Real Estate Finance

Federal Home Loan Banks

(FHLBanks) are 12 regional cooperative banks that lending institutions use to finance housing and economic development in their communities. Created by Congress, the FHLBanks have been one of the largest, private sources of funding for community lending in the U.S. for more than eight decades. They provide stable, on-demand, low-cost funding to financial institutions (not individuals) for home mortgage loans, small business, rural, agricultural, and economic development lending.

Federal National Mortgage Association

(Fannie Mae) was created by Congress in 1938 to bolster the housing industry in the aftermath of the Great Depression. It does not lend money directly to home buyers. Initially, it was authorized to buy and sell FHA-insured loans from lenders, but VA-guaranteed loans were added in 1944. This secondary market for the FHA and VA loans helped make sure that affordable mortgage money was available for people in communities all across America and helped fuel the housing boom in the 1950s. Its role was expanded in 1972, when Fannie Mae was permitted to buy and sell conventional mortgages. This made Fannie Mae the largest investor in the secondary mortgage market. In 1968, the Federal National Mortgage Association was divided into two entities—the Federal National Mortgage Association and the Government Housing Mortgage Association (Ginnie Mae). Fannie Mae became a stockholder company that operated with private capital on a self-sustaining basis, but Ginnie Mae remained a government agency

The Federal Home Loan Mortgage Corporation

(Freddie Mac) is a stockholder-owned corporation chartered by Congress in 1970 to stabilize the mortgage markets and support homeownership and affordable rental housing. Freddie Mac stock is traded on the OTC Bulletin Board under FMCC. Its mission is to provide liquidity, stability, and affordability by providing secondary mortgage support for conventional mortgages originated by thrift institutions. Since its inception, Freddie Mac has helped finance one out of every six homes in America. Freddie Mac links Main Street to Wall Street by purchasing, securitizing, and investing in home mortgages. Freddie Mac conducts its business by buying mortgages that meet the company's underwriting and product standards from lenders. The loans are pooled, packaged into securities, guaranteed by Freddie Mac, and sold to investors such as insurance companies and pension funds. This provides homeowners and renters with lower housing costs and better access to home financing

HFA Single-Family Owner-Occupied Purchase Goals

1. Low-Income Housing Goal (23%). This targets families with incomes no greater than 80% of the area median income. (Area median income is defined as the median income of the metropolitan area, or for properties outside of metropolitan areas, the median income of the county or the statewide nonmetropolitan area, whichever is greater.) 2. Very Low-Income Housing Goal (7%). This targets families with incomes no greater than 50% of the area median income. 3. Families That Reside In Low-Income Areas Housing Goal (11%). Three categories of home purchase mortgages qualify for the low-income areas housing goal: a. Low-income census tracts (tracts with median family income no greater than 80% of AMI) b. Minority census tracts (tracts with minority population of at least 30% and a median family income less than 100% of AMI) c. Federally-declared disaster areas (regardless of the minority share of the population in the tract or the ratio of tract median family income to AMI)

Bonds

A bond is a debt instrument. When you buy a bond, you lend someone money at a fixed interest rate for a fixed period of time. While your money is out you receive interest on it. At a specific time in the future, you receive your principal back. Thus, the interest the bond issuer pays you before the bond matures is the return on capital and, when you get your money back, you receive the return of your capital. The bond market is the market for buying and selling bonds.

Credit Unions

A credit union is a cooperative, non-profit organization established for banking purposes. Credit unions are owned and operated by their members. Usually, members are people in associations who share a common affiliation such as teachers, workers in the same field, government employees, or union members. Credit unions accept deposits in a variety of accounts. All credit unions offer savings accounts or time deposits. The larger institutions also offer checking and money market accounts. Credit unions' financial powers have expanded to include almost anything a bank or savings association can do, including making home loans, issuing credit cards, and even making some commercial loans. Credit unions are exempt from federal taxation and sometimes receive subsidies in the form of free space or supplies from their sponsoring organizations. The members receive higher interest rates on savings and pay lower rates on loans. Both secured and unsecured loans are made at lower rates than other lenders can offer. Because of the low overhead and other costs of doing business, credit unions are a growing source of funds for consumers. The National Credit Union Association Board (NCUAB) supervises them and the federally insured National Credit Union Share Insurance Fund (NCUSIF) insures deposits.

Finance Companies

A finance company is a business that makes consumer loans for which household goods and other personal property serve as collateral. In addition, some private loan companies make home equity loans. The credit criteria may be more relaxed than the underwriting guidelines that traditional lenders follow, which allows those with poor credit to qualify. Because these real estate loans are in a junior position, finance companies try to offset the risk by charging higher placement and origination fees. Usually, interest rates charged by a finance company are the maximum.

Fiduciary Lenders

A financial fiduciary is an institution that collects money from depositors, premium payers, or pension plan contributors and makes loans to borrowers. Financial fiduciaries include commercial banks, thrifts, credit unions, life insurance companies, and pension plans. These lenders have a fiduciary responsibility to the owners of the funds. As a result, lending practices are carefully regulated by law in order to protect the owners of the funds. Most financial fiduciaries are depository institutions. A depository institution is a financial institution that is legally allowed to accept deposits from consumers. The main types of depository institutions in the United States are commercial banks, thrifts, and credit unions. Although they each offer similar banking services, they operate under different regulations. As time has passed, these three types of institutions have become more like each other and their unique identities have become less distinct. A depository lender, such as a commercial bank, pools its deposits and invests them in various ways. These investments include extensions of credit in the form of real estate loans. Depository lenders receive most of their deposits from household savings (savings of individual investors). The main function of depository lenders is to transfer money from the people who deposit money to those who want to borrow it. Financial fiduciaries set their own underwriting guidelines for the loans they originate unless they plan to sell the loans in the secondary mortgage market. In order to sell loans in the secondary market, they must follow the Fannie Mae/Freddie Mac guidelines.

Financial market

A financial market allows people to buy and sell financial securities and commodities relatively easily. Markets work by bringing interested buyers and sellers together and making it easier to complete transactions.

Fixed-Rate Loans

A fixed-rate loan has two distinct features—fixed interest for the life of the loan and level payments. The level payments of principal and interest are structured to repay the debt completely by the end of the loan term. The major advantage of fixed-rate loans is that they present predictable housing costs for the life of the loan. Fixed-rate loans are suitable for the majority of homebuyers. If the borrower plans to stay in his or her home for a long time and can afford the payments associated with a fully amortizing, fixed-rate loan, this type of loan offers level, predictable payments.

Fully amortizing loan

A fully amortizing loan is fully repaid at maturity by periodic reduction of the principal. When a loan is fully amortized, the payments the borrower makes are equal over the duration of the loan. Any mortgage other than a 30-year, fully amortizing, fixed-rate mortgage is a nontraditional mortgage.

Housing GSEs

A government-sponsored enterprise (GSE) is a financial services corporation created by the United States Congress. The housing GSEs are Fannie Mae (Federal National Mortgage Association), Freddie Mac (Federal Home Loan Mortgage Corporation), and the Federal Home Loan Bank System (FHLBank System), which currently consists of 12 Federal Home Loan Banks (FHLBanks). The housing GSEs are critical in providing liquidity, stability, and affordability to the mortgage market, particularly for long-term, fixed-rate mortgages. Fannie Mae and Freddie Mac purchase conforming loans from lenders in the primary market such as mortgage companies and depository institutions who then use the proceeds to finance more mortgages. Fannie Mae and Freddie Mac then securitize the mortgages that they purchased and issue mortgage-backed securities (MBS) that are sold to a wide variety of investors in the capital markets. The FHLBs provide advances and other financial products to support their members' affordable housing activities. The housing GSEs are regulated by the Federal Housing Finance Agency (FHFA), an independent regulatory agency that was established by the Federal Housing Finance Reform Act of 2007. Each year FHFA sets the limit of the size of a conforming loan, which is based on the October-to-October changes in mean home price. Go to www.fhfa.gov for more information about the FHFA.

Lender

A lender is the person who or company that makes mortgage loans, such as a mortgage banker, credit union, bank, or a savings and loan. A lender underwrites and funds the loan.

Basic Features of ARMs

A lender may offer a variety of ARMs, all of which share similar features—initial interest rate and payment, adjustment period, index, margin, and caps. These basic features are incorporated into every ARM loan. For a limited period of time, every ARM has an initial interest rate and payment. These payments are usually lower than if the loan were a fixed-rate loan. In some ARMs, the initial rate and payment adjust after the first month. Other ARMs keep the initial rate and payment for several years before an adjustment is made. For most ARMs, the interest rate and monthly payment change every month, quarter, year, 3 years, or 5 years. The period between rate changes is the adjustment period.

Loan Correspondents

A loan correspondent is usually a third party originator who originates loans for a sponsor. However, the purchaser of the closed loan may make the underwriting decision in advance of closing. Alternatively, the purchaser may grant the authority to underwrite the loan according to its guidelines and allow the entire process to be undertaken by the correspondent who simply ships a funded loan. If the sponsor funds the loan, the process is called table funding. Table funding is the lender's ability to provide loan funds on the same day the transaction is signed by all parties, which is usually the same day as the closing. In the course of table funding, the correspondent closes a mortgage loan with funds belonging to the acquiring lender. Upon closing, the loan is assigned to the lender who supplied the funds. However, some sponsors allow a correspondent to actually fund and close loans in the correspondent's name, providing the loans meet the sponsor's guidelines. The sponsor can force a correspondent to buy back a loan if it does not meet the sponsor's guidelines. Therefore, loan correspondents have a risk that mortgage brokers do not have. The sponsor retains the loan in its portfolio or packages and resells the loan in the secondary mortgage market as part of a pool. Many insurance companies are sponsors for loan correspondents.

Purchase money loan

A loan that is used to purchase property is called a purchase money loan. It is used strictly for financing the purchase of real property. Any loan made at the time of a sale, as part of the sale, is a purchase money loan. Even a second loan that finances part of the purchase of a property is a purchase money loan.

Market economy

A market economy is an economy that relies primarily on interactions between buyers and sellers to allocate resources.

Mortgage Companies

A mortgage company, which is also known as a mortgage banker, is a company whose principal business is the origination, closing, funding, selling, and servicing of loans secured by real property. Mortgage companies originate a majority of all residential loans. They lend their own money or money borrowed from warehouse lenders to fund loans. The biggest role of mortgage companies, however, is to originate and service loans that they package and sell. After loans are originated, a mortgage company might retain the loans in the lender's portfolio or may package and sell them to an investor. The sale of these loan packages provides added capital the mortgage company can use to make more loans to be packaged and sold, thus repeating the cycle. A mortgage company prefers to make loans that can be readily sold in the secondary market, such as FHA, VA, or conventional mortgages. Therefore, mortgage companies are careful to follow the required lending guidelines for these types of loans.

Mortgage pool

A mortgage pool is a group of mortgages that usually have the same interest rate and term. The debt instruments, which are known as mortgage-backed securities, are collateralized by the mortgage pool.

Mortgage-backed security

A mortgage-backed security is a type of asset-backed security that is protected by a collection of mortgages. The mortgages are pooled and secured against the issue of bonds. Most bonds backed by mortgages are classified as mortgage-backed securities (MBS). This can be confusing because some securities derived from MBS are also called MBS. The qualifier pass-through is used to distinguish the basic MBS bond from other mortgage-backed instruments. The value of MBS is based on the underlying pool of residential mortgages.

Mutual Savings Banks

A mutual savings bank is a financial institution owned by depositors, each of whom has rights to net earnings of the bank in proportion to his or her deposits. The depositors' return on their investment is determined by how successful the bank is in managing its investment. Initially, mutual savings banks were state-chartered, mutual organizations that relied on their customers' savings to provide all the capital they needed to be successful. They did not sell stock in the company to shareholders. Mutual savings banks were permitted to change their charter from mutual ownerships to federally chartered stock institutions that issue stock to raise capital. These institutions operate similarly to savings and loan associations and are located primarily in the northeastern section of the United States.

Partially amortizing loan

A partially amortizing loan has a repayment schedule that is not sufficient to pay off the loan over its term. This type of loan calls for regular, periodic payments of principal and interest for a specified period of time. At maturity, the remaining unpaid principal balance is due as a balloon payment. A balloon payment is substantially larger than any other payment and repays the debt in full.

Principal-only stripped mortgage-backed security

A principal-only stripped mortgage-backed security (PO) is a bond with cash flows that are backed by the principal repayment component of a property owner's mortgage payments. Because principal-only bonds sell at a discount, they are zero coupon bonds. A zero coupon bond is a bond that pays no coupons, is sold at a deep discount to its face value, and matures to its face value. These bonds satisfy investors who are worried that mortgage prepayments might force them to re-invest their money when interest rates are lower.

Savings Banks

A savings bank has been described as a distinctive type of thrift institution because it can behave like a commercial bank or like an S&L. While savings banks are authorized to make mortgage loans, most specialize in consumer and commercial loans. However, they are active in purchasing low-risk FHA/VA and conventional mortgages from other mortgage lenders and mortgage companies. Since most savings banks are located primarily in the capital-surplus areas of the northeast and possess more funds than are needed locally, savings banks play an important part in the savings-investment cycle by purchasing loans from areas that are capital deficient. This flow of funds from areas with excess funds to areas with scarce resources helps to stimulate a healthy national financial environment.

Real Estate Investment Trusts

A share in a real estate investment trust (REIT) is a security that sells like a stock on the major exchanges. REITs invest in real estate or mortgages. REITs were designed to provide a similar structure for investment in real estate as mutual funds provide for investment in stocks. REITs are subject to a number of special requirements, one of which is that REITs must annually distribute at least 95% of their taxable income in the form of dividends to shareholders. REITs invest in equities, mortgages, or a combination of the two. Equity REITs invest in property. A mortgage REIT, which is also called a real estate mortgage trust (REMT), makes loans on commercial income property. Some REMTs specialize in buying and selling existing real estate loans. Their revenue is derived from the interest earned on the loans. A hybrid or combination REIT purchases equities and makes commercial loans.

Straight loan

A straight loan is not amortized. The borrower only makes periodic interest payments during the term of the loan. The entire principal balance is due in one lump sum upon maturity. These loans are also called interest-only loans. This type of loan is not commonly offered by institutional lenders but may be offered by a seller or a private lender to a buyer.

Stripped Mortgage-Backed Security

A stripped mortgage-backed security (SMBS) is a type of CMO in which the interest and principal of the mortgage are separated into principal-only and interest-only bonds.

Interest Rate Caps

ARM loans help avoid payment shock with built-in protections called caps. Payment shock is a significant increase in the monthly payment on an ARM that may surprise the borrower. Caps regulate how much the interest rate or payment can increase in a given period. The two interest rate caps are periodic adjustment caps and lifetime caps.

Periodic Adjustment Cap

All adjustable-rate loans carry periodic adjustment caps (interim rate caps). The periodic adjustment cap limits the amount the interest rate can adjust up or down from one adjustment period to the next after the first adjustment. Some ARMs allow a greater rate change at the first adjustment and then apply an interim rate cap on all future adjustments. The interim caps apply at the time the loan adjusts. For example, 1-year ARMs have annual caps, 3-year ARMs have 3-year caps, 5-year ARMs have 5-year caps, and so forth. Hybrid ARMs have two interim caps. A 5/1 ARM has a 5-year cap for the first adjustment period and an annual cap thereafter. An interest rate cap is beneficial to borrowers in a rising interest rate market. It limits the increase on the interest rate at the end of each adjustment period. Interest rate caps are based on the note rate. The note rate is the interest rate on the ARM loan at the time it is funded. It is important to know the note rate, in order to calculate future interest rate increases and future payments. The caps work in both directions. If the borrower has a 1-year ARM with 2.0% annual caps and a 6.0% lifetime cap, the interest rate cannot adjust more than 2.0% above or below the note rate at the annual adjustment period. In this example, the maximum interest rate (lifetime cap) is the note rate plus 6.0%.

Federal Deposit Insurance Corporation

All federally chartered commercial banks must be members of the Federal Reserve System, which supervises member commercial banks. The Federal Deposit Insurance Corporation (FDIC) insures deposits. The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the United States Government. The FDIC protects depositors against the loss of their insured deposits if an FDIC-insured bank or thrift fails. FDIC insurance is backed by the full faith and credit of the United States Government. The deposits are fully insured if a depositor's accounts at one FDIC-insured bank or thrift total $250,000 or less. Deposits in separate branches of an insured bank are not separately insured. Deposits maintained in different categories of legal ownership at the same bank can be separately insured. Therefore, it is possible to have deposits totaling more than $250,000 at one insured bank and still be fully insured.

Lifetime Cap

Almost all ARMs have a lifetime interest rate cap called a lifetime cap. The lifetime cap is the maximum interest rate that may be charged over the life of the loan. The lifetime cap varies from company to company and loan to loan. Loans with low lifetime caps usually have higher margins. Loans that carry low margins generally have higher lifetime caps. Example: An ARM has an initial interest rate of 5.5% with a 6.0% lifetime cap. This means that the interest rate can never exceed 11.5%. If the index increases 1.0% for 10 years, the interest rate on the loan will be 15.5% without the lifetime cap. However, with the lifetime cap it will be 11.5%.

Amortization

Amortization is the liquidation of a financial obligation on an installment basis. An amortization schedule details each payment, displays the specific amount applied to interest and principal, and shows the remaining principal balance after each payment. Amortization type is the basis for how a loan will be repaid. The type of amortization influences changes in repayment terms during the life of the loan. The most common amortization types include fixed-rate loans, adjustable-rate mortgages (ARM), and graduated payment mortgages (GPM).

Interest-only stripped mortgage-backed security

An interest-only stripped mortgage-backed security (IO) is a bond with cash flows that are backed by the interest component of the property owner's mortgage payments. IO bonds change in value based on interest rate movements.

Nontraditional mortgage product

Any mortgage product other than a 30-year, fixed-rate mortgage is called a nontraditional mortgage product. Types of loans include conventional and government-backed (FHA and VA). Loans are further described by occupancy (residence or investment) and by priority (first or second loans).

Approved issuers

Approved issuers are lenders that meet specific requirements and are approved to issue Ginnie Mae MBS. Approved issuers acquire or originate eligible FHA and VA loans. The loans are pooled and securitized into MBS, which are then guaranteed by Ginnie Mae. In fact, Ginnie Mae securitizes more than 90 percent of FHA and VA mortgages.

Capital Market

Capital markets, which consist of markets for stocks and bonds, deal in long-term financing and securities. The capital market is the market in which long-term or intermediate-term securities are traded by buyers and sellers. These securities take more than 1 year to mature. Capital markets consist of primary markets and secondary markets.

Cash-out refinancing

Cash-out refinancing involves refinancing the loan for a larger amount than the current loan. Any loan used to take cash out of a property is a hard money loan. Hard money loans draw on the equity in property. This type of loan includes home equity loans, home equity lines-of-credit, and swing loans.

Collateralized Mortgage Obligation

Collateralized mortgage obligations (CMOs), a type of MBS, are bonds that represent claims to specific cash flows from large pools of home mortgages. The streams of principal and interest payments on the mortgages are distributed to the different classes of CMO interests, known as tranches. Some CMOs are backed by pools of mortgage-backed securities that are issued by another agency such as Fannie Mae, instead of a mortgage pool. Some CMOs are backed by pools of mortgage-backed securities that are issued by another agency such as Fannie Mae ,instead of a mortgage pool. As a result of a change in the 1986 Tax Reform Act, most CMOs are issued in REMIC (Real Estate Mortgage Investment Conduit) form to create certain tax advantages for the issuer. Essentially a REMIC is a way to create many different kinds of bonds from the same mortgage loan to please many different kinds of investors. A REMIC offers regular payments and relative safety.

Commercial Banks

Commercial banks are the all-purpose lenders. Commercial banks receive deposits and hold them in a variety of accounts, extend credit, and facilitate the movement of funds. Deposits held in checking accounts are called demand deposits. A demand deposit is a deposit that can be withdrawn at any time. Commercial banks make the widest range of loans, including loans for buying real estate, home equity loans, business loans, and other short-term loans. Even though they make a variety of loans, a major type of lending activity funded by commercial banks is for short-term (6 to 36 month) construction loans. Commercial banks operate as retail lenders, wholesale lenders, or some combination of both.

Debt

Debt is a dollar amount that is borrowed from another party, usually under specific terms. It can be secured or unsecured. Secured debt is a debt owed to a creditor that is secured by collateral. A good example of this is mortgage debt or a car loan. The opposite of secured debt is unsecured debt, which is a debt that is not connected to any specific piece of property. Instead, the creditor may satisfy the debt against the borrower rather than just the collateral.

Default risk

Default risk is the borrower's inability to meet interest payment obligations on time. Lenders pool mortgages by their interest rate and date of maturity. Additionally, mortgages are pooled by the initial credit quality of the borrower. Pools are comprised of prime, Alt-A, and subprime loans. Prime: Conforming mortgages, prime borrowers, full documentation (such as verification of income and assets), and strong credit scores Alt-A: Non-conforming mortgage (such as vacation home), generally prime borrowers, less documentation Subprime: Non-conforming mortgage, borrowers with weaker credit scores, and no documentation Some mortgage-backed securities have guarantees against the risk of borrower default. MBS guaranteed by Ginnie Mae are backed with the full faith and credit of the U.S. Federal government. Fannie Mae and Freddie Mac use lines of credit with the U.S. Treasury Department to guarantee the MBS they issue.

Foreign National Lenders

Due to the demand for real estate loans to people who are not American citizens, some niche lenders offer foreign national loans. Foreign national loans are similar to standard U.S. loans, except that the required down payment is generally larger—about 30%. A foreign national is not a U.S. citizen, but is temporarily residing in the United States. For tax reporting purposes, foreign nationals are issued individual tax identification numbers rather than social security numbers. Usually niche lenders work with foreign nationals because they do not have social security numbers and their American credit history may be minimal or nonexistent.

Equity

Equity is an owner's financial interest in real or personal property at a specific moment in time. In real estate, it is the difference between what a property is worth and what the owner owes against that property. At purchase, the equity is equal to the amount of the down payment. If the property is encumbered with a loan, the equity is the difference between the appraised market value of the property and the balance of any outstanding loans. Example: Robert purchased his home 3 years ago for $150,000 with a 10% down payment. At that time, his equity was $15,000 and the debt was $135,000. After making payments for 3 years, the mortgage is $130,000 and the current market value of his home is $175,000. Therefore, his equity in the property is $45,000.

Discount Rates

Federal Reserve member banks are permitted to borrow money from the Reserve Banks to increase their lending capabilities. The interest rate the banks pay for the federal funds is called the discount rate. The discount rate is the interest rate that is charged by the Federal Reserve to its member banks for borrowing money. A decrease in the discount rate allows more bank borrowing from the Fed. Bank borrowing increases money available for lending to the consumer. Raising the discount rate results in less borrowing from the Fed. The decrease in bank borrowing reduces the amount of money available for lending to the consumer. The prime rate, which is the rate the bank charges its strongest customers (those with the highest credit ratings), is heavily influenced by the discount rate.

Semi-Fiduciary Lenders

Financial semi-fiduciaries are non-depository lenders. A semi-fiduciary institution is never directly accountable to depositors, premium payers, or pension plan contributors. Therefore, they are less strictly regulated and can take more risks than financial fiduciaries. These semi-fiduciary lenders invest their own funds or borrowed funds. Mortgage companies and real estate investment trusts (REITs) are semi-fiduciary lenders.

Sequential Pay CMO

In a sequential pay CMO, issuers distribute cash flow to bondholders from a series of classes, called tranches. A tranche is a part or segment of a structured security. A security may have more than one tranche, each with different risks and maturities. Each tranche consists of MBS with similar maturity dates or interest rates and is different from the other tranches within the CMO. For example, a CMO can have three tranches with MBS that mature in five, seven, and 20 years each.

Payment Caps

In addition to interest-rate caps, some ARMs have payment caps. A payment cap restricts a payment from increasing more than a specified percentage above the prior year's payment amount. These loans reduce payment shock in a rising interest rate market, but can also lead to negative amortization. Negative amortization is an increase in the principal balance caused by low monthly payments that do not pay all the interest due on the loan. This deferred interest is added to the principal on the loan. In some instances, the borrower can owe more than the amount of the original loan. Typically, the payment caps range between 5.0% and 8.0%. For example, if a loan has a 6.0% payment cap and the borrower's monthly payment in year 1 is $1,000, the payment cannot increase more than 6% ($60) in year 2, regardless of the actual interest rate increase.

Interest-Only Fixed-Rate Loans

Interest-only fixed-rate loans are short-term fixed-rate loans that have fixed monthly payments usually based on a 30-year fully amortizing schedule and a lump sum payment at the end of its term. They typically have terms of 3, 5, and 7 years. The advantage of this type of loan is that the interest rate on balloon loans is generally lower than 30- or 15-year loans, which results in lower monthly payments. The disadvantage is that at the end of the term the borrower must make a lump sum payment to the lender. Additionally, with an interest-only fixed-rate loan, the borrower is not building equity. With this type of loan, the equity in the property can still increase if the market value of the property increases. However, during the term of the loan, the equity can decrease if the home's market value goes down. Interest-only loans with a refinancing option allow borrowers to convert the mortgage at maturity to a fixed-rate loan if certain conditions are met. The interest rate on the new loan is a current rate at the time of conversion. There might be a minimal processing fee to obtain the new loan. The most popular terms are the 5/25

Portfolio lenders

Larger banks and thrifts that lend their own money and originate loans to keep in their own loan portfolio are called portfolio lenders. This is because they originate loans for their own portfolio and not for immediate resale in the secondary mortgage market. Because of this, they do not have to follow Fannie Mae/Freddie Mac guidelines and can create their own rules for determining creditworthiness. Usually, only a few of the loans are held in the portfolio. A loan is considered seasoned once a borrower has made the payments on it for over a year without any late payments. Once a loan has a track history of timely payments, it becomes marketable even if it does not meet Fannie Mae/Freddie Mac guidelines. If the loans are sold, they are packaged into pools and sold in the secondary market. Selling these seasoned loans frees up money for the portfolio lender to make more loans.

Life Insurance Companies

Life insurance companies obtain their funds from insurance premiums. Unlike the demand deposits of depository institutions, the premiums invested in life insurance companies are not subject to early withdrawal and do not earn a high rate of interest. Therefore, life insurance companies have vast amounts of money to invest. Life insurance companies do not usually originate individual loans in the single-family residential market. However, they are a major supplier of money for large commercial loans to developers and builders. Life insurance companies usually do not make construction loans but make takeout loans on large commercial properties. A takeout loan is the long-term permanent financing used to pay off a construction loan.

Loan origination fees or funding fees

Loan origination fees or funding fees are typically one or two points of the amount of the loan. The income the lender derives from this source is called the mortgage yield.

Loan origination

Loan origination is the lending process from application to closing. Historically, mortgage loans were offered directly to borrowers by a direct lender who completed the loan process during retail loan origination. Today, many loans are prepared by a third party originator and sold to a wholesale lender. The third party originator collects a fee from the lender when the borrower's loan is funded. Since the mid-1980s, real estate lending has seen many changes that have brought desirable diversity to a conservative industry. Frequently, lenders such as commercial banks, thrifts, and mortgage companies have both retail and wholesale loan origination departments.

Loan servicing

Loan servicing lenders receive fees for collecting payments from the borrower on behalf of the loan originator or subsequent noteholder. A loan servicer collects payments from borrowers, subtracts fees, and sends the balance of the money to investors who own the loans. The servicer is in charge of collecting payments, handling escrows for taxes and insurance, making payments to the mortgage investor, and administering a loan after it has been made.

Biweekly Payment Plan

Loans with a biweekly payment plan call for payments every 2 weeks. Since there are 52 weeks in a year, the borrower makes 26 payments, which is equivalent to 13 months of payments, every year. The shortened loan term decreases the total interest costs. The interest costs for the biweekly mortgage are decreased even farther because a payment is applied to the principal (upon which the interest is calculated) every 14 days. The loan is repaid much faster. For example, a 30-year loan can be paid off within 21 to 23 years.

Fully Amortizing Fixed-Rate Loans

Maturity dates for fixed-rate loans range from 40, 30, 20, 15, to 10 years. A maturity date is the date on which a debt becomes due for payment. The longer the loan term, the smaller the payment and the more interest is paid over the term of the loan. During the early amortization period, a large percentage of the monthly payment is used to pay interest. As the loan is paid down, more of the monthly payment is applied to principal. The most popular maturity dates are 30 and 15 years. The traditional 30-year fixed-rate loan offers low monthly payments while providing for a never-changing monthly payment schedule. A typical 30-year, fixed-rate loan takes 22.5 years of level payments to pay half of the original loan amount. A 15-year fixed-rate loan is repaid twice as fast because the monthly payment is higher. More money is applied to the principal in the early months of the loan, which cuts the time it takes to reach free and clear ownership. Additionally, the borrower pays less than half the total interest costs of the traditional 30-year loan. A 40-year fixed-rate loan has the lowest monthly payments of fixed-rate loans but has a dramatically higher amount of interest costs.

Mortgage yield

Mortgage yield is the amount received or returned from real estate loan portfolios expressed as a percentage.

Closed-end loans

Most loans used to purchase property are closed-end loans. A closed-end loan is one in which the borrower receives all loan proceeds in one lump sum at the time of closing. The borrower may not draw additional funds against the loan at a later date.

Non-Fiduciary Lenders

Non-fiduciary lenders are non-depository institutions. In other words, they do not take deposits. Because they are relatively free from government regulations, these lenders follow their own underwriting guidelines and risk criteria. They are private lenders that invest their own funds or borrowed funds. Some examples of non-fiduciary lenders are private loan companies, private investors, and foreign lenders.

Pension Funds

Pension funds have huge amounts of money to invest. In fact, it is in the trillions. Both employer and employees contribute to employee pension plans. A pension plan is a retirement fund reserved to pay money or benefits to workers upon retirement. The contributions placed in a pension fund are used to purchase investments for the sole purpose of financing the pension plan benefits. The pension fund manager is responsible to invest the funds wisely and pay out a monthly income to retirees. Like life insurance companies, pension funds are a direct source of funds for developers and large builders of commercial property. Pension funds also buy mortgages issued by banks. Large pension funds, such as those held by the state for the benefit of public employees, often guarantee the repayment of millions of dollars in bank loans used to build low-income and moderate-income housing. In exchange for the guarantee, these funds charge developers a percentage of the value of the loans they guarantee. Additionally, they invest in blocks of mortgage-backed securities in the secondary mortgage market.

Private Individuals

Private individuals are non-fiduciary lenders who offer an alternative source of financing. They participate in financing real estate by carrying back loans on their own property and by investing in security instruments (mortgages and deeds of trust). Sellers are a major source of junior loans to buyers. Sellers may finance a portion of the purchase with a carryback loan. Sellers often require larger down payments than institutional lenders because of the higher risk normally associated with this type of loan. Private investors who are looking for a higher rate of return than what is available in a bank certificate of deposit may buy and sell existing short-term junior loans through a mortgage company. Their main objectives are the safety of the loan and a high return on their investment.

Refinancing

Refinancing replaces the old loan with a new one. A person may refinance to reduce the interest rate, lower monthly payments, or change from an adjustable-rate to a fixed-rate loan. The loan amount remains the same, but the terms change. Refinancing usually makes sense only when there has been a drop in interest rates and a person wants a new loan at a lower rate than the existing loan. Refinancing may also benefit those who want to refinance for a longer term to lower monthly payments.

Reserve requirements

Reserve requirements refer to a certain percentage of each deposit in a bank that must be set aside as a reserve. When the Fed requires a larger reserve, the banks have less to lend, so interest rates increase while borrowing and spending decrease. If the Fed lowers the reserve requirement, the banks have more money to lend, interest rates may decrease, and borrowing and spending increase.

Residential Loan Originators

Residential mortgage lenders (loan originators) are part of the primary mortgage market. They originate and fund loans to borrowers. Primary mortgage market lenders include commercial banks, thrifts, mortgage bankers, credit unions, and others. A mortgage banker is a direct lender that lends its own money, whose principal business is the origination and funding of loans secured by real property. Once a loan is originated, lenders have a choice. Either they can hold the mortgage in their own portfolios or they can sell the mortgages to secondary market issuers. About half of all new single-family mortgages originated today are sold to secondary market issuers. When lenders sell their mortgages, they replenish their funds so they can turn around and lend more money to home buyers. In contrast, a mortgage broker originates loans with the intention of brokering them to lending institutions. Both mortgage bankers and mortgage brokers are loan originators who take residential mortgage loan applications and offer or negotiate terms of a residential mortgage loan for compensation or gain.

Retail Loan Origination

Retail loan origination refers to lenders (banks, thrifts, and mortgage bankers) that deal directly with the borrower and perform all of the steps necessary during the loan origination and funding process. This retail approach to loan origination is an outgrowth of early 20th century banks and savings and loans. A retail lender employs loan officers and commissioned loan representatives to market the lender's mortgage loan products. While the loan officers may stay and work at the lending institution, loan representatives solicit business by talking to real estate agents at local real estate offices. Normally, a retail lender is paid a commission of 1% or more of the loan amount, which is called the origination fee or points. This fee is payable upon funding of the loan, plus any negotiated settlement fees and premiums paid by the purchaser of the mortgage to the lender after funding. As mentioned earlier, lenders may retain some loans in their own portfolios and sell others into the secondary market. These retail lenders often act as servicers when selling the loans into the secondary market. However, their retail presence is an important factor in the origination process.

Warehouse Line of Credit

Since mortgage companies do not have depositors, they use short-term borrowing called a warehouse line or warehouse line of credit. A warehouse line is a revolving line of credit extended to a mortgage company from a warehouse lender to make loans to borrowers. Both the mortgage company and the warehouse lender want to create a profitable business relationship. The mortgage company borrows money on the warehouse line to fund a loan. Steps in Using a Warehouse Line A mortgage company submits a pre-funding loan package to the warehouse lender. The mortgage company borrows money against its warehouse line for that loan and the money is wired to the closing agent to fund the loan. When the loan is closed, the closing agent sends the warehouse lender the original promissory note (endorsed in blank) and a certified copy of the security instrument. The remaining loan documents are sent to the mortgage company. The mortgage company prepares and sends the closed loan package to an investor for purchase. At the same time, the mortgage company asks the warehouse lender to send the original promissory note to the investor. The investor purchases the loan and wires the proceeds directly to the warehouse lender. This repays the warehouse lender for the advance on the line of credit for that particular loan. Any transaction fees due to the warehouse lender are subtracted from the proceeds and the balance is sent to the mortgage company.

Compensating balances

Some banks require commercial borrowers to keep a certain amount of money on deposit as a requirement of the loan agreement. These deposits are called compensating balances. Deposits held as compensating balances by a bank do not earn interest. As a result, the lender's earnings on the loan are increased. Typically, compensating balances are 10% of the loan amount. Commercial banks are generally stock corporations whose principal obligation is to make a profit for their shareholders. Their corporate charters and the powers granted to them under state and federal law determine the range of their activities. Banks can choose a state or a federal charter when starting their business and can convert from one charter to another after having been in business. State-chartered commercial banks are regulated by the responsible state agency but may be members of the Federal Reserve System.

COFI—11th District Cost of Funds Index

The 11th District Cost of Funds Index (COFI) is more prevalent in the West. The COFI reflects the weighted-average interest rate paid by 11th Federal Home Loan Bank District savings institutions for savings and checking accounts and other sources of funds. Unlike the CMT and the LIBOR, this index tends to lag behind market interest rate adjustments. In fact, the COFI is the slowest moving and most stable of all ARM indexes. It smoothes out a lot of the volatility of the market. The COFI is one of the most widely used indexes for option ARMs.

Board of Governors

The Board of Governors (BOG) oversees the Federal Reserve System. It is made up of seven members who are appointed by the President and confirmed by the Senate.

Open Market Operations

The Federal Open Market Committee (FOMC) consists of twelve members—seven members from the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the other eleven Reserve Bank presidents. The purpose of the FOMC is to set the nation's monetary policy. It does this by overseeing the open market operations. Open market operations refer to the purchases and sales of U.S. Government and federal agency securities. Each year, the FOMC holds eight regularly scheduled meetings to review economic and financial conditions and set monetary policy. Its decisions influence the availability and cost of money and credit, which affect a range of economic variables, including output, employment, and the prices of goods and services. The committee also decides whether to change its target for the federal funds rate and, if so, by how much. When implementing open market operations, the Fed buys and sells government securities to influence the amount of available credit. When the Fed buys securities, the banks have more money to lend. When the Fed sells securities, the opposite is true. The open market operations process is the most flexible and widely used technique for expanding or slowing the economy.

Government National Mortgage Association

The Government National Mortgage Association (Ginnie Mae) is a government-owned corporation within the Department of Housing and Urban Development (HUD). Ginnie Mae's focus is to support the market for FHA, VA, and other loans. Unlike Fannie Mae and Freddie Mac, Ginnie Mae does not buy or sell pools of loans. Ginnie Mae does not issue mortgage-backed securities (MBS). Instead, Ginnie Mae guarantees investors the timely payment of principal and interest on MBS backed by federally insured or guaranteed loans—mainly loans issued by the FHA and the VA. In fact, the FHA insures approximately two-thirds of the loans backing Ginnie Mae securities. In contrast to the MBS issued by Fannie Mae and Freddie Mac, all Ginnie Mae securities are explicitly backed by the full faith and credit of the U.S. Government. This is because Ginnie Mae is a wholly owned government corporation.

LIBOR—London Interbank Offering Rate

The London Interbank Offering Rate (LIBOR) is the interest rate charged that major international banks are willing to offer term Eurodollar deposits to each other. A Eurodollar is a dollar deposited in a bank in a country in which the currency is not the dollar. The Eurodollar market has been around for over 40 years and is a major component of the international financial market. London is the center of the Eurodollar market in terms of volume. The LIBOR rate quoted in the Wall Street Journal is an average of rate quotes from five major banks: Bank of America, Barclays, Bank of Tokyo, Deutsche Bank, and Swiss Bank. The LIBOR is an international index that tracks world market conditions. The LIBOR is similar to the CMT and less stable than the COFI. The LIBOR index is quoted for 1, 3, and 6 months, and 1 year. The 6-month LIBOR is the most common.

MTA—Monthly Treasury Average

The Monthly Treasury Average, which is also known as the 12-Month Moving Average Treasury index (MAT), is relatively new. This index is the 12-month average of the monthly average yields of U.S. Treasury securities adjusted to a constant maturity of one year. The MAT index reacts more slowly in fluctuating markets, so adjustments in the ARM interest rate lag behind other market indicators.

National Credit Union Share Insurance Fund

The National Credit Union Share Insurance Fund (NCUSIF) insures the shares and deposits in a credit union. Share insurance is similar to the deposit insurance protection offered by the Federal Deposit Insurance Corporation (FDIC). Most share accounts that have been established properly in federally insured credit unions are insured up to the Standard Maximum Share Insurance Amount (SMSIA), which is $250,000. Insurance coverage on certain retirement accounts such as IRAs and Keoghs is $250,000. Generally, if a credit union member has more than one account in the same credit union, the accounts are added together and insured in the aggregate. However, members may obtain additional separate coverage on multiple accounts if they have different ownership interests or rights in different types of accounts. Members of an insured credit union do not pay directly for share insurance protection. Credit unions pay assessments into the NCUSIF based on the total amount of insured shares and deposits in the credit union. Insured credit unions are required to deposit and maintain 1% of their insured shares and deposits in the NCUSIF. The NCUSIF is backed by the full faith and credit of the United States Government.

U.S. Department of the Treasury

The U.S. Department of the Treasury was created in 1789 to manage the government finances. Alexander Hamilton was the first Secretary of the Treasury. The Secretary of the Treasury serves as a major policy advisor to the President and has primary responsibility for participating in the formulation of broad fiscal policies that have general significance for the economy. The government uses fiscal policy to regulate the total level of economic activity within a nation. Examples of fiscal policy include setting the level of government expenditures and the level of taxation. In addition, the Secretary helps formulate domestic and international financial, economic, and tax policies and helps manage the public debt. The Treasury Department's responsibilities vary from printing and minting all paper currency and coins in circulation (United States Mint) to collecting all federal taxes (Internal Revenue Service).

Red funds rate

The fed funds rate is the rate at which depository institutions trade balances at the Federal Reserve. The Fed influences the supply of money and credit available by raising and lowering the amount of reserves that banks are required to hold and the discount rate at which they can borrow money from the Fed. The Fed also trades government securities (called repurchase agreements) to take money out of or put it into the system. This is called open market operations.

Index

The index is a publicly published number that is used as the basis for adjusting the interest rates of adjustable-rate mortgages. The most common indices, or indexes, are the Constant Maturity Treasury (CMT), the 11th District Cost of Funds Index (COFI), the London Inter Bank Offering Rates (LIBOR), Certificate of Deposit Index (CODI), and the Bank Prime Loan (Prime Rate). Each index has advantages and disadvantages. Each of these indexes moves up or down based on conditions of the financial markets. Some indexes lag behind market changes. Generally, a loan tied to a lagging index, such as the COFI, is better for borrowers when interest rates are rising. Leading index loans, like those tied to the CMT, are best during periods of declining rates. The CMT, COFI, and LIBOR indexes are the most frequently used. Approximately 80% of ARMs are based on one of these three indexes. In most circumstances, if the index rate moves up, so does the interest rate. On the other hand, if the index rate goes down, monthly payments can go down. Not all ARMs allow for a downward adjustment to the interest rate. ARM loan products offer a variety of index options that accommodate individual borrower needs and lender risk tolerances. ARMs with different indexes are available for both purchases and refinances. When an ARM is tied to an index that reacts quickly to market changes, the borrower has the advantage of lower loan payments as interest rates fall. As rates rise, the reverse is true—loan payments suddenly increase.

Interest Rate

The interest rate on an ARM changes periodically, usually in relation to an index, and payments may go up or down accordingly. The interest rate is made up of two parts: the index and the margin. The index is a measure of interest rates and the margin is an extra amount that the lender adds. The initial interest rate is determined by the current rate of the chosen index. Then, a margin, which might be anywhere from 1 to 3 percentage points, is added to the initial interest rate to determine the actual beginning rate (start rate) the borrower will pay. There is usually a limit to how much the interest rate can change on an annual basis, as well as a lifetime cap, or limit, on changes to the interest rate. Some ARMS have an annual maximum increase (cap) of 1.0% to 2.0% and a lifetime cap of 5 or 6 points above the start rate on the loan. Many loans have caps that are greater or less than these caps.

Margin

The lender adds a few percentage points, or margin, to the index to determine the interest rate that a borrower pays. The amount of the margin may differ from one lender to another, but it is constant over the life of the loan. Some lenders base the amount of the margin on the borrower's credit record—the better the credit, the lower the margin the lender adds and the lower the interest on the loan. Margins on loans range from 1.75% to 3.5%, depending on the index and the total amount financed in relation to the property value. When the margin is added to the index, the result is known as the fully indexed rate on the loan. Example: The current index value is 5.5% and the loan has a margin of 2.5%. Therefore, the fully indexed rate is 8.0%. Many adjustable-rate loans (ARMs) have a low introductory rate or start rate, sometimes as much as 5.0% below the current market rate of a fixed-rate loan. This start rate is usually good for 1 month to as long as 10 years. As a rule, the lower the start rate, the shorter the time before the lender makes the first adjustment to the loan.

Money Market

The money market is the interaction of buyers and sellers of short-term money market instruments such as short-term financing and securities. These short-term market instruments may have low or high interest rates, which is part of their risk. The interest rate on a money market instrument is usually set on the date the money is borrowed. While the interest rate is negotiable, it is usually based on some type of index that matures in 1 year or less, such as the federal funds rate or the interest rate paid on certificates of deposit (CDs). When an appraiser uses the cost approach as part of an appraisal, he or she needs to factor short-term borrowing costs into the costs of construction.

Categories of the Money Supply

The money supply is categorized by how quickly the asset can be converted into cash. The Federal Reserve Board tracks and publishes the money supply. Currently, it is measured two different ways—M1 and M2—with M1 being the most liquid. The categories frequently are referred to as monetary aggregates.

Money Supply

The money supply, or money stock, is the total amount of money available for transactions and investment in the economy. It consists of currency in circulation, money in checking accounts, deposits in savings, and other liquid assets. Liquid assets are securities and financial instruments that are converted easily and quickly into cash. Liquid assets include certificates of deposit (CDs), stocks, bonds, mortgage-backed securities, and a variety of other financial assets. Real estate is not considered liquid and, as a result, is not part of the money supply.

Brokerage Firms & Investment Banks

The mortgage-backed securities created by the issuers are marketed by stock brokerage firms and investment banks such as Goldman Sachs, Merrill Lynch, Morgan Stanley, Credit Suisse, Citigroup, Deutsche Bank, and JP Morgan Chase. The Securities and Exchange Commission (SEC) licenses stock brokerage firms to buy and sell securities for clients and for their own accounts. Investment banks help issuers take new bond issues to market, usually by acting as the intermediary between the issuer and investors.

Prime Rate

The prime rate refers to the interest rate that individual banks charge their most creditworthy customers for short-term loans. Because many large banks choose to set their prime rates based on the federal funds rate, the prime rates offered by different banks is similar. Banks use this rate as a base rate when determining the interest rates they charge on commercial loans and on some consumer loan products.

Two Phases and Turning Points of Real Estate Cycle

The real estate cycle, just like the business cycle, has two phases and two turning points. The two phases are expansion (recovery or boom) and contraction (recession or bust). The two turning points are peaks and troughs. An expansion is an increase in the pace of economic activity. Conversely, a contraction is a slowdown in the pace of economic activity. The peak is the upper turning point of a business cycle, and the trough is the lower turning point of a business cycle.

Pass-Through Securities

The simplest mortgage-backed securities are pass-through securities. The pass-through or participation certificate represents direct ownership in a pool of mortgages. They are called pass-throughs because the principal and interest of the underlying loans are passed directly through to investors. Each investor owns a pro-rata share of all principal and interest payments made into the pool as the issuer receives monthly payments from borrowers. Pass-through securities are comprised of mortgages with the same maturity and interest rate. A residential mortgage-backed security (RMBS) is a pass-through MBS that is backed by mortgages on residential property. A commercial mortgage-backed security (CMBS) is a pass-through MBS that is backed by mortgages on commercial property.

Federal Reserve Banks

The twelve Federal Reserve Banks are the operating arms of the central bank. The Federal Reserve Banks handle the Treasury's payments, assist with the Treasury's cash management and investment activities, and sell government securities. They supervise member banks, holding companies, and international organizations that do banking business in the United States. Often called the banker's bank, a Federal Reserve Bank (Reserve Bank) stores currency and coin, processes checks and electronic payments, and operates a nationwide payments system to distribute the nation's currency and coin.

Mortgage Brokers

There is a niche for everyone in the mortgage loan business. A mortgage broker originates loans with the intention of brokering them to lending institutions that have a wholesale loan department. Mortgage brokers are third party originators (TPOs) and not lenders. Mortgage brokers qualify borrowers, take applications, and send completed loan packages to the wholesale lender. The lender approves and underwrites loans and funds them at closing. Usually, mortgage brokers are not authorized to provide final loan approval and they do not disburse money. The loan is funded in the name of the lender and not the mortgage broker. The mortgage broker does not service the loan and has no other concern with it once it is funded. Mortgage brokers coordinate the loan process between the borrower and the wholesale lender and charge an origination fee to provide this service to the borrower. If the lender wants to make 2 points on the loan (2% of the loan amount), the lender charges the points to the borrower and discloses the amount as points on the Loan Estimate or Good Faith Estimate (GFE). A mortgage broker must disclose the same fee on the GFE as a broker fee.

CODI—Certificate of Deposit Index

These indexes are averages of the secondary market interest rates on nationally traded Certificates of Deposit. The 6-month Certificate of Deposit Index (CODI) generally reacts quickly to changes in the market.

Third Party Originators

Third party originators (TPOs) originate but do not underwrite or fund loans. TPOs complete loan packages and act as the mediator between borrowers and lenders. TPOs include mortgage brokers and loan correspondents.

Third party originators (TPOs)

Those who originate but do not underwrite or fund loans are called third party originators (TPOs). This classification includes mortgage brokers and loan correspondents. TPOs package loans for lenders and are paid a commission when the loan is funded. Third party loan origination, which is also called wholesale lending.

Thrifts

Thrifts are the largest single resource for residential mortgage credit. A thrift is an organization formed to hold deposits for individuals. Types of Thrift Institutions: Savings and loan associations Savings banks Mutual savings banks These institutions are referred to as thrifts because they originally offered only savings accounts or time deposits. Now, they offer checking accounts (demand deposits) and make business, consumer, and residential real estate loans. Any thrift can be owned by the shareholders (stock ownership) or by their depositors (mutual ownership). Mutual ownership means that all the depositors share ownership in the savings and loan association, which is managed by a board of trustees. The depositors (investors) in S&Ls, savings banks, or mutual savings banks are paid dividends on their share of the organization's earnings. Mutual organizations issue no stock. On the other hand, if the institution is organized as a stock institution, investors can become shareholders by purchasing stock through their stockbroker. A stock institution is managed by a board of directors who represent the shareholders of the bank. Deposits for thrifts are insured by the FDIC, which was discussed earlier. Thrifts count on short-term deposits from savers, and they loan that money to borrowers for long-term, fixed-rate mortgage loans. Their profit margins diminish in markets where they have to pay a higher interest rate to their depositors than they earn on their long-term loans. If thrifts cannot compete with the higher returns from other sources, depositors, and their money, drift away.

Savings and Loan Associations

Traditionally, savings and loan associations (S&Ls) have played a major role in the economy by pooling the savings of individuals to fund residential mortgages. The first customers of S&Ls were depositors and borrowers. As their customer base grew, the S&L associations became a primary source of loans for financing homebuilding. Prior to 1992, S&Ls were the largest private holder of residential mortgage debt and the largest originator of residential mortgages in the country. Deregulation in the early 1980s allowed the S&Ls to participate in a wide range of investment opportunities. Within less than 10 years, 20% of S&Ls were insolvent, 20% were marginal, and only 60% were financially sound. This led to many S&L failures and caused others to change their charters to become savings banks.

Points

Up-front finance charges, such as points and fees, increase the lender's yield on the loan. Points, or discount points, are calculated as a percentage of the loan amount. One point equals one percentage point. Therefore, 2 points on a $100,000 loan is $2,000.

Adjustable-Rate Loans

When a fixed-rate loan is out of reach or impractical for the borrower, a nontraditional mortgage product, such as an ARM product may meet the borrower's specific financial situation. An adjustable-rate loan or adjustable-rate mortgage (ARM) is a loan with an interest rate that adjusts in accordance with a movable economic index. The interest rate on the loan varies upward or downward over the term of the loan depending on money market conditions and the agreed upon index. The interest rate on the ARM only changes if the chosen index changes. The borrower's payment stays the same for a specified time (for example, one year or two years) depending on the borrower's agreement with the lender. At the agreed upon time, the rate adjusts according to the current index rate. ARMs are complex loans. They are very different from the traditional 30-year fixed-rate loan. An ARM may be the ideal home loan after all the variables are considered. In 2005, ARMs made up about 40% of all home loan originations. ARM share data maintained by Freddie Mac records that ARM shares increased from 11% to 33% between 1998 and 2004. ARMs became more popular because of higher home prices and investor activity. However, the share of ARMs to total home loans changes relative to the cost of the product and the health of the economy. When fixed-rates decline, ARM products are not as attractive to borrowers.

Wholesale Loan Origination

When a lender buys a processed loan from a mortgage broker it is called wholesale mortgage lending. Wholesale loan origination, which is sometimes called third party origination, is the process in which mortgage brokers and loan correspondents originate loans. The third party originator completes the loan application with the borrower; verifies application information such as employment, income, and bank account information; and packages the file for underwriting. When the wholesale lender gets the loan package, the underwriting and funding is completed before the lender pays any premium due to the TPO. Many retail lenders have a wholesale lending division that works with mortgage brokers and loan correspondents (TPOs) for loan origination. However, wholesale lenders that do not have any retail branches rely solely on TPOs for their loans. The lender takes completed loan packages from the TPOs and underwrites the loans. If the lender has both retail and wholesale lending divisions, the TPO is given discounted pricing, which is lower than the rate the retail division offers to the public. Then the TPO adds his or her fee. The result for the borrower is that the loan costs about the same as if it were obtained directly from one of the wholesale lender's retail branches.

Wholesale lenders benefit from the flexibility of the market. If a market declines rapidly, they can: a) start up in a location where the market is attractive. b) pay fewer points to a loan originator. c) hire a larger staff. d) All of the choices apply

a) If a market declines rapidly, a wholesale lender can stop purchasing loans in one geographic area and buy loans in another location where the market is more profitable

CMT—Constant Maturity Treasury

The 1-year Constant Maturity Treasury Index (CMT) is the most widely used index. Nearly half of all ARMs are based on this index. It is used on ARMs with annual rate adjustments. The CMT index is a volatile index that responds quickly to market changes. The CMT index generally reacts more slowly than the CD index, but more quickly than the COFI.

Capital

Capital consists of equity (one's own money) and debt (borrowed money). In other words, if you are going to purchase a home, typically you use some of your own money and a lot of the bank's money.

Cycles

Cycles are periodic, irregular up and down movements of economic activity that take place over a period of 2 to 6 years. Real estate markets are cyclical due to the relationship between demand and supply for particular types of property.

Securitization

Securitization provides liquidity to originators of real estate loans. Securitization is the pooling and repackaging of cash flow that turns financial assets into securities that are then sold to investors. Any asset that has a cash flow can be securitized. Before securitization became prevalent, banks funded real estate loans with their customers' deposits (savings). The availability of credit was dictated, in part, by the amount of bank deposits.