Chapter 15 Real Estate Finance

Rural Housing Service (RHS)

(RHS) was created in 1994 as a result of the Department of Agriculture Reorganization Act to meet housing and community development needs of rural America. The USDA Rural Housing Service has various programs available to aid low-to-moderate-income rural residents to purchase, construct, repair, or relocate a dwelling and related facilities. Qualified homebuyers can get loans with minimal closing costs and no down payment.

Advantages of Conventional Loans

1. Processing a conventional loan usually takes less time. Loan approval from a conventional lender can take 30 days or less, while approval on a government-backed loan seldom, if ever, can be done in less than 30 days. 2. Conventional loans typically have fewer forms, and processing can be more flexible than government-backed loans. 3. There is usually no legal limit on loan amounts with conventional loans; however, government-backed loans have dollar limits that vary by agency. 4. In the event of a loan refusal, borrowers have other lenders that they can make application to. There is only one of each government agency type; so if the loan is refused by a particular agency, there are no alternative lenders available. 5. Conventional lenders are much more flexible. Many offer a variety of loans with attractive provisions.

Loan Types

1. Straight (Interest-only) 2. Amortized 3. Balloon payment 4. Adjustable-rate

Fixed-rate fully amortized loans have two distinct features

1. The interest rate remains fixed for the life of the loan. 2. The payments remain level for the life of the loan and are structured to repay the loan at the end of the loan term.

Disadvantages of Conventional Loans

1. Typically, conventional loans require higher down payments than government-backed loans require. 2. Some conventional loans carry prepayment penalties, while government-backed loans do not.

Balloon Payment

A balloon mortgage is a loan that has one large final payment due when the loan matures. The major problem with a balloon payment loan is that the borrower has to come up with a large sum of money at the end of the term. Many borrowers believe that if they have been a good credit risk and made payments on time the lender will extend the balloon payment for another term. This could happen, but lenders are not obliged to make an extension and could choose to require the full payment when the note comes due. Balloon payment loans are partially amortized loans. This means that the monthly payments are not large enough to fully amortize the loan by the end of the term, leaving the large balloon payment due. For example, a loan for $125,000 at 5% can be computed on a 30-year amortization schedule but be paid over a term of 20 years. That means the payment amount will be figured as if the loan were a 30-year loan, but the loan will mature and the final balloon payment will be due at the end of the 20th year. In this example, the monthly payment (principal plus interest) will be $671.03. At the end of year 20, the balloon payment due will be $63,527.64 (the amount of principal still left on the loan).

Blanket Loan

A blanket mortgage loan covers more than one piece of property. Land developers commonly use blanket mortgages when they buy a plot of land and divide it into many separate lots. A blanket loan usually includes a clause called a partial release clause. This clause allows the borrower to obtain a release of any individual lot from the lien by repaying a certain part of the loan. The lender will issue the partial release for the one lot, with the provision that the mortgage will continue to cover the remaining lots.

Swing/Bridge Loan

A bridge loan is a short-term loan that covers the period between the end of one loan and the beginning of another. Bridge loans are typically used in two situations. To cover the time period between the end of a construction loan and the issue of a permanent loan on a property. When a person needs to borrow money on his or her unsold home (a second mortgage of sorts) to fund the acquisition of a new home. This is useful when a seller will not accept a property sale contingency.

Buydown

A buydown is a variation of the PAM described above. In a buydown, the lump sum payment that is made to the lender at closing usually comes from a builder as an incentive to the buyer or from a family member trying to help out. That payment serves to reduce the interest rate on the loan for the first few years. At the end of that time, the rate rises. The lender assumes the borrower's income will also have risen during these years and he or she will be able to make the increased payments.

Deed in Lieu of Foreclosure

A defaulting borrower who faces foreclosure may avoid court actions and costs by voluntarily deeding the property to the mortgagee. This is accomplished with a deed in lieu of foreclosure, which transfers legal title to the lender. The transfer, however, does not terminate any existing liens on the property.

Sale with Buyer Assuming the Debt

A mortgage assumption is the act of acquiring title to a property that already has an existing mortgage and agreeing to be personally liable for the terms and conditions of the mortgage, including the payments. For example, Jim Jones is the mortgagor of a property for which Commercial Lending is the mortgagee. Jim sells his property to Hal Barks, who becomes the principal guarantor on the mortgage note and is primarily liable for any deficiency judgment that might arise from any default and foreclosure action. However, Jim is still liable as security on the note if Hal defaults. Hal's personal liability to pay the mortgage note is usually created by an assumption clause in the deed. Normally, the original mortgagor is the only person who signs the deed, but in the example of the assumption above, both Jim and Hal sign so that Hal becomes bound to the assumption. Because Jim is still personally liable, he's apt to have asked a higher price for the property if he's allowing Hal to assume the mortgage. In this scenario, Commercial Lending is a third-party beneficiary of the assumption agreement. There is little reason for a lender to relieve the original seller from liability on an assumed note. Lenders usually prefer to have both the buyer and the seller remain liable. However in some cases the lender will agree to release the original seller from liability. This usually happens only after the lender has renegotiated the terms of the loan with the new mortgagor, raised the interest rate and charged an assumption fee.

Package Mortgage

A package mortgage is one that includes all the personal property and appliances that are installed on the property. This type of loan has been used extensively in the sale of furnished condominiums. The loan will include furniture, draperies, carpeting, kitchen appliances, washer and dryer, freezers and other items as part of the purchase price for the residence.

Pledged Account Mortgage

A pledged account mortgage (PAM) is a type of graduated payment mortgage under which the owner/borrower contributes a sum of money into an account that is pledged to the lender. The account is drawn on during the first three to five years of the loan to supplement the periodic mortgage payments, thereby reducing the borrower's monthly payments in the initial years. Once the account is empty, the borrower makes the full mortgage payment. Example: Jim gets a pledged account mortgage for a $90,000 home. He makes a down payment of $10,000, which the lender puts in a pledged account. Jim makes the payments based on a mortgage principal of $90,000, but his actual payments are reduced in the first three to five years by drawing a subsidy from the $10,000 pledged account.

80-10-10 financing

A popular way to avoid having to pay private mortgage insurance is through the use of what's known as 80-10-10 financing. What this means is that the institutional lender provides the traditional 80-percent first mortgage. Then the borrower gets a 10-percent second mortgage and makes a 10-percent cash down payment. For example: Purchase price $200,000 First mortgage (80%) $160,000 at 8% Second mortgage (10%) $20,000 at 9.5% Down payment (10%) $20,000 The total of the two mortgage payments above will still be less than a single first mortgage of $180,000 with PMI. In addition, all of the interest will be tax deductible. Where does the second mortgage come from? It commonly comes from one of two sources. Home seller - Some sellers would be happy to offer secondary financing, either as a way to secure the sale or because they want to get income from the loan. These sellers often offer lower interest rates as well. Seller carry-back mortgages are usually short-term balloon notes that are due and payable three to five years after origination. Institutional lender - A borrower can sometimes get a second mortgage from the same lender who is providing the first mortgage. Sometimes the loan is structured as a home equity loan; other times it may be a conventional second mortgage. It may or may not be a balloon note. If it is fully-amortized, it's usually structured as a 15-year mortgage. Even though this financing is referred to as 80-10-10, if the borrower absolutely cannot afford a 10-percent down payment but could afford 5 percent down, the loan could be structured as 80-15-5.

Sale of Property

A property with an existing mortgage can sell in one of three ways: Free and clear Subject to a mortgage Loan assumption

Purchase Money Mortgage

A purchase money mortgage is most commonly a technique in which the buyer borrows from the seller in addition to the lender. The purchase money mortgage is created at the time of the purchase and delivered at the time the property is transferred as part of the sale transaction. This is sometimes done when a buyer cannot qualify for a bank loan for the full amount, so the seller "takes back" a portion of the purchase price as a second mortgage.

Reverse Annuity Mortgage (RAM)

A reverse annuity mortgage is quite different from the others. With a reverse annuity mortgage, the lender is making payments to the borrower. This system allows older property owners to receive regular monthly payments from the equity in their paid-off property without having to sell. The borrower pays a fixed rate of interest and then repays the loan either when the home sells or from the borrower's estate upon his or her death.

Shared Equity Mortgage

A shared equity mortgage is a form of participation mortgage in which the lender shares in the appreciation of a mortgaged property if and when the property sells. The borrower agrees to the lender's participation in the income, inducing the lender to make the loan. This is more common with commercial properties, but can also be done with residential mortgages.

Open-End Loan Wraparound Loan

A wraparound mortgage allows a borrower who has an existing loan to get another loan from a second lender without paying off the first loan. The second lender issues a new larger loan to the borrower at a higher interest rate. The new loan is a combination of the first loan and the second loan. The borrower makes the new higher payments to the second lender and then the second lender pays the first lender out of those funds. A wraparound loan is often used in a refinancing situation or for the purchase of a home when a buyer cannot prepay the existing mortgage. Note: A wraparound mortgage is only possible if the original loan documents allow it.

Adjustable Rate Loans

Adjustable-rate mortgages (ARMs) became very popular in the 1980s when interest rates were at an all-time high. When 30-year fixed rates are in a reasonable range, the adjustable rate does not appeal to most borrowers. For a borrower that only intends to own the property for a short period of time, an ARM may be a good option. The components of an ARM are: Index Margin Calculated rate Initial rate Adjustment period Mortgage payment adjustment period Interest rate caps Payment cap Negative amortization cap Conversion option Step rate or buy down

Free and Clear Cash Sale

Although not very common, this type of property sale is the simplest. The parties get attorney representation, the seller provides the deed and the buyer pays in cash.

Adjustment Period

An ARM loan specifies a specific time at which the interest rate may change. The adjustment period may be for any period of time but one year, three years and five years are the most common. A multi-year ARM usually converts to a one-year adjustable after the first adjustment period. An ARM is still a 15- or 30- year loan with specific adjustment periods.

Certificate of Reasonable Value (CRV)

An approved VA appraiser must issue a Certificate of Reasonable Value (CRV) showing the value of the property to be equal to or greater than the sales price. The CRV is valid for six months on existing property and 12 months on new construction. The DVA will never issue a certificate that shows the value to be greater than the sales price. For example, if a home is selling for $300,000 and the appraisal comes in at $325,000 the CRV will be $300,000. On the other hand, if the sales price is $300,000 and the appraisal is $275,000, the CRV will be $275,000. The veteran may proceed with the purchase if the sales price exceeds the CRV, but he or she will be required to pay the difference in cash. The source of the cash must be approved by the VA. If the CRV is not equal to or greater than the sales price, the veteran may withdraw from the contract.

Index

An index is a measure of economic conditions. Some of the most popular ones are the one-year Treasury Bill, the five-year Treasury note, the Cost of Funds Index and the Federal Home Loan Bank average. The lender selects an index and uses that as the starting point for the rate calculation. The interest rate is typically the index plus the margin.

Open-End Loan

An open-end loan is an expandable loan which gives a borrower a limit up to which he or she may borrow. Each incremental advance must be secured by the same mortgage and any advances may not exceed the original borrowing limit. The interest rate on the original amount borrowed is fixed. But the interest rate on any future advances can be at the prevailing rate at the time of the advance. An open-end loan is usually less expensive than the conventional home improvement loan. It allows the borrower to "expand" the mortgage to increase the debt to the original amount. Farmers have used this type of loan to meet their seasonal operating expenses, hopefully paying off the advance after they harvest their crops.

additional facts to know about FHA loans:

As of 2006, the borrower must pay two insurance premiums. The first is the "upfront" Mortgage Insurance Premium (MIP), which is a percentage of the loan amount. The borrower can pay this one-time premium at closing or the charge could be financed with the loan. This premium could be paid by some other party, such as the seller. The second premium, called Mutual Mortgage Insurance (MMI), is a monthly premium that is paid with the monthly principal, interest, taxes and insurance payment. This is often referred to as PITI + MMI. MMI premiums may be dropped when the remaining loan balance is 80 percent loan-to-value ratio or less. FHA requires that the monthly amounts the borrower pays toward taxes, insurance and MMI be deposited into an escrow or impound account. The lender can charge points and either the borrower or the seller (or both) can pay them. Note: Both interest rates and discount points are fully negotiable between borrower and lender. Loans are assumable, but the rules for assumptions vary depending upon when the loan originated, the type of property, and the specific FHA program under which the original loan was given.

Land Contract

As we discussed in an earlier chapter, with an installment land sales contract, also called a contract for deed, the buyer does not receive legal title until the final payment is made. The seller keeps legal title until the debt is paid in full. The buyer receives equitable title until the debt is fully paid. The buyer agrees to give the seller a down payment and to make regular payments of principal and interest for some agreed-upon number of years. The buyer also agrees to pay real estate taxes and insurance premiums and to maintain the repairs and upkeep of the property. Many installment contracts contain a provision that allows the seller to cancel the contract, keep all payments and evict the buyer if the buyer defaults. But many states require the seller to refund at least a part of the buyer's payments in that situation.

Private Mortgage Insurance

As we said on an earlier page, most conventional loans require the borrower to make a down payment of 20% or more, making the loan 80% or less of the property's sale price. However, a borrower can get a conventional loan with a lower down payment by insuring the loan through a private mortgage insurance program (PMI). The lack of a substantial down payment has made some borrowers more of a risk than other conventional buyers Therefore, most mortgage lenders require private mortgage insurance for people who want to borrow more than 80 percent of the purchase price of the home. PMI insurance is designed to make sure the lender gets his payments. If the borrower defaults on the loan and subsequent sale of the home doesn't yield enough money to repay the bank, the mortgage insurance will provide the difference. The lender purchases the insurance from a private mortgage insurance company. The lender passes the cost to the borrower by charging a fee at closing plus an additional monthly fee while the insurance is in force. Private mortgage insurance premiums vary, but there are usually two types of payment plans. In one plan, a single premium is charged to cover the lender's risk. In the second, more common plan, an initial premium is charged at closing and then an annual premium is charged and added to the monthly mortgage payment until the lender's risk is reduced. On average, homeowners pay between $240 and $1,200 a year in PMI premiums.

taxes

Consumers pay taxes to the government to cover public services, such as schools and police, fire and ambulance services.

Conventional loans

Conventional loans are typically uninsured. The mortgage itself provides the only security for the loan. To protect its interests, the lender relies on the appraisal of the property and the borrower's ability to repay the loan, as indicated by the borrower's credit reports. Note: When writing conventional loans, many lenders follow the underwriting standards that are provided by Freddie Mac and Fannie Mae so that they can sell their loans in the secondary mortgage market instead of keeping them in their own portfolios.

amortization period

During the early amortization period, a large percentage of the monthly payment is used for paying the interest. As the loan is paid down, more of the monthly payment is applied to principal. The most common fixed-rate loans are 30-year mortgages, because the payment is stable and there is always the opportunity to pay the balance down or to refinance for a better rate at a later date. Recently, 15-year mortgages have become popular as borrowers realize that the interest savings is significant over the 30-year loan.

The following items are important to know about FHA loans.

FHA loans can be either fixed-rate 10-to-30-year loans or one-year-adjustable loans. The maximum loan term is 30 years or 75 percent of the remaining economic life of the property, whichever is less. Down payments are low. However, the borrower must have cash for a down payment and closing costs. These items cannot be added to the sales price and become part of the loan repayment. The maximum loan fee is 1 percent of the loan amount and is typically paid by the buyer.

Duties of a Mortgagor

He or she must keep the property in good repair. Damage to any structures should be promptly restored. The mortgagor must pay all the property taxes and any assessments in a timely manner. The mortgagor must protect the property from loss due to fire or other untimely disaster by purchasing and maintaining property and/or flood insurance. Most lenders require that the property be insured for at least 80 percent of its value. Lenders could also require that the borrower insure the property for 100 percent of the loan value minus the lot value.

Direct Loan Program

Individuals or families receive direct financial assistance from the Rural Housing Service in the form of a home loan at an affordable interest rate. These loans may be made to eligible applicants to buy, build, repair, renovate, or relocate homes, to provide related facilities, or to refinance home debts under certain conditions. Applicants for direct loans from RHS must have very low or low incomes. Even though there is no required down payment, families must be able to afford the mortgage payments, including taxes and insurance. In addition, applicants must be without adequate housing and be unable to obtain credit elsewhere, yet have acceptable credit histories. Loans are typically made for up to 33 years.

Sale "Subject To" a Mortgage

If a grantee takes title to a property "subject to" a mortgage, that person is not personally liable to the lender for payment of the mortgage. The seller is still responsible for making the mortgage payments. With this approach, as long as the new owners are financially able and believe it is to their advantage, they will keep up the payments on the mortgage. However, if for some reason the buyers believe that there is no advantage to making further payments or if they become unable to do so, they may default on the payments. If they do this, they risk losing all the equity they have in the property. However, they cannot be held personally liable for the amount of the debt they assumed. The original owner is still personally and legally responsible for the loan, and he or she may be held liable for any deficiency judgment that could be the result of a foreclosure sale. For example, if Jim owned a farm that was worth $175,000 and he had an existing mortgage of $125,000 with Hometown Bank, he could sell the property to Henry for $175,000 subject to the mortgage. Jim would use Henry's payments toward the mortgage payment. If Henry defaulted in his payments, he would lose the property, but Hometown Bank would not be able to sue Henry for any mortgage deficiency. They would have to go after Jim.

Deficiency Judgment

If the sale does not yield sufficient funds to cover the amounts owed, the mortgagee may ask the court for a deficiency judgment. This enables the lender to attach and foreclose a judgment lien on other real or personal property the borrower owns.

Department of Veterans Affairs (DVA) Loans

In an effort to make it possible for veterans returning from World War II to purchase a home, the Veterans Administration (VA), now the Department of Veterans Affairs (DVA), offered the opportunity for veterans to purchase a home with no money down. (Note: We will be using the acronyms DVA and VA interchangeably in this course.) In order to make this VA mortgage loan acceptable to lenders, the VA agreed to guarantee the top portion of the loan. Since lenders were now protected in the event of a default by the borrower, lenders agreed to loan four times the current DVA Entitlement. The basic entitlement of a DVA loan is $36,000; although some loans are eligible for up to $60,000 if they are over $144,000. The DVA-guaranteed amount is calculated as 25 percent of the home loan amount up to $104,250. The VA limits the maximum amount of a loan with no down payment to $417,000. Most lenders require that a combination of the guarantee entitlement and any cash down payment must equal at least 25 percent of the reasonable value or sales price of the property, whichever is less. Note: In certain cases, a veteran may have a partial entitlement if the amount to be guaranteed has increased since the first time the veteran used his eligibility.

Insurance

Insurance as part of the PITI payment could be homeowner's insurance, flood insurance and/or mortgage insurance.

Recording a Mortgage

It is important that the mortgage be recorded. The recording provides constructive notice to the public of the ownership of the property. The system of recording creates a hierarchy of claims against a property. The priority of those claims is determined by the order in which they are recorded. So if a mortgage is not recorded, someone who gets and records a future interest in the same property could have a claim that takes priority over the person who had the earlier interest but did not record it.

Payment Cap

It is important to understand the difference between an interest rate cap and a "payment" cap. A payment cap insures a set monthly payment that remains the same although the actual interest rate may fluctuate throughout the year. A common payment cap is 7.5 percent of the initial payment. In this instance a monthly payment of $900 could not vary either up or down by more than $67.50 per month in any one-year period. While this appears to be a good thing, it could be a problem if the payment cap prevents the payment from covering the interest. When that happens, the unpaid interest is added back to the loan, generating even more interest and debt. If this trend continues, the borrower will make many payments but end up owing more than he or she did at the beginning of the loan, creating a negative amortization.

Construction Loan

Lenders give construction mortgages to finance the construction of improvements to property, such as homes, apartments and office buildings. The lender commits to the full amount of the loan, but disburses payments over the life of the construction project. The payments are made to the general contractor or the owner for the parts of the construction completed since the last payment. But before making a payment, the lender will inspect the completed work and ask the contractor to submit proof that the mechanic has waived the lien rights for the work the payment is covering. Interest rates on construction loans are usually higher than on other loans because the risk is greater. Risks include: Inadequate protection against mechanics' liens Potential delays in construction completion Financial failure of contractors or subcontractors The borrower pays interest on only the money that has been actually disbursed up to the payment date. These loans are short-term. The borrower can get a permanent loan, usually called a takeout loan, which pays off or "takes out" the lender of the construction loan, when the construction is complete. Alternatively, a borrower may be able to convert the construction loan to a permanent fixed mortgage if the lender offers that option.

Avoiding PMI

Lenders today have become very creative in finding ways for the borrower to avoid paying for private mortgage insurance. One way is often referred to as "lender-paid" mortgage insurance. In this case, the lender provides a loan at approximately one-half percent higher than the market rate and there is no additional charge for mortgage insurance. The lender is actually purchasing the insurance in what is called a "pool" policy where a large number of policies are purchased together, thereby keeping the cost down. A side benefit of this program is that all of the interest is tax-deductible, whereas the PMI payment was not. The down-side of the program is that the higher rate of interest will remain for the life of the loan, as it will not be subject to the new regulation that PMI must be dropped when a 78% loan-to-value ratio is reached. Assuming that a minimum down payment is made, it takes close to 15 years for a loan to reach the 78% position. Considering that the average life of a loan today is seven to eight years, most borrowers will never reach that point without either selling the property or refinancing. Comparing the cost of a loan at 8 percent with PMI and one for 8.5 percent without PMI, the higher interest rate without PMI will result in a slightly lower monthly payment in addition to providing a tax deduction.

Prepayment Penalty

Lenders typically do not want loans that are bringing in high interest to be paid off early. Consequently, a lender will try to control prepayments by including a prepayment penalty clause that allows the lender to assess a penalty to the borrower for paying early. Typically, the penalty is a certain percentage of the original loan amount or a percentage of the current outstanding balance.

Fixed Rate Mortgages

Most conventional loans have traditionally been designed as fixed-rate loans. With this common type of mortgage program, the monthly payments for interest and principal never change. Property taxes and homeowner's insurance may increase, but generally the monthly payments will be very stable. Fixed rate mortgages are available for a number of different loan terms. There are also "biweekly" mortgages, which shorten the loan by calling for half the monthly payment every two weeks. (Since there are 52 weeks in a year, the borrower makes 26 payments, or 13 "months' worth," every year.)

Attachment of note

Most mortgages do not describe in detail all the terms of the note. The mortgage document simply refers to the note, stating in some way that the borrower will pay the full sum due according to the terms of the note

Home Equity Loan

Owners have the ability to borrow against the equity they have built up in their home. Homeowners can use a home equity loan for: Purchasing high dollar items. Taking a vacation. Consolidating other loans or credit card debt. Paying medical expenses. Paying college tuition. Making home improvements. A home equity loan is an alternative to refinancing. It can be given as a fixed amount or it can be a line of credit that the homeowner can borrow against as he or she needs

Points or Discount Points

Points represent prepaid interest, and the lender charges them to get additional income on the loan. Points are paid at closing and are equal to 1 percent of the loan amount. Two (2) points on a $75,000 loan would be $1,500 ($75,000 x .01 x 2 points). Points are a means of raising the effective interest rate of the loan. This in turn facilitates the lender's ability to sell the loan to the secondary mortgage market at competitive rates. The rule of thumb is 1/8 percent for each discount point. So a charge of 4 points would increase a 7 ¼ percent mortgage to a 7 ¾ percent yield. 4 points x 1/8 percent = 4/8 = ½ percent 7 ¼ + ½ = 7 ¾

PITI

Principle, Interest, Taxes, Insurance

Government-backed loans

The Federal Housing Administration (FHA) The Department of Veterans Affairs (DVA) - sometimes simply referred to as VA Rural Housing Service (RHS

Federal Housing Administration Loans (FHA)

The Federal Housing Administration (FHA) was established in 1934 during the great depression to stimulate the housing market in the United States. The FHA provides low-down-payment FHA mortgage loans to qualified buyers. The Department of Housing and Urban Development (HUD) oversees the FHA. The loans FHA provides are high loan-to-value ratio loans, so FHA insures the loans in order to make them available to higher risk individuals. Important Note: FHA does not build homes or loan money directly. They insure loans made by approved lending institutions, including qualified mortgage companies, savings and loan associations and commercial banks. FHA-insured loans protect lenders against any loss they would suffer from a borrower's default.

Homeowners Protection Act

The PMI payments will terminate once the loan has been repaid to a certain level. A federal law called the Homeowners Protection Act requires that any loans originated after July 1999 must have the PMI terminated after the borrower: Has accumulated 22% of equity in the property (loan-to-value ratio is 78%). Is current with all loan payments. However, the law also states that a borrower whose equity equals 20% of the purchase price or appraised value may request that the lender cancel the PMI. The lender must grant the request if the borrowers' payment history is good, the home has not decreased in value and the borrowers have not taken out any other loans on the property. The Homeowners Protection Act requires that lenders inform all borrowers of their right to terminate the PMI by sending out an annual notice explaining the PMI cancellation rights.

Guaranteed Loan Program

The Rural Housing Service guarantees loans made by private sector lenders. This means that if the individual borrower defaults on the loan, RHS will pay the private financier for the loan. The purpose of this loan program is to enable eligible low-and moderate-income rural residents to acquire modestly priced housing for their own use as a primary residence. The program is available for the purchase and repair of existing and newly constructed homes. As with the direct programs, there is no required down payment, but families must be able to afford the mortgage payments, including taxes and insurance. In addition, applicants must be without adequate housing and be unable to obtain credit elsewhere, and have acceptable credit histories. Loans are made for up to 30 years.

Acceleration clause

The acceleration clause outlines what will happen if the borrower fails to pay the mortgage, maintain the property, or perform any other agreement, stipulation or condition contained in the mortgage. Any failure on the part of the borrower can result in the lender's accelerating the mortgage and taking whatever steps are needed to recover the investment.

Right of Redemption

The borrower's right of redemption, also called equity of redemption, is the right to reclaim a property that has been foreclosed by paying off amounts owed to creditors, including interest and costs.

principal

The capital amount borrowed, on which interest payments are calculated, is the original loan principal. In an amortizing loan, part of the principal is repaid periodically along with interest, so that the principal balance decreases over the life of the loan. At any point during the life of a mortgage loan, the remaining unpaid principal is called the loan balance or remaining balance.

Funding Fee

The funding fee is a percentage of the loan amount charged for the privilege of obtaining a VA loan. This fund is used for administrative costs and to offset losses incurred in cases of default by the borrower. It is very similar in function to FHA mortgage insurance premiums. The veteran can pay the fee up front or choose to finance it as part of the loan, as long as it does not increase the loan amount beyond the maximum allowed. If so, it must be paid separately by either the veteran or the seller.

Calculated Rate, or Note Rate

The index plus the margin establishes the calculated rate, or note rate. Since borrowers share the risk with the lender in an ARM, the interest rates tend to be less than fixed rate loans. Further, to increase the marketability of ARMs, lenders often offer a lower initial or "teaser" rate.

Initial Rate

The initial rate is lower than the current market rate and is fixed only for the first adjustment period set by the lender at the origination of the loan. In all probability, the interest rate will increase in the second adjustment period. This sudden increase in payment may create a serious problem for the borrower.

Margin

The lender sets a margin, usually between two percent and three percent, at the time of a loan's origination. The margin is added to the current index to set the interest rate, providing the lender the desired yield on the loan.

Insurance

The lender will require the mortgagor to provide hazard insurance in an amount that will adequately protect the lender's interest in the property. In addition to adequate coverage, the lender must be named as a coinsured party. As with the property taxes, a percentage of the annual insurance premium will be paid with the monthly mortgage payment and be put into the escrow account for payment when due. Note: The lender has the right to approve the insurance company the borrower chooses.

These are some other rules that apply to VA-guaranteed loans.

The maximum VA home loan term is 30 years and 32 days. However, the loan term cannot exceed the remaining economic life of the property. The DVA does not require a down payment. There is no maximum loan amount. However, as we mentioned earlier, DVA guarantees only a portion of the loan. So most lenders will limit the amount they are willing to lend on DVA loans. Interest rate and discount points are negotiable between the lender and the veteran borrower. The loan origination fee cannot exceed 1 percent of the loan amount. DVA requires only monthly principal and interest payments. Even though they do not require taxes and insurance to be included, DVA recommends that they be included. The loan may be prepaid without penalty. DVA requires a structural pest report from a recognized inspection company. If repairs are indicated, the work must be done and certified by both the veteran and an inspector.

More facts about FHA loans include:

The mortgaged real estate must be appraised by an approved FHA appraiser. These appraisals are called "conditional commitments" and are good for six months on existing property and one year on new construction. There is no maximum on what the purchase price of the property can be. The borrower can pay more than the appraisal; but the loan will be based on the appraisal amount. The property must meet the FHA standards for type and construction. FHA also has standards about the quality of the neighborhood. These loans are available for one-to-four family residences and some condominium units. The borrower must occupy the property. FHA requires evidence from a recognized structural pest inspection company that an existing property has no pest infestation. FHA loans are also available to help residents or investors repair or rehabilitate single-family properties. There are no prepayment penalties on FHA loans on one-to-four-family residences. However, the borrower must give 30 days' written notice to pay a loan in full before it is due. There is no due-on-sale clause. Original terms of the loan stay the same and cannot change because of a sale.

Identification of participants

The names of the mortgagor (borrower) and the mortgagee (lender) are listed on the mortgage document.

Sale and Leaseback

The sale and leaseback arrangement is typically used by commercial enterprises to free up money that has been tied up in the real estate to use as working capital in the business. The owner of the real estate sells the property and then leases it back from the buyer. The buyer becomes the owner and the former owner becomes the tenant. These arrangements are very complicated and should be undertaken only with proper and adequate legal and tax advice.

Veteran Eligibility

The veteran must provide a Certificate of Eligibility showing the amount of entitlement available. The entitlement is the maximum number of dollars that DVA will pay if the lender suffers a loss. The following veterans are eligible, based on time spent in the service. Active-duty veterans discharged during WWII or later, without the status of "dishonorable" Active-duty veterans with at least 90 consecutive days of service during major conflict Peacetime veterans and active duty personnel with at least 180 days of consecutive service Enlisted veterans whose service began after 1980 or officers whose service began after 1981 and who have served at least 2 years National Guard and Selected Reserve members who have served for 6 years (Note: Eligibility for members of the Selected Reserve expired on September 30, 2007.) Certain unmarried spouses of veterans who were deemed missing in action or prisoners of war, who died in action or died due to a service-related accident or who have served as a US public health officer may also be eligible. The veteran must plan to occupy the property. In order to use both incomes for a couple to qualify, they must either be married or both have VA eligibility. Otherwise, DVA will only guarantee half of the amount of entitlement.

Federal Deposit Insurance Corporation, the Federal Reserve Board, the Office of the Comptroller of the Currency and the Office of Thrift Supervision standards

These limits are: 65 percent for land acquisition 75 percent for land development 80 percent for multi-family and commercial real estate 85 percent for one-to-four family residences

Negative Amortization Cap

This cap limits the amount of unpaid interest that the lender can actually add to the principal balance. Usually a negative amortization cap limits the total amount the borrowers can owe to 125% of the original loan amount.

Preservation and maintenance of property

This clause requires the borrower to maintain the physical condition of the property and to not allow any abuse or destructive use that would reduce the value of the property.

Defeasance clause

This clause states that if the borrower repays the debt when due, the words of grant are void, the mortgage is canceled and the title is given back to the borrower.

Mortgage Payment Adjustment Period

This determines when the lender will change the amount of the monthly payment to reflect the change in the interest rate. Typically, this period corresponds to the interest rate adjustment period. In such a case, the payment will go up when the interest rate goes up. Conversely, if the interest rate goes down, the monthly payment will go down as well.

Due-On-Sale Clause

This is a form of acceleration clause that requires the borrower to pay off the entire mortgage debt when the property is sold. The due-on-sale clause is also known as an alienation clause, a non-assumption clause, a call clause or a right-to-sell clause. This clause has the effect of eliminating the possibility that a new buyer can assume the existing loan unless the lender permits it. In most cases, the lender would agree to the loan assumption only after increasing the interest rate, charging the new buyer an assumption fee, requiring additional down payment money or even requiring all three conditions.

Signatures and acknowledgement

This is the part of the document where the borrowers sign, showing they accept all of the conditions of the contract. The signatures must be dated and notarized, so that the document can be accepted for recording

Property description

This should be a proper legal description of the property. In addition to the real property, many forms include a statement that pledges the property, anything permanently attached to it and all of the mortgagor's rights in the property as collateral for the loan.

Property taxes

This states that the mortgagor must pay all property taxes, assessments, claims, charges and liens on the property and that any failure to do so could put the mortgage into default. Some mortgagees require the borrower to pay a certain percentage of the annual taxes with the monthly mortgage payment. The tax money accumulates in an escrow account and is paid out when due.

A veteran may use VA-guaranteed financing for any of the following situations.

To buy a home. To buy a townhouse or condominium unit in a project that has been approved by VA. To build a home. To repair, alter or improve a home. To simultaneously purchase and improve a home. To improve a home through installment of a solar heating and/or cooling system or other energy efficient improvements. To refinance an existing home loan. To refinance an existing VA loan to reduce the interest rate and add energy efficiency improvements. To buy a manufactured (mobile) home and/or lot. To buy and improve a lot on which to place a manufactured home which you already own and occupy. To refinance a manufactured home loan in order to acquire a lot.

Interest Rate Caps

To protect borrowers from unlimited increases in the interest rate, lenders establish "rate caps." The first cap (the periodic cap) sets the amount of increase (or decrease) allowed in each adjustment period. The second cap (overall or aggregate cap) sets a maximum interest-rate increase over the life of the loan. A two percent increase in the interest rate results in approximately a 15 percent increase in the monthly payment. These rate caps are also known as ceilings or lifetime caps.

Loan origination fee

Typically 1 percent of the loan amount, although it could be higher. It covers the lender's cost for generating the loan.

Funding Fee Exemptions

Veterans receiving VA compensation for service-connected disabilities Veterans who would be entitled to receive compensation for service-connected disabilities if they did not receive retirement pay Surviving spouses of veterans who died in service or from service-connected disabilities (whether or not such surviving spouses are veterans with their own entitlement and whether or not they are using their own entitlement on the loan)

satisfaction of mortgage

When a mortgage is paid in full, the lender will issue a certificate called a satisfaction of mortgage. This document is also called a release of mortgage. It describes the mortgage, says where it is recorded, certifies that it has been paid and consents that the mortgage is discharged. It is vital that this document of satisfaction also be recorded.

promissory note

Whenever a potential homebuyer borrows money for the purpose of buying a home, he or she will be required to sign a document that describes the amount of money borrowed, the terms under which it will be repaid, and any conditions that relate to either the borrowing of the money or the consequences in event of default

Graduated Payment Mortgage

With a graduated payment mortgage (GPM), the monthly payment for principal and interest gradually increases by a certain percentage each year for a certain number of years and then it levels off for the remaining term of the mortgage. This type of plan might be especially attractive to someone who is just starting a career and expects that his or her income will increase over time. This plan allows a person to start out with a lower monthly payment than he or she would have with a traditional fixed-payment plan. The buyer can qualify for the loan based on expected salary increases along with the expectation that the value of the home will also increase over time. With a GPM loan, the buyer may have initial payments that are less than the interest-only portion of the loan at that point. The interest owed and not paid in the initial months is added back to the principal causing what is referred to as a negative amortization.

Straight Loan

With a straight or term mortgage, also called an interest-only loan, the monthly payments are allocated only to interest. No principal is paid off. At the end of the term, the borrower must be able to pay off the entire principal amount or get another loan. These loans have become very popular in recent years. The attraction is due to the fact that the payments are typically lower than with other loan types. An interest-only loan could be a wise choice for someone who plans to own the property for a short time and believes the property will appreciate during that time. Conversely, it could be very risky. If the property does not appreciate in value, the borrower could end up with less in proceeds on the sale than what he needs to pay off the loan.

Amortized Loan

With an amortization plan, a borrower makes a periodic (usually monthly) payment of principal plus interest. These payments result in the loan being paid off gradually over time. Amortized loans are usually fixed-interest, long-term loans of 15 or 30 years. At the end of the loan term, the full amount of the principal and all of the interest is totally paid off and the balance is zero. With a fully amortized loan, the borrower has the same payment amount every month. The payment goes first to the interest and then to the principal. Over the life of the loan, the amount going toward interest decreases, while the amount going to principal increases. In the early years of the loan, the principal payment is very small; so it takes several years for the borrowers to increase their equity in the property. However, closer to the end of the repayment period, the borrowers' equity increases much more quickly. Example: Remember that our $150,000 30-year loan at 6% had a monthly payment of $899.33. When making the first payment, only $149.33 of the payment goes to principal with the remainder going to interest. However, by year 21 of the repayment period, $524.79 of the payment is going to principal. With a straight amortized loan, the borrower pays a different amount with each payment. A fixed amount goes to the principal with each payment. The interest amount changes as the principal balance declines.

Interest

a charge for the use of the lender's money. Interest may be paid in advance at the beginning of the payment period, or in arrears at the end of the payment period, according to the terms of the note. Mortgage interest is most commonly paid in arrears. The interest rate is a percentage applied to the principal to determine the amount of interest due. The rate may be fixed for the term of the loan, or it may be variable, according to the terms of the note. A loan with a fixed interest rate is called a fixed-rate loan; a loan with a variable interest rate is commonly called an adjustable rate loan.

right of assignment

allows the lender to sell the mortgage at any time and free up the money that the lender has invested.

Types of Mortgages

basically two categories of loans available to buyers in the marketplace - conventional loans and government-backed loans.

mortgagor

borrower who gives the mortgage

default

failure to pay back a loan

mortgage

financing instrument that creates a lien against a property

Government-Backed Loans

government-backed loans include those loans offered by: The Federal Housing Administration (FHA) The Department of Veterans Affairs (DVA) - sometimes simply referred to as VA Rural Housing Service (RHS

Foreclosure

if the purchaser defaults, the lender has the right to bring legal action through the courts to satisfy the debt. This is done through foreclosure - the process that leads up to selling the property that was pledged to secure the debt. Judicial foreclosure is relatively common in Oklahoma. The mortgagor is sued by the lender, the property is sold at auction and the proceeds are divided up among those parties who have mortgages or other liens.

judicial foreclosure

lender has the right to bring legal action through the courts to satisfy the debt

mortgagee

lender who gives the money

Most conventional loans

require the borrower to make a down payment of 20% or more, making the loan 80% or less of the property's sale price.

conventional mortgage

the most common type of loan and is generally viewed as the most secure