteran's entitlement is insufficient (described next).

Key Terms

Combined Loan-to-Value—The relationship between the unpaid principal balances of ALL mortgage loans and the appraised value (or sales price if it is lower) of the property. Conventional Loan—A loan made by an institutional lender or a private party with real estate as security for the loan. The government neither guarantees nor insures conventional loans. Junior Mortgage—Any mortgage with a lower lien position than another. Lien Position—The order in which liens are paid off out of the proceeds of a foreclosure sale. Loan-To-Value Ratio (LTV) —The amount of money borrowed, compared to the value (or price) of the property. Private Mortgage Insurance (PMI)—Insurance offered by private companies to insure a lender against a borrower's default on a loan. Secondary Financing—When a buyer borrows money from another source in addition to the primary lender to pay for part of the purchase price or closing costs.

Home Equity Loan and HELOC

Equity is the difference between the value of a home and the balance of any loans using the home as collateral. Loans that take advantage of the equity a homeowner has include the following: A home equity loan is typically a closed-end loan that offers a fixed amount of money that can be repaid with regular payments over a fixed term. A home equity line of credit (HELOC) is a type of open-end loan in which a borrower is granted a specific credit limit from which he can draw and pay back principal only as it is used. As the balance is paid down, the principal is available to be used again. Now let's review.

Equity

Equity is the difference between the value of a property and the balance of any loans on that property. As the amount of monthly PITI payments applied to principal decreases the balance owed, equity increases. For example: If a borrower obtains a mortgage loan for $300,000 with no down payment for a property that is valued at $300,000, the borrower's equity is $0. The value of the home and the loan balance are the same. If after several years of making payments, the borrower now owes only $200,000 on a property that is still worth $300,000, the borrower's equity is $100,000. Equity can also increase when the value of the property value increases over time due to market conditions or home improvement.

FHA-Insured Mortgage Loans: Qualifying Standards

FHA qualifying standards are more liberal than the Fannie Mae and Freddie Mac requirements for conforming loans. A borrower who would be considered marginal by Fannie Mae and Freddie Mac standards might qualify more easily for an FHA loan. FHA allows a maximum payment-to-income ratio of 31%, which provides for a higher monthly house payment. FHA's maximum payment includes PITI (principal, interest, taxes, and insurance) and must include monthly homeowner's association dues or assessments (if any) such as condominium fees. Additionally, FHA allows the borrowers to have a maximum total debt-to-income ratio of 43%, which includes all debt payments owed (with 10 or more payments left). A borrower seeking an FHA-insured loan must make a minimum required investment of at least 3.5% of the home's purchase price or appraised value, whichever is less (i.e., maximum LTV of 96.5%) from an acceptable source. The entire required minimum investment can be a non-repayable gift from a relative, an employer or labor union, a charitable organization, or a close friend with a clearly defined and documented interest in the borrower.

Conforming Conventional Loan Products

Fannie Mae and Freddie Mac have standardized products for the mortgage loans that they purchase. Among the loan types Fannie Mae or Freddie Mac purchases in the secondary market are: Standard fixed-rate mortgages with terms ranging from eight to 30 years and a maximum loan-to-value of 95%. 97% loan-to-value loans are available when certain restrictions are met. Adjustable-rate mortgages with terms ranging from eight to 30 years with a maximum loan-to-value of 90% for owner-occupied home loans. Fannie Mae Home Ready or Freddie Mac Home Possible loans that offer relaxed guidelines require homebuyer education and require the borrower to meet specific annual income limits. Fannie Mae High LTV Refinance Option and Freddie Mac Enhanced Relief Refinance offer loans for borrowers who have a consistent mortgage repayment history, but the property has negative equity (i.e., loan balance exceeds appraised value). Construction-to-Permanent mortgage loans combine a construction loan with permanent, long-term financing as a single transaction using a single note and security instrument. Most conventional loans are conforming; however, conventional loans may be conforming loans or nonconforming loans.

Unit Summary

Finance instruments are written documents establishing rights and duties of the parties involved in a transaction. Mortgage notes are written promises to pay money. They're negotiable instruments and freely transferable from one party to another. Security instruments give creditors the right to sell collateral to satisfy the debt if the debtor doesn't pay as agreed. A security instrument gives a debtor the right to hypothecate (pledge) property as collateral without giving up possession. Mortgages are instruments that create a lien against property as security for payment of a note. In case of default, judicial foreclosure is the remedy. Trust deeds are instruments held by a third party as security for payment of a note. Upon default, a non-judicial foreclosure can take place by a power of sale clause. Many clauses are common in real estate contracts. An acceleration clause lets the lender call the loan balance due if in default. A prepayment clause lets the lender charge a penalty for paying off a loan early. An alienation clause gives the lender some stated rights if property is transferred (also called due on sale clause). A defeasance clause is used to defeat or cancel a certain right upon the happening of a specific event. A partial release clause provides for a lien to be released from part of land if some part of the balance is paid.

Short Sale: Procedures

If a short sale is the best option, the seller must contact the lender and ask for someone with authority in the loss mitigation department. The seller should explain the situation and ask for the lender's short sale policy. A letter of authorization from the seller to the lender is required in order for the seller's agent or representative to contact the lender on the seller's behalf. To qualify for a short sale, the seller must prove to the lender that he is suffering a financial hardship. This is typically done with a hardship letter in which the seller documents the specific reasons for the hardship, along with supporting evidence. The goal is to convince the lender to approve the short sale. As a licensee, NEVER initiate discussions with a lender on behalf of a seller about modifying the financing agreement between them, as this may exceed the provision of brokerage services allowable under the license laws of some states.

Loan Fees

In addition to interest, there are loan fees associated with processing a real estate mortgage loan, including fees for obtaining a borrower's credit bureau report, securing a property appraisal report, and completing necessary property inspections. Other items like title insurance and recording fees are paid if and when a loan closes. Fees that occur only when a loan closes are likely to be paid out of closing funds, but other early expenses incurred must be paid even if the loan doesn't close and are referred to as "POC" or paid outside of closing costs. For loans that actually close, lenders may charge a loan origination fee to cover the administrative costs of making and processing the loan, including setting up the loan on the lender's books. The fee may be expressed as a percent of the loan amount. So, for example, on a $120,000 loan, the borrower would have to pay an additional $1,200 if the lender charged a 1% origination fee. Origination fees are charged for lender services, such as closing fees, underwriting fees, documentation fees, etc.

Finance Concepts and Calculation Basics

Introduction In this unit, you will review terms, concepts, and calculations that are foundational to understanding real estate financing. After completing this unit, you will be able to: Define components of a mortgage loan payment, including principal, interest, taxes, and insurance (PITI). Define key real estate financing terms, including amortization, debt service, equity, usury, and loan-to-value. Calculate the monthly principal and interest (P&I) payment amount. Calculate the annual interest charged to a loan and the interest rate applied to a loan. Calculate the amount paid to the interest portion and/or principal portion of a mortgage loan. Identify components that impact the fees and costs associated with a mortgage loan, including loan fees, discount points, and yield. Calculate the total cost of discount points to reduce the note rate. Calculate the loan-to-value ratio and the amount of money a person can borrower based on the loan-to-value requirement.

Rights of Borrowers and Lenders

Introduction Let's do a quick review of how the various clauses in a mortgage note, mortgage, or deed of trust provide certain rights to borrowers and lenders and learn more about the foreclosure and short sale processes. After completing this unit, you will be able to: Recall the rights of borrowers and lenders set forth in various clauses within a financing instrument. Identify differences between the judicial, non-judicial, and strict foreclosure processes. Identify short sale procedures including the rights of involved parties and the broker's role.

Government Loan Programs

Introduction Up to this point, we've been looking only at conventional loans, but there are several government loan programs that offer a real alternative to borrowers who either don't qualify for a conventional loan or who are looking for a better deal. Government financing refers to loans that are insured, guaranteed, or in some way sponsored by government dollars. This unit presents information about three major government mortgage protection programs, including the Federal Housing Administration (FHA) home loan insurance programs, Department of Veterans Affairs (VA) loan guarantee programs for eligible military veterans, and the USDA Rural Development Program that provides assistance for farm loans, as well as grants and loans in rural communities for a variety of facilities (e.g., clinics, schools, fire stations). After completing this unit, you will be able to: Explain characteristics and basic qualifying standards for FHA-insured loans. Describe the use of upfront mortgage insurance premiums with FHA-insured loans. Explain characteristics and basic qualifying standards for VA-guaranteed loans. Describe VA-guaranteed loan eligibility and entitlement. Identify the characteristics and eligibility requirements of USDA loan programs.

Mortgages and Deeds of Trust

Introduction When borrowers take out a loan to buy a home, they are required to sign a mortgage note and a mortgage or deed of trust. In this unit, you will learn about the purpose and essential elements of these three real estate financing instruments. After completing this unit, you will be able to: Define key terms associated with real estate financing instruments, including mortgage, mortgagor, mortgagee, mortgage (promissory) note, deed of trust, grantor, trustee, beneficiary, lien theory, title theory, default, foreclosure, statutory redemption period, and equity of redemption. Identify the purpose, types, and essential elements of a mortgage (promissory) note. Identify the distinct differences between a mortgage and deed of trust. Identify the essential elements of a mortgage and deed of trust.

Mortgage Note: Negotiable or Nonnegotiable?

Most promissory notes used in real estate are negotiable instruments, meaning that they are freely transferable from one party to another. When a note is freely transferable, the lender or other creditor can obtain immediate cash by selling the note. For example, a lender may sell real estate notes to the secondary market. The secondary market consists of private investors and government enterprises that buy and sell real estate mortgage notes. You will learn more about the secondary market later in the course. A nonnegotiable note is one that cannot be transferred or assigned to another party. Most real estate promissory notes are negotiable.

Short Sale: Broker's Role (2 of 2)

Once the seller has an offer from a qualified buyer, a short sale package can be submitted to the lender's loss mitigation department. In most cases, the listing agent coordinates this. The loss mitigator will review the short sale package and, if it is complete, determine the best plan of action to remedy the borrower's situation with the least amount of loss to the lender. Scroll down to see the items that are typically included in a short sale package: Cover letter summarizing the seller's hardship situation, amount owed on the home, the offer, and the amount the lender can expect to net from the sale Hardship letter with supporting documentation Employment pay documentation from the past two months Bank statements from the past two months Income tax returns from the past two years (including W-2s and/or 1099s) Financial statements and monthly budget Comparative market analysis (CMA) Preliminary settlement statement showing zero profit to the seller Report of any property damage or needed repairs, including photos and cost estimates Market conditions and history reports Listing agreement Purchase contract Written proof of the buyer's ability to purchase Short sale application

Monthly Principal and Interest Payment Calculation

Once you know the factor, you can multiply it by the loan amount (per $1,000) to find the monthly payment of principal and interest (P&I). Let's walk through an example. Josie is considering financing $155,000 on a 30-year loan at 7%. So, you would first find the factor from the table: 6.66 Then you need to divide the loan amount by $1,000 to get the loan amount per $1,000: 155 If you multiply these two numbers, you get the estimated monthly P&I payment for that loan: $1,032.30 Don't forget that this is principal and interest only. The monthly payment must include taxes and insurance which we will cover in more detail later in this unit.

Private Mortgage Insurance

Private mortgage insurance (PMI) is offered by private companies to insure a lender against default on a loan by a borrower. Prior to the advent of PMI, lenders would only lend 80% of the value of a property, assuming that the 20% down payment was the incentive needed for the borrower to keep their loan payments current. Lenders also felt comfortable that, in the event of default, a foreclosure sale would yield 80% of the original sale price (or appraised value) and recover the loan amount. PMI evolved to compensate the lender for the reduced borrower equity, thus making loans easier for borrowers and safer for lenders.

Alternative Solutions to Foreclosure

Please take a few moments to scroll through the following descriptions of alternative solutions to foreclosure: Deed in Lieu of Foreclosure - As an alternative to judicial or non-judicial foreclosure, a homeowner voluntarily conveys ownership of the property to the lender by signing over the deed, which could be a quitclaim deed, grant deed, or warranty deed, depending on the state or jurisdiction where the property is located. Once the deed is signed over to the lender, the property can then be sold to recoup all or part of the lender's losses. Loan Modification - The lender agrees to modify the loan terms by reducing the monthly payment amounts or interest rate, extending the term of the loan, or some other agreed-upon change. Repayment Plan - The lender and the homeowner reach an agreement in which an additional predetermined amount is added to the loan payment for several months until the delinquent amount is paid in full, bringing the account current. Borrowers can then focus on rebuilding their credit while remaining in the home. Forbearance Agreement - The lender agrees to temporarily reduce, postpone, or suspend the loan payment and not proceed with foreclosure as long as the borrower brings the loan current within the specified time. If the homeowner fails to meet the obligations under the forbearance agreement, he cannot contest any actions taken by creditors to collect. Refinancing the Home - The homeowner may be able to refinance the loan at a lower interest rate or extend the loan over a longer period of time. To refinance, there must be adequate equity in the home and the homeowner must have a good credit score. Renting the Home - If the homeowner is able to find alternate housing, he may want to consider renting the home until his financial situation improves or the real estate market recovers. There are, obviously, many responsibilities that go along with being a landlord, so it is not the right solution for everyone. Selling the Home. The homeowner can proceed with a home sale if the homeowner can cash in assets or borrow money to pay off the mortgage note and pay the real estate commission, and closing costs. If the homeowner cannot afford to pay off the loan and other costs, a typical home sale is not an option. Loan Assumption - A buyer assumes the current loan at the original loan interest rate. To assume the loan, the buyer must apply for a new loan and be approved by the lender. Most conventional lenders do not permit loan assumptions. FHA and VA lenders allow loan assumptions with proper approval and release. Bankruptcy - The borrower may want to consider filing for bankruptcy; however, it negatively affects one's credit score more than any other alternative. Chapter 7 and Chapter 13 are the two most common options that an individual facing foreclosure might consider.

Calculating Principal and Interest

Recall that interest is the cost of borrowing money, while principal is the balance of the loan. The T-Math strategy can be used to solve problems involving interest. The annual interest is the part, so it goes on the top. The principal is the whole, so it goes on the bottom with the interest rate. If you know any two factors in the equation, you can easily find the third. Let's walk through some calculations, using this T-Math equation to determine annual interest, interest rate, and annual amount applied to interest.

Purchase Subject to Seller's Existing Mortgage

Similar to an assumption is "subject to" financing. With subject to financing: A buyer purchases property subject to the seller's existing financing. The deed is transferred into the buyer's name. The loan remains in the seller's name, but the buyer makes payments. The buyer acknowledges the seller's existing financing but accepts no personal liability. The seller remains liable for the existing financing. This type of financing might be used if the seller needs to sell the house quickly and/or is having difficulty meeting an existing mortgage obligation. It also is an option when there are few potential buyers and a potential buyer does not meet lender or loan requirements. However, as with an assumption, an alienation clause in the note may not allow a seller from participating in subject to mortgage financing. Understand, unlike with assumable loans, a subject to financing transaction does not involve a lender. Licensees will want to work with a seller-client to ensure the buyer is creditworthy before the seller accepts an offer that includes taking the property subject to the seller's mortgage.

Lender's Perspective

So, while a mortgage loan is a means to an end for a homebuyer, you cannot forget that, from the lender's perspective, a loan is an investment. A lender loans money to a borrower and expects a return on the investment. The borrower will repay the amount borrowed (principal amount) plus interest(cost of money). The finance charges (loan origination fees and servicing fees, as well as any discount points paid at closing) and the interest rate (a charge for the money that the borrower pays) represent the lender's return on the investment.

Strict Foreclosure

Strict foreclosure, on the other hand, requires a court proceeding but is less involved than a judicial foreclosure. Under strict foreclosure, the court establishes a date by which the borrower must pay the balance in full. If the deadline passes, the lender is simply awarded title to the property. No sale is held. The borrower loses all equity in the property and usually has no course of redemption or reinstatement. The lender, however, loses the right to seek any deficiency judgment. This method is not commonly used.

Seller Financing

Sometimes the only way sellers can make a deal is to finance all or part of the purchase price for the buyer. Of course, in order to consider this, the seller must not need all the cash immediately from the sale. The seller is taking a risk, but this may enable the property to be sold or sold at a higher price. A seller can charge below market interest rates or offer financing to a buyer considered a credit risk by other lenders since a seller isn't bound by institutional policies on loan ratios, interest rates, or qualifying standards. When the seller finances all or part of the sale of property for the buyer, the seller retains a mortgage as security and title passes to the buyer. When the seller finances the purchase, the instruments that the buyer gives to the seller as consideration at settlement are collectively called a purchase money mortgage (PMM). This term is also sometimes used to describe seller financing in general. When a seller takes part of the purchase price as a mortgage loan to help the sale, it may also be known as a soft money loan, because the borrower receives credit toward the purchase instead of actual cash. The simplest form of seller financing is when the property being sold is unencumbered, meaning it is commonly considered to be free and clear of mortgages or other liens (has no real estate tax liens, for example). The buyer and seller negotiate the amount and terms of financing and have documents drawn up. Seller financing, which is also called purchase money financing, may take many possible forms (e.g., fixed or variable interest rates) with almost no limits. It's not uncommon, however, to negotiate a seller financing arrangement when there is an existing mortgage, as in this example: Assume that a property has a purchase price of $200,000. The seller has an existing mortgage at 4.5% with a balance of $100,000. The buyer has a $25,000 down payment but cannot qualify for a $175,000 loan at 6% from a mortgage lender. The seller wants to sell the house; the buyer wants to buy the house. They negotiate a seller-financed transaction as follows: The seller finances the buyer's purchase (lending the buyer $175,000 at 5.5% interest). The seller receives the buyer's $25,000 down payment. The buyer repays the seller $175,000 at 5.5%. The seller repays the existing mortgage at 4.5%. In this example, the seller is essentially earning 1% interest on $100,000 and 5.5% interest on $75,000 as the buyer repays the loan.

Conventional Loan Classification: LTV (2 of 2)

The 80% conventional loan has been the standard conventional loan for many years. With this type of loan, the buyer makes a 20% down payment and obtains a 30-year, fixed-rate conventional loan for the balance of the purchase price. So, let's say a buyer wants to buy a house that costs $80,000. For an 80% conventional loan, the buyer would need to make a 20% down payment or $16,000. You can borrow the 80%, or $64,000, of the sales price of the home, assuming that the property was actually appraised at $80,000 or higher. If the house were appraised for less than $80,000—say, $75,000—you could borrow only 80% of that appraised value, or $60,000 ($75,000 x .80 = $60,000). If you still wanted to buy the home, you would need to pay the extra money as part of the down payment. When the LTV ratio is above the lender's required 80%, the buyer can make a larger down payment, the seller can assist the buyer (seller financing), the buyer can get a gift from a family member, or the seller could lower the sales price. Alternatively, a borrower who does not have enough money for a 20% down payment but still wants a conventional loan can try to get a 90% conventional loan with a 10% down payment, a 95% conventional loan with a 5% down payment, or even a 100% conventional loan. Loans with an LTV higher than 80% are possible because of private mortgage insurance (PMI) and secondary financing, which are explained in more detail next in this unit. Let's review the calculation for determining how much a buyer can borrower based on an 80% LTV requirement.

FHA-Insured Mortgage Loan Programs: Title II Section 203(b)

The FHA has several loan programs. The most widely used program is the Title II Section 203(b) loan program. This is a basic fixed-rate loan that applies to residential single-family and two-, three-, or four-unit dwellings.

Federal Housing Administration

The Federal Housing Administration (FHA) insures loans for single-family and multi-family homes made by approved lenders. Mortgage insurance, you'll recall, provides lenders with protection against losses when borrowers default. A common misconception about FHA loans is that they are targeted to lower-income borrowers or first-time homebuyers only, but this is not the case. The FHA does not have income limits to determine who is eligible for its loans. Anyone who is a U.S. citizen, permanent resident, or non-permanent resident with a qualifying work visa, and who meets the lending guidelines, may qualify for an FHA-insured loan. However, the FHA sets a maximum mortgage amount that it will insure.

FHA Loan Program Operated by HUD

The Federal Housing Administration (FHA) is part of the Department of Housing and Urban Development (HUD). Oversight of FHA loan programs is through HUD's Office of Housing. HUD issues regulations and establishes guidelines for approving lenders authorized to make FHA loans. Its regulations have the force and effect of law. The FHA defines the loan programs and sets guidelines for the programs in accordance with HUD's regulations.

FHA-Insured Mortgage Loans: Characteristics

The following are additional key characteristics/requirements of FHA-insured loan programs: Owner Occupancy Required - Borrowers with FHA-insured loans are required to establish bona fide occupancy of the property as their principal residence within 60 days of signing a security instrument (e.g., mortgage, trust deed). Furthermore, they are required to live in the house for at least one year. Generally, a borrower may have only one FHA-insured loan at a time, although some exceptions may be made. Maximum Loan Amount Varies by Region - Although there are no income limits with FHA loans, HUD limits the maximum loan amount—sometimes called a loan ceiling or base—that may be insured in a given community. When determining limits, boundaries may be based on county, zip code, or metropolitan statistical area (MSA). The loan amounts are reviewed every three years. Interest Rate Set by Lender - Borrowers are offered mortgage loan interest rates based on the current market and the results of the credit inquiry. The FHA does not set the rate. Must Use FHA-Approved Appraisers. FHA requires an appraisal, but not a full inspection. However, the FHA appraisal does include a cursory inspection. Lenders can look up an FHA-approved appraiser by state at https://fhaloans.guide/appraisers. Prohibited Prepayment Penalties - HUD regulations prohibit prepayment penalties in FHA loans. Loan Assumption Restrictions - For FHA-insured loans endorsed on or after December 15, 1989, the lender will require a creditworthiness review of the new borrower as well as a fee. Assumptions without credit approval may be grounds for acceleration of the mortgage. Therefore, any offers involving mortgage assumptions must be investigated thoroughly with the lender, who must supply a specific release of liability, and perhaps even with legal counsel.

Loan-to-Value

The loan-to-value ratio (LTV) refers to the amount of money borrowed (the loan amount of a first mortgage loan) compared to the value of the property. Lenders use LTV to determine how much they are willing to loan on a given property based on its value. The lender will always use the lower of the appraised value or the sale price to protect its interest. The lower the LTV, the higher the borrower's down payment, which means the loan is more secure. For example, for years, the 80% conventional loan was the standard so, for a house with a sale price of $200,000, the most a borrower could borrow would be $200,000 x 0.8 = $160,000 loan amount. Subtracting the loan amount from the sale price indicates that the borrower would need a down payment of $40,000.

Usury, Discount Points, and Yield

The term "usury" refers to the charging of an interest rate that is higher than the law allows. Usury laws are federal and state laws enacted to protect individual borrowers from being charged excessive interest rates by lenders. Yield refers to the return or profit on an investment. Discount points are fees charged by a lender at the beginning of a loan to increase the lender's yield on a loan, particularly a loan with a below market interest rate. Discount points are a form of prepaid interest and are typically paid by the borrower, although they may be paid by the seller. One point equals 1% of the loan amount, and one point increases the lender's yield on the loan by approximately 1/8%.

Private Mortgage Insurance: How to Pay

The traditional way that private mortgage insurance companies charge for PMI is with a one-time fee at closing when the loan is made and a recurring fee, called a renewal premium, that's added to the borrower's monthly mortgage payment. Some PMI insurers offer a one-time mortgage insurance premium, with no renewal fee. Combining the initial premium and renewal premiums into one payment allows the borrower to finance the PMI premium. When the PMI premium is financed, monthly payments may still be lower than if the renewal premiums are added to the regular mortgage payment.

Theories of Finance: Lien Theory and Title Theory

There are two main theories of financing used in home lending—lien theory and title theory. Some states follow what is called lien theory, others follow what is called title theory, and some states follow a hybrid of the two, sometimes called intermediate theory. In lien theory states, a mortgage is the security instrument that creates a lien against the property that must be repaid by the debtor. The property serves as collateral, or security, for the debt. The borrower still holds legal title to the property and has possession of it. In most lien theory states, the lender would be required to go through a judicial foreclosureproceeding to obtain title in the event of borrower default. In title theory states, while the debt is outstanding, the lender (or the lender's trustee) holds legal title to the property through a deed of trust. The borrower has possession of the property, but until the debt is fully paid, the borrower has only equitable title. Once the loan amount has been repaid, legal title is conveyed to the owner (borrower). Upon default, the creditor may begin a non-judicial foreclosure procedure, which allows the property to be sold without court supervision. North Carolina is a title theory state.

Monthly Payment Components: Taxes and Insurance

Two other components that factor into a monthly mortgage loan payment are taxes and insurance. A person who obtains a mortgage loan will also need to pay property taxes and homeowner's insurance. Lenders generally require borrowers to establish an escrow account—sometimes called an impound account or reserve account—into which the borrower makes periodic payments to cover the property taxes and property insurance that is owed. The necessary amount, which is prorated over the next 12 months, is added to the monthly principal and interest (P&I) due for loan repayment. Upon payment each month, the insurance and taxes are deposited into the client's escrow account. When property taxes and insurance become due, the lender/servicer forwards the payment to the respective recipients on behalf of the property owner. This process protects the lender's interest in the property by ensuring these important payments are made.

When LTV is Too High

We just saw an example where LTV was calculated to be 81%, which did not meet the lender's requirement of 80% LTV. When this occurs, there are some options to try to move forward. The buyer can make a larger down payment. The seller can assist the buyer (seller financing). The buyer can get a gift from a family member. The seller could lower the sales price. Alternatively, a borrower who does not have enough money for a 20% down payment but still wants a conventional loan can try to get a 90% conventional loan with a 10% down payment, a 95% conventional loan with a 5% down payment, or even a 100% conventional loan. Loans with an LTV higher than 80% are possible because of private mortgage insurance(PMI) and secondary financing. The qualifying standards for higher LTV loans tend to be more stringent. Also, these loans may have a higher interest rate, call for higher loan origination fees, or impose additional conditions and standards. You will learn how private mortgage insurance and secondary financing make it possible to offer loans with an LTV higher than 80% later in this chapter.

Rights of Lenders: Right of Foreclosure

When a borrower fails to repay the debt according to the terms of the agreement, he is considered to be in default. The lender's remedy for borrower default, in most cases, is some type of foreclosure proceeding, which can differ depending on the laws of each state and whether the security instrument is a mortgage or a deed of trust. This is a general discussion on foreclosure actions. Every state has its own laws that govern the requirements, timeframes, and procedures related to foreclosure.

Sale of Mortgaged Property

When a buyer decides to purchase a home from a seller, a decision has to be made about how to pay for the home purchase in order to obtain clear title of the home. Sellers also have decisions about financing options that may give them an advantage in the marketing and sale of their property. This unit covers the advantages and disadvantages of cash sales, assumptions, subject to sales, and seller financing. After completing this unit, you will be able to: Outline the features of cash sales, assumptions, subject to sales, and seller financing when used to buy and sell real estate. Explain the legal and personal advantages or disadvantages of a cash sale, assumption, subject to sale, and seller financing for a buyer or seller of real estate.

The Mortgage Note

When borrowers take out a loan to buy a home, they are required to sign two documents—a mortgage note and a mortgage or deed of trust. First, let's find out more about the mortgage note. Simply stated, the mortgage note is a written promise to pay money. Before a lender will finance the purchase of a house, the borrower must promise to repay the funds by signing a mortgage (promissory) note. The person promising to pay the money is called the maker of the note, usually the borrower. The one to whom payment is promised is called the payee, usually the lender (though it could also be the seller). Promissory notes are basic evidence of debt, showing who owes how much to whom.

Private Mortgage Insurance: How it Works

When insuring a loan, the mortgage insurance company shares the lender's risk, but only part of the risk. The insurer does not insure the entire loan amount but rather the upper portion of the loan that exceeds the standard 80% LTV. The amount of coverage can vary but is typically 20% to 25% of the loan amount. In this example, $18,000 is the maximum amount a lender can claim as a loss and collect from the PMI insurer. In the event of default, the insurer and the lender will negotiate how best to proceed. For example, the insurer could pay off the loan or allow the lender to foreclose. If the proceedings from the foreclosure action do not fully reimburse the lender for the principal balance, the lender may be able to submit a claim to the private mortgage insurer. If the insurer were to take the loan, the insurer may be able to file for a deficiency judgment against the borrower.

Conventional Mortgage Loan Characteristics: 15-Year Term

A 15-year conventional loan, however, can be a good alternative. Lenders will often give a better interest rate because the shorter term means less risk for the lender. Over the life of the loan, the total interest paid on a 15-year, fixed-rate loan is about one-third less than a 30-year loan at the same interest rate. Of course, there are disadvantages to 15-year loans for borrowers: Payments are higher. Higher payments consume financial resources that might be invested in other ways and earn a higher return than the interest rate paid on the loan. The borrower's income tax deduction declines more quickly because less interest is paid each year as the principal is paid sooner.

Justifying Discount Points

A borrower who considers paying discount points to bring down the interest rate on a loan should plan on staying in the property long-term. The longer she stays in the property, the more likely she is to recover that upfront investment. Someone who expects to move or refinance in five years or so will not likely see the benefit of paying points. Let's look at Deb's situation in more detail. She's borrowing $150,000 on a 30-year loan. Assuming no other bank fees, at an interest rate of 4.75%, she will owe her bank about $782 every month for 360 months to cover the principal and interest due on the loan. If she brings the interest rate down to 4.5% by paying 2 points, her monthly payment to the bank will be about $760. So, every month, Deb would pay about $22 less. How many years does Deb have to pay on that loan to recover her $3,000 upfront payment? $3,000 / $22 = 136.36 months If Deb stays in that house and continues to pay off her 30-year mortgage loan, it will take her about 11 years and four months to account for those two points (136.36 / 12 = 11.36).

Cash Sale

A cash sale is simply where a buyer gives the seller cash at closing in exchange for clear title to the home. A sale involving a mortgage is a form of a cash sale in the sense that the buyer takes out a mortgage loan to pay a seller cash to close the purchase transaction. Cash sale also refers to a buyer using cash on hand to pay for the home's purchase. In cases where a buyer can pay cash on hand (without taking out a mortgage loan), the benefit to both buyer and seller is that the home buying process is faster. Additionally, from a legal standpoint, the parties involved do not need to abide by lender rules or loan requirements associated with a mortgage transaction. For example, there are no property appraisals or inspections required, the buyer does not have to pay interest, and insurance is optional. It is also obviously less costly in the long run for the buyer to pay cash on hand versus paying the fees and interest associated with a mortgage loan. On the flip slide, a buyer loses the legal protections that come with having a lender involved in the purchase transaction. With no property appraisals, inspections, titles search, required insurance, etc. a real estate licensee must work harder to ensure a buyer-client's interests are protected. Also, a buyer that uses cash on hand to pay for a home purchase may lose the "cash cushion" needed in case of emergencies or lose the opportunity to make investments with a higher return. Compared to other investments, taking out a mortgage loan is fairly inexpensive.

Sales with Assumption of Seller's Existing Mortgage

A loan assumption occurs when a buyer agrees to take over payments of a seller's debt on an existing mortgage with the terms of the note staying unchanged. An assumable loan transfers the loan to the buyer's name and legally, since the mortgage is attached to the property and the property is still security for the loan, the buyer becomes primarily liable for repayment. The seller remains secondarily liable unless he gets a release from the lender. Marketing a house along with assumable loan financing may make a home purchase more attractive to some home buyers especially if loan rates are rising. Additionally, assuming a loan is less expensive than obtaining a mortgage loan as settlement fees tend to be less, an appraisal is not necessary, and a mortgage recording tax does not need to be paid. Though a buyer has to prove to a lender he is eligible to assume the loan through standard documentation such as bank statements and credit reports, the borrower does not have to go through the full mortgage approval/underwriting process. In deciding whether or not to assume a mortgage loan, buyers will need to consider if the seller has accumulated substantial equity in the home. If the seller's loan balance is $350,000 and the property's sale price is $410,000, the buyer will need to pay the $60,000 difference with cash or some other type of subordinate financing. If there is an alienation clause in the note, a loan assumption is not possible unless the lender approves the transaction. Even without an alienation clause, lenders try to protect their interests by approving a new buyer. When considering an assumption, there are three possibilities: The lender will accept the assumption and leave the loan terms intact. The lender will accept the assumption but will charge an assumption fee and/or increase the loan's interest rate. The lender will not allow the assumption and exercise the alienation clause by demanding full payment of the loan if the transfer takes place.

Prepayment Penalty Clause

A prepayment clause gives lenders the right to charge borrowers a penalty for paying off the loan early or making substantial principal reductions, essentially depriving the lender of further interest income. Conventional lenders used to penalize early loan repayment to discourage it, but most lenders today would rather be assured of repayment and reinvest the money. Some lenders charge a flat one-time fee as a prepayment penalty. Other lenders might charge a percentage of the balance, which could change depending on how long the borrower has held the loan. For example, if Joe repays his mortgage loan after two years, the lender might charge 3% of the balance. If he repays the loan after five years, the lender might charge 2% of the balance.

Rights of Borrower: Right of Reinstatement and Redemption

Additionally, borrowers have the right to reinstatement and right to equity redemption. The statutory right of reinstatement is a way for borrowers to cure the default by bringing the loan current—including all accumulated costs and fees—within a specified time period after they receive a notice of foreclosure or after the notice was recorded. The lender generally cannot proceed with the foreclosure action until the reinstatement timeframe has passed. Borrowers also have the right to redeem (save) the property from foreclosure from the time a notice of foreclosure is filed until the foreclosure sale takes place and/or the court has ratified the sale. This is done by paying the amount that is in default, as well as applicable court costs and attorneys' fees. This right to redeem the property prior to the sale is called the equitable right of redemption. A foreclosure sale may not take place until the timeframe for equitable right of redemption has passed. Some states also allow what is called a statutory right of redemption through which debtors may redeem the property after the foreclosure sale. North Carolina allows a 10-day statutory redemption period. Once the redemption is made, the court will set aside the sale, pay the parties, and the debtor regains title to the property.

Acceleration Clause

An acceleration clause gives the lender the right to declare the entire loan balance due immediately because of borrower default or for violation of other contract provisions. This process is sometimes referred to as "calling the note." This clause ensures that the lender does not have to initiate a separate action for each missed payment. A debtor who misses one payment may discover that he doesn't owe just two payments next month but rather the entire loan balance. Most lenders will wait until payments are at least 90 days delinquent before enforcing an acceleration clause. Most promissory notes, mortgages, and trust deeds contain an acceleration clause.

FHA-Insured Mortgage Loans: Mortgage Insurance

As a federal mortgage insurance agency, FHA insures approved lenders against losses from defaults on FHA loans. FHA's insurance program is called the Mutual Mortgage Insurance Plan. Under the plan, lenders approved by FHA to make insured loans submit applications from prospective borrowers to the local FHA office or, if authorized by FHA, perform the underwriting functions themselves (review of appraisal, credit, etc.). As the insurer, FHA incurs full liability for losses from default or foreclosure. In turn, FHA regulates many conditions of the loan. FHA regulations have the force and effect of law and help shape real estate finance. A mortgage insurance premium (MIP)—not to be confused with private mortgage insurance (PMI) for conventional loans—is required for all FHA-insured loans, regardless of the down payment. There is an initial premium—called the upfront mortgage insurance premium (UFMIP)—that must be paid at closing, although it can be financed as part of the loan. If that is the case, the UFMIP does NOT count toward the loan-to-value. In addition, FHA-insured loans impose a monthly mortgage insurance premium on the balance. The monthly MIP is based on the LTV and the loan term. So, for example, a 30-year mortgage with a 95% LTV has a higher MIP than a 15-year mortgage with a 90% LTV. FHA does change the premium occasionally—up or down. But note that MIP does NOT go away automatically when the loan-to-value reaches a certain point. For some FHA-insured loans, borrowers are required to pay MIP for as long as the loan is active.

Bond in Lieu of Mortgage Promissory Note

As a final point to make about mortgage (promissory) notes, some states will use bond in lieu of a mortgage note. When a bond is used as a promise to pay, as compared to a mortgage note: The bond holder, like the note holder, is entitled to a repayment of a mortgage loan. A bond used as a promise to pay tends to have a longer term until maturity than a mortgage note. Bonds are apt to be more complex than notes and tend to only be issued by sizable borrowers.

Short Sale: Broker's Role (1 of 2)

As a licensee working with a potential short sale owner, you should first advise the owner to explore every possible alternative to a short sale. Suggest that the seller consults with an attorney, tax consultant, as well as a credit counselor, because a short sale can have wide-ranging consequences. When a short sale is the only viable option, there are a number of things a licensee can do to help a seller be successful, for example: Generate a comparative market analysis or broker's price opinion to help the seller determine a possible listing price. Generate a preliminary net to seller estimate so that the seller is aware of sales-related costs. When listing a short sale property on the multiple listing service (MLS), follow its guidelines. Typical listings for short sale properties contain phrases like "subject to bank approval" or "subject to lienholder approval" or "subject to third-party review" or simply "short sale." Next, Lin Ewing will discuss the importance of the net to seller estimate.

Conforming Versus Nonconforming

As already mentioned, most conventional loans are written to guidelines set by government-sponsored enterprises such as Freddie Mac and Fannie Mae so that they may be sold into the secondary market. When a loan meets the criteria necessary to be sold in the secondary market, it is considered a conforming loan. Conforming conventional financing has traditionally used the following qualifying guidelines: The borrowers' monthly loan payment does not exceed 28% of their stable monthly income, referred to as 28% total housing expense ratio. The borrowers' monthly loan payment plus other recurring monthly debt do not exceed 36% of their stable monthly income, referred to as 36% total debt-to-income ratio. Nonconforming loans, on the other hand, do not meet these standards and therefore cannot be sold to Fannie Mae or Freddie Mac. There are two main reasons why a loan would be classified as nonconforming: Size of the Loan - So-called jumbo loans exceed the maximum loan amount established by the Federal Housing Finance Agency for Fannie Mae and Freddie Mac conforming mortgage loan limits. Credit Quality of Borrower - The lender issues a loan to a borrower who does not meet the minimum standards established by Fannie Mae/Freddie Mac, classified as a B or C borrower. This might be someone who has had a credit problem in the past. Annually the Federal Housing Finance Agency (FHFA) adjusts the Fannie Mae and Freddie Mac conforming loan limits based on the average U.S. home price.

VA-Guaranteed Loans: Loan Amount Guarantee

As with any mortgage loan, the value of the collateral being used to secure the note is critical. An appraisal is required to help ensure that any property that will become the security for a VA-guaranteed loan has a value of at least as much as the loan amount and that it is in a condition acceptable to the VA. Every appraisal made for VA purposes must be reviewed by either the lender's VA-authorized staff appraisal reviewer or a VA staff appraiser, who then issues a Notice of Value (NOV) or a Certificate of Reasonable Value (CRV). Every CRV issued in conjunction with an appraisal review must include a list of any conditions and requirements that must be satisfied for the property to be eligible for VA loan guarantee. The VA doesn't limit the price a veteran can pay for a house (as long as the house will appraise for the loan amount), but the VA does limit the amount it will guarantee in case of default to 25% of the loan amount. A veteran's maximum guarantee amount, known as entitlement, represents the portion of the loan that the VA guarantees in the event of default by the borrowing veteran. Veterans who have full entitlement may be approved for a VA-backed loan with no down payment and no maximum home price. However, a lender may limit the loan amount offered to four times the veteran's available entitlement—if the veteran meets qualification requirements based on income, assets, credit score, etc. Full entitlement means that the veteran has never obtained a VA-backed loan or has repaid a previous VA loan and sold the house. If the veteran's remaining entitlement is insufficient, loan limits may apply. If the veteran is buying a home for greater than the CRV, the excess amount must be paid by the veteran in cash as a down payment.

Judicial Foreclosure (1 of 2)

As you know, a mortgage creates a lien against property as security for a debt. Generally speaking, when a borrower fails to repay a debt according to the terms of the mortgage, the lender accelerates the due date of the debt to the present and gives the debtor a notice of foreclosure or notice of default demanding that the debtor pay off the entire outstanding balance of the loan at once. The notice of foreclosure is recorded in the municipality or county where the property is located, giving constructive notice of pending court action (lis pendens). If the debtor fails to satisfy the debt within the timeframe stated in the notice of foreclosure, the lender files a lawsuit, called a foreclosure action, in a court of jurisdiction where the land is located. The court will determine whether the lender is rightfully owed the money and the debtor is in default. If the court finds in favor of the lender, the judge will issue a summary judgment of foreclosure, after which a foreclosure sale may be scheduled, assuming any statutory redemption period has passed. The public is then notified of the place and date of the sale via advertising that runs for a specified number of weeks in a newspaper circulated in the county. On the sale date, a public auction, sometimes called a sheriff's sale or a judgment sale, is held where anyone can bid on the property. The minimum bid is generally a set percentage of the appraised value, and it must be a cash transaction. The property is sold to the highest bidder, and a document called a certificate of purchase is filed to finalize the sale. The officer of the court makes out a sheriff's deed to the purchaser of the property once the sale is confirmed. This deed—which does not include any warranties—is executed, acknowledged, and recorded like any other deed.

Conventional Mortgage Loans: General Characteristics

Conventional financing refers to real estate that is paid for or financed with a conventional loan—one that is usually made by a bank or institutional lender and that is not insured or guaranteed by a government entity or agency, such as the Federal Housing Authority (FHA) or the Department of Veterans Affairs (VA). However, most conventional loans are written to guidelines set by government-sponsored enterprises such as Freddie Mac and Fannie Mae so that they may be sold into the secondary market. A loan written to guidelines set by a government-sponsored enterprise is called a conforming loan. The secondary market consists of private investors and government enterprises that buy and sell real estate mortgage notes.

Conventional Loan Classification: LTV (1 of 2)

Conventional loans are classified by the relationship between the amount of money being loaned and the value of the property. As you learned previously, this is known as the loan-to-value ratio or LTV. The LTV tells you how much money the borrower is putting down to purchase the property. Lenders use LTV to determine how much they are willing to loan on a given property based on its value. The property's value is defined by the lender as the appraised value or the sales price, whichever is less. The lender will always use the lower of those two numbers in order to protect its interest: The lower the LTV, the higher the borrower's down payment, which means the loan is more secure.

Conventional Mortgage Loan Characteristics: Traditional

Conventional loans are typically fully amortizing, fixed-rate, and long-term: A fully amortizing loan is one for which the total payments over the life of a loan pay off the entire balance of principal and interest due at the end of the term. Fixed-rate loans have interest rates, but not necessarily payments, that remain constant for the duration of the loan. Long-term loans today limit borrowers to terms of a maximum of 30 years. The Secure and Fair Enforcement for Mortgage Licensing (SAFE) Act defines a nontraditional loan as any loan other than a 30-year fixed-rate fully amortizing loan. Therefore, a traditional loan is a 30-year fixed-rate fully amortizing loan. This is the type of loan with which borrowers are most familiar.

Secondary Financing Conditions

For conventional loans, the primary lender will often insist on certain conditions with secondary financing from any source. Although individual lenders may impose additional or different specific conditions, the following are typical examples: LTV and CLTV - The first mortgage cannot exceed 80% LTV and the CLTV cannot exceed 95%. Loan Terms - The term of the second loan cannot exceed 30 years or be less than five years. Interest Rate - The interest rate on a second mortgage could be fixed or adjustable. Note, however, that a borrower cannot have an adjustable-rate on both the first mortgage and the second mortgage. No Prepayment Penalty - The second mortgage must be payable in full or in part at any time without penalizing the borrower for paying the debt early. Regularly Scheduled Payments - Although payments must be due on a regular basis, they do not have to be monthly. Secondary finance payments can be monthly, quarterly, semi-annually, or any other regular schedule. Payments can fully or partially amortize the debt, or pay interest only. No Negative Amortization - Negative amortization occurs when the payments are not sufficient to cover the accrued interest on the loan. Payments on the second mortgage must, at least, equal the interest on the loan. Loan balances cannot grow because of deferred interest. Ability to Qualify - The borrower must be able to afford payments on the first and second mortgages. This means that the primary lender on the first mortgage will count both mortgages when qualifying the borrower for the mortgage debt. Subordination Clause - Most primary lenders require secondary financing to have a subordination clause to ensure that the primary lender's lien will take priority, even if the second mortgage is recorded first.

Short Sale: Defined

If none of the options to stay in the home are viable, a short sale may be a preferable alternative to foreclosure. In the real estate realm, a short sale, or short payoff, is when the lender agrees to accept less than the loan balance when real property is sold. Actually, "short sale" is a bit of a misnomer as the process is much longer than a typical home purchase—sometimes taking months for final approval! Before we go on, let's dismiss a few myths about short sales. Any homeowner can qualify. This is simply untrue. All homeowners must receive lender approval. Proof of financial hardship as well as other requirements must be met. Any property can qualify. A property must have negative equity, which means it's worth less than the balance left on the loan. This fact can be substantiated by comparable sales. All lenders accept short sales. This is not always the case. Contacting the lender's loss mitigation department is one way to find out whether or not the lender will consider a short sale. Short sales are quick. Short sales take a considerable amount of time to close if they close at all. Many do not. Anyone contemplating a short sale must realize that patience is a virtue. The existence of a possible short sale is a material fact that must be disclose to potential buyers. A buyer agent should advise the buyer client about the process and use appropriate contract addenda when making an offer; however, a buyer agent is not expected to discover the possibility of a short sale.

Additional Terms Defined

In addition to knowing the definition of mortgage, mortgagor, and mortgagee, knowing the definition of these key terms will make it easier to understand the different types of real estate financing instruments that will be discussed in this unit. Promissory Note—A financing instrument that evidences a promise to pay a specific amount of money to a specific person within a specific time frame. When applied to real estate financing, also called a Mortgage Note. Deed of Trust—A security instrument placing into the hands of a disinterested third party a specific financial interest in the title to real property as security for the payment of a note. Also called Trust Deed. With a trust deed, the: Borrower is called the grantor or trustor. Lender is the beneficiary who retains both the note and the deed of trust. Trustee holds legal title to the security property described in the deed of trust, subject to the terms of the trust for the benefit of the lender. Default—Failure to fulfill an obligation, duty, or promise. Judicial Foreclosure— A lawsuit filed by a lender or other creditor to foreclose on a mortgage or other lien; a court-ordered sheriff's sale of the property to repay the debt. Non-Judicial Foreclosure—Foreclosure by a trustee under the power of sale clause in a deed of trust, without the involvement of a court. (Not used in some states.) Statutory Right of Redemption—Lets a mortgagor redeem property for a set period of time after a foreclosure sale, regardless of the timing of other events. Time frames for statutory right of redemption vary by state. This is not used in all states. Equitable Right of Redemption—The right of a debtor to redeem property from foreclosure proceedings prior to confirmation of sale.

Essential Elements of Trust Deed and Mortgage: Other Covenants

In addition to the typical clauses, there are also a number of covenants. Covenants, simply, are promises. Covenants can appear in deeds, deeds of trust, mortgages, or any other document. Typical covenants can compel or prevent certain actions by the property owner or uses for the property. Typical covenants in deeds of trust and mortgages include provisions protecting the lender's security interests in the property. These covenants include such things as the property owner: Promising to keep the property in good condition and repair. Not committing waste, which is damaging or diminishing the value of the property in any way. Promising to keep fire, hazard, and flood insurance in force on the property. Agreeing to pay taxes and other assessments on time. Failure to keep any of these promises or covenants can be cited in the deed of trust, mortgage, or note as causing the borrower to be in default. If a borrower is in default for violating a covenant and the security instrument contains a demand clause, the lender may demand that the default be cured or the note is due and payable immediately. There are, of course, many other clauses and covenants important to typical deeds of trust and mortgages. Borrowers should make sure they understand them and should be encouraged to consult legal counsel before entering into a deed of trust or mortgage. The trustor or mortgagor (borrower) is responsible for maintaining the pledged property to avoid the possibility of foreclosure due to deferred maintenance.

Security Instruments: Mortgage or Deed of Trust

In almost all real estate financing transactions, a mortgage (promissory) note is accompanied by a security instrument. A security instrument requires a debtor to hypothecate his property as a condition of a loan, which means that a debtor pledges personal or real property as security for a debt, typically without giving up possession of it. A security instrument serves as protection for the creditor, and motivation for the debtor, to make sure that the terms of the note are fulfilled and the note is repaid as agreed. When the debt is repaid, the note and the security instrument are canceled. The two main types of security instruments used in real estate transactions are trust deeds and mortgages. As explained, the promissory note is the equivalent to a promise to pay. The mortgage (or deed of trust) identifies what happens if the promise is broken.

Non-Judicial Foreclosure

In some states, most commonly title theory states where a lender or the trustee with a deed of trust retains legal title until the debt is repaid, the lender or trustee may begin a non-judicial foreclosure action (sometimes referred to as non-statutory foreclosure) when the debtor defaults. This non-judicial action is authorized by a power of sale clause in the trust deed or note. The lender or trustee has the authority to sell the property after proper notice to the defaulting borrower without the time and expense involved in court proceedings. If the selling price is insufficient, the lender may further sue for a deficiency judgment. While there is generally no right of redemption, the borrower may have the right to stop the sale and reinstate the loan by making back payments (plus interest, trustee's fees as applicable, and attorneys' fees).

Distinctions between Trust Deeds and Mortgages

In summary, there are two main differences between trust deeds and mortgages: With a trust deed, there are three parties that are included in the transaction: Grantor, beneficiary, and trustee. With a mortgage, there are two parties, the lender (the mortgagee) and the borrower (the mortgagor). With a trust deed, the trustee has the authority under the terms of the trust to commence a non-judicial foreclosure action when the lender has declared the loan to be in default. With a mortgage, the lender may commence a judicial foreclosure action.

Essential Elements of Trust Deed and Mortgage: Clauses

Just as with the clauses described that may be part of a mortgage (promissory) note, a deed of trust or mortgage is likely to include: An acceleration clause that gives the lender the right to declare the entire loan balance due immediately if the borrower defaults or violates other contract provisions. An alienation clause that gives the lender certain stated rights when there is a transfer of ownership in the property. It may also be referred to as a due on sale clause. A prepayment clause that gives the lender the right to charge the borrower a penalty for paying off the loan early, such as when refinancing a loan. Additional clauses in a deed of trust or mortgage include: A defeasance clause is a clause in a legal document that states that in the event a stated condition has been fulfilled, the document becomes null and void. This clause can appear in deeds of trust or mortgages. With a mortgage, for example, once the borrower has repaid the debt, the mortgage is canceled and the mortgagor can redeem title to the property. This clause is more likely to be found in title theory states where the title is transferred to the lender until the debt is repaid. A partial release, satisfaction, or reconveyance clause in a contract obligates the creditor to release part of the property from the lien and convey title to that part back to the debtor once certain provisions of the note or mortgage have been satisfied. Usually, this occurs after a certain percentage of the mortgage balance has been paid. This is an important clause that appears in some construction mortgages so the developer or builder can sell off completed homes with clear title before having to pay back the entire amount borrowed for the entire development project.

VA-Guaranteed Loans: Eligibility

Lenders may not process or close a VA loan without verifying the eligibility of the borrower with a Certificate of Eligibility (COE) issued by the VA. To be eligible for a VA-guaranteed loan, the borrower must have completed a minimum number of days of active duty—generally more than 180 days in peacetime or at least 90 days in wartime—and must not have been dishonorably discharged. Most commonly, this is evidenced by a Certificate of Release or Discharge from Active Duty, or DD-214, issued by the Department of Defense. The DD-214 identifies the character of service and reason for discharge (honorable, dishonorable, etc.). VA home loan eligibility also includes surviving military spouses who have not remarried and: Survived a spouse who died in service or from a service-related disability. Survived a spouse who was missing in action (MIA) or a prisoner of war (POW) for at least 90 days (limited to one-time use of benefit). Survived a spouse who was rated continuously totally disabled for the specified period of time, and was eligible for disability compensation at the time of death by any cause.

Mortgage Payment Components: Principal and Interest

Let's start by defining two common terms in the mortgage loan business—principal and interest. When a person obtains a mortgage loan, the monthly payment to pay back the loan is broken into two main portions: Principal which is the amount of money borrowed from the lender. Interest which is the amount of money it will cost for a person to borrow the money.

Judicial Foreclosure (2 of 2)

Proceeds from a foreclosure sale are used to first pay reasonable expenses associated with the sale and then to pay off the mortgage(s) and any other liens, generally in the order in which they were filed: Real estate taxes are always paid first. After taxes are paid, any costs associated with the foreclosure proceedings are paid, such as fees for the sheriff, appraisers, transfer tax, auctioneer, etc. Then the first lien (usually the senior mortgage) is paid in its entirety. If any money remains, the second lien (often a junior mortgage) is paid. Then, the third lien is paid, and so on, until all the money has been disbursed. Any overages (surplus) remaining after all debts, liens, expenses, and costs related to the property are paid may go to the debtor.

Secondary Financing

Secondary financing is when a buyer borrows money from another source to pay part of the purchase price or closing costs. A secondary financing strategy that a borrower can use to eliminate PMI is to obtain and use a second mortgage. For example, a home costs $300,000, the buyer obtains a first mortgage for $240,000 and makes a $30,000 down payment. The buyer also obtains a second mortgage for $30,000. This eliminates the need to pay PMI because the LTV ratio of the first mortgage is 80%. Understand, however, the buyer now has a second mortgage that will almost certainly carry a higher interest rate than the first mortgage.

Essential Elements of Trust Deed and Mortgage

Select the link to review the contents of a sample mortgage. A deed of trust or mortgage must be in writing, as required by the Statute of Frauds, and must include: The name of the borrowers The address and evidence of the property to be used to secure the debt A legal description of the property

USDA Rural Development Loan

The U.S. Department of Agriculture (USDA) Rural Development Loan program is operated through the Rural Housing Service of the U.S. Department of Agriculture. In 1994, the U.S. Department of Agriculture (USDA) was reorganized to create USDA Rural Development in order to administer farm financial programs for rural housing, community facilities, water and waste disposal, and rural businesses. Although one mission of Rural Development is to provide financial support to low-income homebuyers in rural communities, the definition of "rural" may be broader than one might think. It can include small towns up to 35,000 people, even those in areas that may be in close proximity to larger metropolitan areas. In addition, the USDA could determine that particular areas are temporarily eligible for their programs in response to certain conditions or natural disasters such as a flood or hurricane. The USDA Section 502 loan program either guarantees loans made by approved private lenders or makes direct loans if no local lender is available. Loan characteristics include longer than normal repayment periods, no down payment (100% financing), and subsidized interest rates. Section 502 loans can be used for a variety of situations: Purchase or construct an existing home Renovate, repair, or relocate an existing home Purchase and prepare a site for a home, including sewage and water facilities Applicants for Section 502 loans—guaranteed and direct—must meet certain income requirements based on the area median income (AMI). Assuming that the applicant meets the income eligibility and the house is in an approved area, the borrower may receive 100% financing, based on the appraised value or acquisition cost, whichever is less. Unlike FHA loans, these USDA loans do not require mortgage insurance of any kind. Borrowers must personally occupy the dwelling following the purchase. Dwellings must be structurally sound, functionally adequate, and in good condition. You may contact the North Carolina state office at https://www.rd.usda.gov/nc to obtain loan and area information.

Monthly Payment Components: PITI

The acronym PITI is an acronym that represents all four components of a mortgage loan payment. Principal (amount of money borrowed from the lender) Interest (amount of money it will cost for a person to borrow the money) Taxes (property taxes and perhaps mandatory special assessments, if applicable) Insurance (homeowners hazard insurance and mortgage insurance, if applicable) The following is a simple calculation that shows a borrower's monthly PITI payment: A borrower is getting a $100,000, fixed-rate, 30-year mortgage loan at 5% interest to purchase a house. The monthly payment of principal and interest is $600. Property taxes are $1,500 per year. $600 P&I+ $125 taxes ($1,500/12)+ $ 40 insurance ($480/12)$765 monthly PITI payment To be approved for a mortgage loan, PITI cannot be more than a certain maximum percentage of a potential borrower's monthly gross income. We'll learn how to qualify borrowers using PITI and income later in this chapter.

VA-Guaranteed Loans: Additional Characteristics

The following are key characteristics/requirements of VA-guaranteed loan programs: Occupancy - A veteran obtaining a VA-guaranteed loan must certify that he or she intends to personally occupy the property as a principal residence within a reasonable time, which generally means within 60 days after the loan closing. Interest Rate Set by Lender - Borrowers are offered mortgage loan interest rates based on the current market and the results of the credit inquiry. The VA does not set the rate. Variable Funding Fee Requirement - While there are no upfront or monthly mortgage insurance premiums required for VA-guaranteed loans, borrowers must pay a one-time variable funding fee at closing for guaranteeing the loan. The variable funding fee is waived for disabled veterans and surviving spouses of veterans who died in service or from service-connected disabilities. The funding fee may be financed or paid in cash. If financed, the funding fee percentage must be applied to the loan amount. The fee is based on the veteran's status, the number of times the veteran has used the program, and the amount of any down payment. Prohibited Prepayment Penalties - The VA does not allow clauses for prepayment penalties to be included in VA loans. Loan Assumption Restrictions - For VA loans committed and closed on or after March 1, 1988, VA loan assumptions are NOT allowed unless the veteran first has the assumption approved by the Department of Veterans Affairs or its authorized agent (i.e., the loan holder). VA Direct Loan Exceptions - The VA rarely loans money directly to borrowers. It may do so in isolated rural areas where financing isn't readily available, but usually a veteran must borrow money from a VA-approved lender.

Monthly Principal and Interest Payment

There are a variety of tools that can be used to determine a monthly principal and interest payment. At one time, every mortgage loan originator and quite a few real estate brokers would carry an amortization table that shows the monthly payment (principal and interest) that is due, based on the annual interest rate and the term of the loan for every $1,000 of the loan. Take a minute now to download a sample Amortization Table for Monthly Payment Per $1,000 of Loan and either print it or keep the window open for reference as we continue. On this sample table, interest rates (5%, 5.5%, 6%, etc.) are listed on the left column, and the terms of the loan (5 years, 10 years, 15 years, etc.) are listed along the top. Look down the left column to find the interest rate that the buyer will be paying, and then look across to locate the term of the loan desired. The intersecting point of these two variables will show the factor (dollar amount) the buyer will be paying for every $1,000 of the financed amount. Other versions of an amortization table may have more precise detail, for example showing the interest rates at one-eighth intervals (5 1/8, 5 1/4, 5 3/8, etc.) and/or the term on a year-by-year basis.

Mortgage Note Types

There are four basic types of promissory notes used in real estate transactions. The differences are based on the way that the repayment of the loan is structured: Straight Note - Requires payments of interest only during the term of the note with a balloon payment (lump sum) at the end of the loan term to pay off the principal amount (also referred to as a term note). Installment Note - Requires periodic payments of the principal amount only, with a balloon payment at the end of the loan term to pay off the balance due, as well as interest and fees. Fully Amortized Installment Note - Requires regular payment of principal and interest calculated to pay off the entire balance by the end of the loan term. This is the most common type of conventional home loan payment structure in use today. Adjustable-Rate Note - Permits the lender to periodically adjust the interest rate so the rate accurately reflects fluctuations in the cost of money; rate adjustments are tied to upward and downward movement of a selected index.

Rejecting the Short Sale

There are several viable reasons why the lender may reject a short sale: Seller does not qualify. A seller would likely be ineligible if the hardship is due to careless money management or if the settlement statement shows a profit for the seller. Buyer does not qualify. A buyer who cannot provide a loan pre-approval letter may end up not being qualified when the loss mitigator checks the loan approval status. Offer price is too low. If the offer price is lower than the appraised value of the property, the lender may reject the offer in hopes of obtaining a higher offer or selling price through foreclosure. The loss mitigator is not likely to reveal the price that's acceptable so as to get the highest possible offer. Lender sold the loan. If the lender is simply servicing the loan and does not own the loan, it does not have the authority to approve the sale. One of the most frustrating aspects of a short sale is the time it takes to close; months of waiting is not unusual. Every stakeholder—the lender, loan servicer, lienholders, mortgage insurers, securities investors, and possibly others—must decide whether or not to approve the short sale. Often, offers will expire before the lender responds to the short sale agreement, requiring the seller to find another willing buyer. The short sale processing time can be extended further when there is a second lien holder or PMI (private mortgage insurance) insurer involved, as they must also approve the sale. As a result of such time delays, many buyers simply walk away. Another common, yet disheartening occurrence is that after months of waiting, the lender rejects the offer.

Calculating Principal and Interest: Fully Amortizing, Fixed Rate Example

These examples assume a fully amortized, fixed-rate loan, which means that the payment stays the same over the life of the loan term, but the amount applied to interest and principal varies every month. In the earlier years of the loan, more of the monthly payment is applied to interest. As the principal balance is retired, the ratio of interest to principal payment decreases. By the end of the term, the loan is completely repaid. You may find questions on the state licensing exam related to principal and interest, or P&I. Listen as Sam Martin walks through some more common examples next.

Conventional Mortgage Loans

Today, nearly half of all residential real estate lending is completed with conventional financing programs through conventional mortgage loans. In this unit, you will learn about the characteristics and classifications of conventional mortgage loans. In addition, you will also learn about the purpose and features of private mortgage insurance and secondary financing. After completing this unit, you will be able to: Describe features of a traditional conventional mortgage loan, a conforming loan, and a nonconforming loan, including how a conventional loan is classified by an 80% loan-to-value requirement. Recall how to apply an 80% LTV requirement to determine if a borrower qualifies for a loan, the allowable loan amount, and the required down payment amount. Describe how private mortgage insurance works to insure the portion of the loan that exceeds the LTV requirement. Explain how secondary financing can be used to eliminate the need for private mortgage insurance. Calculate the combined loan-to-value ratio as it is used in secondary financing.

Trust Deeds

Trust deeds, or deeds of trust, are instruments placing a specific financial interest in the title to real property into the hands of a disinterested third party as security for the payment of a note. With a trust deed, the: Borrower is called the grantor or trustor. Lender is the beneficiary who retains both the note and the deed of trust. Trustee holds legal title to the security property described in the deed of trust, subject to the terms of the trust for the benefit of the lender. Who is eligible to be a trustee varies from state to state; it could be an attorney, for example, or a title company that provides trustee services. With a trust deed, the borrower has possession of an equitable title to the property. When the loan is paid, the note and the deed of trust are canceled and both legal title and equitable title are then vested in the borrower. A distinguishing characteristic of trust deeds is that when the lender has declared the loan to be in default, the trustee has the authority under the terms of the trust to commence a non-judicial foreclosure action, which is a foreclosure without the involvement of a court. Such action would not be taken until after the trustee has notified the borrower of the default and given the borrower the opportunity to cure.

Obligation to Pay and Signatures

Understand, the person who signed the promissory note is the only person obligated to repay the loan. The signing of the mortgage or deed of trust does not obligate a person to repay; it merely identifies the property that is collateral for the loan, which does help enforce the obligation to repay the terms of the note, of course. Obviously, lenders would prefer that all persons who signed the mortgage or deed of trust also sign the promissory note; allowing them more individuals from which to pursue repayment in case of default. In the rare cases when only one spouse has signed a promissory note, both must sign the mortgage or deed of trust.

Underwriting Loan with Secondary Financing

Underwriting is the lender's process of evaluating and deciding whether to make a new loan and on what terms. When underwriting a loan that will have secondary financing, the primary lender will include that payment as part of the borrower's monthly housing expense and consider the total amount borrowed when determining the combined loan-to-value (CLTV). The combined loan-to-value (CLTV) is the percentage of the property value borrowed through a combination of more than one loan, such as a first mortgage and a second mortgage. The CLTV is calculated by adding all loan amounts and dividing by the home's appraised value or purchase price, whichever is lower. For example, a buyer purchases a property valued at $100,000 with two loans—a first mortgage for $80,000 and a second for $10,000: ($80,000 + $10,000) / $100,000 = 90% CLTV. For the purpose of private mortgage insurance, however, only the loan-to-value ratio of the first mortgage is considered, so a borrower with a higher CLTV would not have to pay PMI if the LTV is 80% or less. Sam will discuss combined loan-to-value as it relates to secondary financing next. Most primary lenders require secondary financing to have a subordination clause to ensure that the primary lender's lien will take priority, even if the second mortgage is recorded first.

VA-Guaranteed Loans

VA-guaranteed loans are guaranteed by the federal government through the Veterans Benefits Administration, which is part of the Department of Veterans Affairs. The VA's main purpose in guaranteeing loans is to help meet the housing needs of eligible veterans who have served or are currently serving on active duty in the U.S. Armed Forces, which includes: Army, Navy, Air Force, Marine Corps, Coast Guard, Reserves, or National Guard. VA loans are available to eligible veterans for the purchase of owner-occupied single-family homes and for multi-family dwellings up to four units if the veteran intends to occupy one of the units as the primary residence. It's possible for a qualified veteran to obtain a VA-guaranteed loan with no down payment.

Essential Elements of Mortgage Note: Special Note Provisions

Various clauses are used in financing instruments to give certain rights to the lender or borrower. Many of these clauses can be found in the promissory note or the security instrument, such as a mortgage or deed of trust, and often they appear in both. Let's review the purpose of three types of common clauses in mortgage (promissory) notes: Acceleration clause Due-on-sale clause or alienation clause Prepayment penalty clause