Lesson 7: loan types, terms, issues

Mortgage fraud risk management practices include:

Document everything Disclose everything to the lender (representing the buyer does not include helping them cheat the lender) Be sure everything is accurate on the HUD statement. If you believe your transaction is involved in illegal activity withdraw from the transaction. Tell the seller that if he/she intends to continue with the transaction, they need to seek legal advice

Borrowers may consider refinancing for several different reasons

A lower monthly payment Go to a fixed rate mortgage from an adjustable rate mortgage Avoid balloon payments Banish private mortgage insurance (PMI) Cash out a portion of the home's equity

Prepayment

A borrower can lessen the term of his or her loan by making principal payments before they are due. This saves money because, provided that the monthly payments are enough to cover the interest on the loan, any prepayment goes directly toward reducing the principal balance. For this reason, some notes carry prepayment penalties to help lenders recover lost interest.

Permanent Buydown

A borrower pays a percentage of the loan amount, called a discount, thereby lowering the note interest rate. These discounts are either paid as cash at closing or are financed into the loan amount

jumbo loan

A loan that is above the conventional loan limit and faces a somewhat higher interest rate because larger loans imply more lender risk.

Conforming ARMs

Both Fannie Mae and Freddie Mac offer competitive ARM products. Fannie Mae ARMs have the London Interbank Offered Rate (LIBOR), available from Fannie Mae or the Wall Street Journal, as their index.

Discount Points

Discount points are percentages of the loan amount that the lender charges to lower the lending rate. One discount point is equal to one percent of the loan. Lenders will offer these points when the net present value of the future cash flows from interest is less than the value of the discount. are treated as prepaid interest.

Fannie Mae Balloon Mortgage

Fannie Mae offers a seven-year balloon mortgage with a conversion option to a 23-year mortgage at the end of the balloon mortgage's term (and thus is sometimes referred to as a 7/23 convertible mortgage).

Mortgage Interest Tax Deduction

For most homebuyers who are purchasing or improving their homes, the interest payment on a mortgage is tax deductible. However, interest on mortgages in excess of $1 million is not deductible.

Freddie Mac Balloon Mortgages

Freddie Mac offers both five- and seven-year balloon mortgages (referred to as balloon/resets). Freddie Mac allows for the seven-year (but not the five-year) mortgages to be underwritten for borrowers with "A-minus" credit.

negative amortization or deferred interest.

If the payment being made is not sufficient to cover the interest due for any payment period, the unpaid interest is added to the principal balance.

interest rates

Interest rates are determined by the market (the individual lenders) but are influenced by the Federal Reserve System's open-market activities and its primary lending discount rate (the interest rate the Fed charges to other banks). They are also limited by usury laws, which prohibit lenders from charging excessive interest on a loan.

Biweekly Mortgage

Loan payments are every-two weeks, a device that reduces total interest paid, but also shortens risk period for the lender.

Package Mortgage

Mortgage loans which also finance articles of personal property as part of the purchase transaction.

Reverse Mortgages: The Good, the Bad and the Ugly

Reverse mortgages are loans designed for people over the age of 62. The borrower does not have to qualify for the loan. The lenders' protection is in the property. There are no monthly payments. Sounds good but since there are no payments, interest is being added to the amount borrowed every month (negative amortization). So the balance is constantly going up. The longer the borrower has the loan, the higher the balance will get. One of the best things about reverse mortgages is that they are non-recourse loans. There is no personal liability. If the borrower lived a long happy life and the balance on the loan now exceeds what the property will sell for, the lender cannot force anyone to pay the loss. If the heirs choose to let the lender have the property rather than pay the debt, the lender will foreclose on the property, sell it for what they can, and the rest of the loss is the lenders. high upfront fees.

Annual Percentage Rate (APR)

The APR is not the same as the interest rate: it is the ratio of the total cost of financing to the loan amount. The cost of financing includes interest paid, discount points, and loan fees but does not include other fees that would have to be paid regardless of financing (for example, title insurance or home inspection fees).

Mortgage Interest Tax Credit

The federal government provides certain first-time homebuyers with the opportunity to receive a tax credit for 20 percent of their mortgage interest payments if their gross annual income is less than $30,000 and for 10 percent if their income is greater than $30,000. Mortgage Credit Certificate (MCC)

Seller Financing

This occurs when the seller of the real estate provides financing for the sale by taking back a secured note in the form of a mortgage or deed of trust. 1. The seller's home has no loan on it and the seller simply becomes the lender at the time of closing instead of taking the cash out of the property. Many times the seller can make more interest this way than in a savings account or CD. 2. FHA and VA loans are assumable with qualifying. If the buyer does not have the cash available to buy the seller equity but would love to assume that old first lien mortgage at that great low interest rate, the seller could carry part of the equity on a second lien. The difference between seller financing and a contract for deed or lease options is that the buyer gets the title to the property. The seller has a second lien. Seller financing can be a win-win.

Who is required to have PMI?

Typically on a conventional loan, if your down payment is less than 20 percent of the value of the home, lenders will require you to carry private mortgage insurance. Usually, you pay those mortgage insurance premiums until you have enough equity in your home to have a loan-to-value ratio (LTV)—this is simply the amount of money you borrowed divided by the value of the property you bought—of 80 percent.

Flipping

When a property is purchased and then quickly resells at a value that is artificially inflated by false appraisals, loan fraud has taken place.

Temporary Buydown

are an alternative to the adjustable rate mortgage or graduated payment mortgage. They provide the borrower with the temporary help he or she needs without any chance of negative amortization and with a predictable payment structure. The disadvantage is that there is a higher loan fee for this type of loan.

amortization

is a Latin term that means "killing off." If the note is to be amortized, there will be equal monthly payments that contribute to both principal and interest until the entire loan is paid. The payments will be credited first to the interest when due, with any remainder credited to the principal.

Graduated Payment Mortgage

is a blanket term for a family of loans characterized by low initial payments that increase (or "graduate") at set intervals and by set amounts during the term of the loan. Payments usually increase anywhere between 7.5 percent and 12.5 percent annually until reaching a fixed amount that continues for the rest of the term.

Conventional Loans

is any loan that is neither insured by the government nor guaranteed by the government. Conventional loans are divided into two categories: conforming loans and nonconforming loans.

Refinancing Existing Conventional Loans

is the process of obtaining a new mortgage in an effort to reduce monthly payments, lower interest rates, take cash out of a home for large purchases, or change mortgage companies.

interest

is the rent paid on money

two types of mortgage insurance

mortgage insurance bought from the government, designed for those with FHA loans (this is called mortgage insurance premiums or MIP) or private mortgage insurance for conventional loans which is bought from the private sector (this is called private mortgage insurance or PMI).

Construction Mortgage

the lender pays funds to a borrower in installments, called draws, as the construction progresses. The sum total of these draws is typically 75 percent of the value of the property when it is completed. At the end of the building's construction, the entire loan amount plus the interest accrued becomes due. This is usually paid for with a long-term mortgage that the borrower has arranged for in advance.

Sale-Leaseback

the owner of a parcel of real estate sells it and immediately leases it back. This type of arrangement is mostly used by commercial investors who desire to turn their illiquid real estate into cash without losing the use of the asset. In addition, an investor can claim a tax deduction for rent paid on property she or he uses for business. The selling investor often will reserve the right to repurchase the property at the end of the lease period. The sale-leaseback is beneficial to the purchasing party because the party receives a steady stream of rental income, more or less guaranteed, and the party profits by reselling the property to its original owner at its new market price.

Open-End Mortgage

they allow the mortgagor to borrow additional funds at a later date on top of the original loan amount. This is useful, for example, to a new homebuyer who wishes to buy, for example, furniture or a washer and dryer after the home purchase. Thus the borrower may receive more money without the necessity of refinancing. To pay off the new debts incurred, the monthly payment or the loan term (sometimes both) will be increased, often with a concurrent change in the interest rate. One important type of open-end mortgage is the construction mortgage.

Mortgage fraud red flags include:

Inflated price or appraisal Licensee is asked to remove the property from MLS (a violation of MLS rules) or being asked to increase the price in MLS to a higher price to match the sales price. False financial statements by the buyer Contract calling for future improvements. High fees to the mortgage broker, real estate broker or both No fee for a title policy on the closing statement A title company you have never heard of before Last minute amendments to the contract, increasing the sales price

Buyer Rebates

Anything during the transaction that causes money to go back to the buyer, either at or after closing, without the knowledge of the lender, is illegal.

Home Equity Loans

In accounting and finance, equity is the difference between the value of the asset and the cost of the loans of something owned. For example, if someone owns a home worth $215,000 but owes $50,000 on a loan against that home, the home represents $165,000 equity.

release clause

developers often have a release clause included in the mortgage contract. The release clause states that when specific amounts of repayment are reached, as set forth in the contract, individual parcels of land may be released from the mortgage (that is, they become unencumbered). This gives buyers and their lenders more security.

Float-To-Fixed Rate Loans

float-to-fixed rate loans have initial interest rates determined by a margin and an index. After the initial float rate period (one or two years, typically) the loan converts to a fixed-rate loan. These loans allow borrowers to take advantage of the lower earlier rates (as with ARMs) but avoid the risk of later rate increases.

Blanket Mortgage

have more than one collateral property that acts as security for the loan. These mortgages typically are used by land developers and commercial investors, but anyone seeking to consolidate mortgage debts may receive such a loan. create a blanket lien on the collateral properties. This means that in the event of default, the lender may foreclose on all of the properties thus encumbered.

ARMs and lenders

help to avoid the interest rate risk inherent in real estate investment. The risk is this: If a lender lends a borrower money at a fixed rate, and the interest rates subsequently go up, the lender loses money in the form of an opportunity cost. That is, if the lender still had the money, he or she could lend it out at a higher rate and make more profit. The ARM avoids this risk because it allows the lender to adjust the rate according to market conditions.

advantages and disadvantages of temporary buydown

The advantages of a temporary buydown include low initial payments and the borrower is most often qualified on the basis of the lower initial payments. The disadvantages of a temporary buydown include: Buydown plans are typically expensive and require a large payment at closing. A buydown is only temporary, and the borrower will have increased monthly payments that may be difficult to afford.

interest rates

are inversely correlated with property values. That is, rising interest rates cause falling property values, and falling rates cause rising values. This is because most real estate is purchased with borrowed money: A borrower must pay more money to a lender during periods of high interest rates and thus is willing to spend less on the property itself.

Participation Agreements

are loans made by multiple lender to a single borrower. Several banks, for example, might chip in to fund one extremely large loan, with one of the banks taking the role of the "lead bank". This lending institution then recruits other banks to participate and share the risks and profits. The lead bank typically originates the loan, takes responsibility for the loan servicing of the participation loan, organizes and manages the participation, and deals directly with the borrower.

Conventional conforming loans

are loans that conform to the guidelines set by Fannie Mae and Freddie Mac and thus can be sold on the secondary market to Fannie Mae and Freddie Mac. Conforming loan limits are set about once every year.

Conventional nonconforming loans

are loans that do not follow Fannie Mae and Freddie Mac guidelines and thus will not be purchased by Fannie and Freddie on the secondary market (although other secondary market buyers may choose to purchase them).

The Home Affordable Refinance Program, also referred to as "HARP"

is a federal-government program designed to help homeowners refinance at today's low mortgages rates even if they are they are currently underwater on their mortgage. The goal is to allow borrowers to refinance into a more affordable or more stable mortgage.

FHA 203K Property Rehabilitation Program

is a government loan designed to preserve the nation's existing housing stock by facilitating renovation and restoration. It features down payments of as little as 3 percent and can involve loan amounts up to 110 percent of the home's after-improved value.

Equity Participation Mortgage

is a mortgage loan in which the lender has a partial equity interest in the property or receives a portion of the income from the property during ownership (if an income-producing property).

Subprime and Predatory Lending

is a type of mortgage that is normally made out to borrowers with lower credit ratings. As a result of the borrower's lowered credit rating, a conventional mortgage is not offered because the lender views the borrower as having a larger-than- average risk of defaulting on the loan. Because of the default risk associated with such mortgages, subprime mortgages have very high interest rates.

Private Mortgage Insurance

is insurance paid to a private company by a borrower so that the lender will be insured for the loan amount in case of borrower default. In many cases it is required for the loan to be underwritten; in other cases, it is simply recommended. The premiums for the insurance may be paid in several ways: as monthly installments, as an up-front payment at closing, or as a lump sum financed into the loan amount. 20-22 percent equity it is terminated.

Balloon Mortgage

is not fully amortizing. It has a short term, usually five or seven years, but payments based on a longer term, as if it were 30 years. At the end of the loan's term, the often-large remaining balance of the mortgage is due as a lump sum. At this time, the borrower can refinance this amount (if they qualify).

80-10-10 Piggyback Loans

is really two mortgages in one. Instead of giving the borrower one fixed-rate loan at the current market rate, the borrower receives two loans, one larger loan for 80 percent of the sale price at the market rate and a smaller loan for 10 percent of the sale price at a higher interest rate. The appeal of the 80-10-10 loan is that it does not require the borrower to pay for private mortgage insurance and that, unlike PMI, the interest on the second loan is tax-deductible.

Growth Equity Mortgage (GEM, sometimes growing or graduated equity mortgage)

is similar to the GPM in that it involves an increasing payment schedule. GEMs do not negatively amortize: All of the payment increases go toward principal—that is, equity— from which the mortgage derives its name. Some GEMs have payment increases that are tied to an index. Unlike ARMs, however, it is the rate of the principal payment's increase that is tied to the index rather than the interest rate, which remains constant.

Predatory Lending

is the unfair, deceptive, or fraudulent practices of some lenders during the loan origination process. While there are no legal definitions in the United States for predatory lending, an audit report on predatory lending from the office of inspector general of the FDIC broadly defines predatory lending as "imposing unfair and abusive loan terms on borrowers."

Purchase-Money Mortgage (Seller Financing)

like a wraparound mortgage, involves the buyer receiving funds from the seller in the form of a mortgage loan to purchase the property. In a purchase-money mortgage, however, there is often no encumbrance from an original mortgage remaining on the property as the seller already has paid off the mortgage. If there is an underlying mortgage on the property it is a wraparound mortgage and will require an attorney to create the purchase agreement.

Adjustable Rate Mortgages

loan starts at an interest rate typically lower than the market rate for conventional loans, and the rate is adjusted at set intervals known as adjustment periods. These adjustments are based upon the market fluctuations of some economic indicator external to both the lender and the borrower, such as Treasury securities, called the index. contains a lookback period, which is the number of days before the adjustment period that the last published rate for the index becomes the index rate for that period. The lender adds a fixed rate called the margin to the index rate at the lookback date to determine the ARM rate for any particular adjustment period. Margins are often given in terms of basis points; 1,000 basis points equals a rate of 1 percent.

Housing and Economic Recovery Act (HERA)

provisions set loan limits as a function of local-area median home values. Where 115 percent of the local median home value exceeds the baseline loan limit, the local loan limit is set at 115 percent of the median home value. The local limit cannot, however, be more than 50 percent above the baseline limit.