FINANCING

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FANNIE MAE

Fannie Mae was originally a government agency, then became a quasi-public corporation owned by private shareholders, and today is again a government agency. It obtains its capital: by borrowing; by selling long-term notes and bonds in the capital markets; by issuing and selling its own common stock; from earnings from its mortgage portfolio and fees; and from the sale of its mortgage-backed securities.

A borrower paid $50 interest for one month on a loan with an interest rate of 10%. To find the loan balance, first convert the monthly interest to an annualized figure by multiplying by 12. 50 x 12 = $600. Then divide $600 by 10%. This is $6,000. Annual Interest ÷ Rate = Loan Balance $600 (50 x 12) ÷ 10% = $6,000 .

A borrower paid $1,700 interest on a straight note in one year on a $20,000 loan. The rate would be determined by dividing $1,700 by $20,000. It would be 8.5%. Annual Interest ÷ Loan Balance = Rate $1,700 ÷ $20,000 = .085

Interest may be simple or compound. Simple interest is interest paid only on the principal owed. Compound interest is interest paid on accrued (unpaid) interest as well as on the principal owed. For most real estate loans, the interest charged is simple interest.

A borrower who owes $100,000 would be charged interest on the $100,000. When he pays $1,000 of principal to reduce the principal balance to $99,000, the next interest charge will be based on $99,000.

A mortgage broker brings borrowers and lenders together for a real estate loan. It will seldom make or service loans for its own account. After a loan is closed, it will not collect payments or handle any other service functions for the lender. Its function is to take and process loan applications and arrange for lenders to make the loans. As a result, a mortgage broker's transactions involve loans using money belonging to others, not its own money.

A mortgage broker receives a commission or a finder's fee for its services that is paid by the borrower. Some mortgage brokers will arrange for the purchase and sale of existing mortgage loans in the secondary mortgage market, again earning a fee for the service. Occasionally, a lender will even broker a loan when it is unable to provide one requested and earn a fee for the brokerage service.

The basic simple interest formula has three components: Interest Rate Loan balance

Annual Interest = Rate x Loan Balance

In reviewing the credit of the applicant, the lender will analyze his capital, capacity, and character:

Does he have the capital (i.e., down payment) necessary to obtain a loan? The down payment required will depend on the property offered as security, as well as the purpose and type of the loan. The greater the risk: the lower the loan-to-value ratio; and the greater the down payment the lender will require. Does he have the capacity to repay the loan? The lender will look at his employment record. The longer he has been at one job, the better. The lender will also look at other income, including a spouse's income. What is his character, or credit worthiness? The most difficult aspect to evaluate is the applicant's willingness to repay the loan. To help evaluate this aspect, the lender considers credit reports, showing the borrower's history of paying past debts, and his credit score. The credit score is a rating of how the applicant has handled his credit. Scores close to 800 indicate excellent credit and result in favorable terms. Those closer to 600 or below indicate poor credit and result in higher interest rates, higher down payments, or rejection of the application.

The Rural Housing Service (RHS), formerly known as the Farmers Home Administration, was established primarily to make and insure loans to farmers and ranchers unable to secure credit from other sources. Among its programs, the RHS has made financing available in rural areas for the purchase, repair and rehabilitation of housing occupied by low-to-moderate-income families and senior citizens.

For low-income borrowers, RHS offers a direct loan program through which it subsidizes a part of the mortgage payments. For moderate-income borrowers, the RHS has a guaranteed loan program similar to that offered by the federal VA. Under this program, the borrower obtains a loan of up to 100% of the property value from a private lender and pays a funding fee so the RHS will guarantee the lender against loss resulting from default by the borrower.

Conventional loans are loans made by private parties and nongovernment lending institutions without any government insurance or government guarantee against loss for the lender. Conventional loans may be uninsured or insured. One factor affecting a lender's risk of loss is the amount of the borrower's down payment. A lender could reduce his risk by requiring a substantial down payment. When a buyer cannot afford such a down payment, the lender may require mortgage insurance.

Generally, a conventional loan of up to 80% of the property's value will be made without mortgage insurance. To compensate for the greater risk when the loan is above 80% of the value, some lenders charge higher interest rates, but most require that the loan be insured by a private mortgage insurance company. The borrower pays the insurance premium for the policy that insures the lender against loss in the event of a foreclosure. The premium and the insurance stop once the loan is paid down to 80% of the value of the property at the time the loan was taken. In the event of a default, the insurance company will either pay off the loan or let the lender foreclose and pay the lender for its loss.

GINNIE MAE

Ginnie Mae is a government corporation within HUD. It has three major activities: Manage and liquidate a portfolio of federally owned mortgages Provide special assistance functions, such as financing support for urban renewal projects, housing for the elderly, below-market mortgage risks and experimental housing projects, for which financing is not readily available Guarantee pass-through securities (backed by pools of FHA, VA or RHS mortgages) privately issued by approved financial intermediaries

Although a mortgage banker may also provide mortgage brokerage services, the mortgage banker differs from the mortgage broker in that, as a mortgage banker, it will use its own money to make loans and does not need the consent of anyone else in making the loan.

However, the mortgage banker is generally not the ultimate lender. Because mortgage bankers do not hold funds belonging to depositors or investors, they often do not have a large amount of loan funds of their own. They prefer to negotiate loans that are most readily salable in the secondary market. As a result, mortgage bankers are very active in making government-insured and government-guaranteed loans, conventional loans for one- to four-family properties, and large construction and development loans for which they have identifiable purchasers. In many cases, a mortgage banker will make a loan only after obtaining a commitment to purchase the loan from a savings bank, bank, insurance company, Fannie Mae, Freddie Mac or other investor. In other instances, the mortgage banker may make the loan and then sell it to the most suitable lender on an individual case-by-case basis.

GINNIE MAE

In 1968, when Fannie Mae was rechartered as a private corporation, Congress created the Government National Mortgage Association, today known as Ginnie Mae (GNMA), to administer support programs for FHA, VA and RHS mortgages which could not be carried out in the private market.

FREDDIE MAC

In 1970, Congress created the Federal Home Loan Mortgage Corporation, today called Freddie Mac (FHLMC), in order to provide a secondary mortgage market for members of the Federal Home Loan Bank System (primarily savings and loan associations).

The Office of Federal Housing Enterprise Oversight (OFHEO) sets the criteria on what constitutes a conforming loan limit that Fannie Mae and Freddie Mac can buy. The criterion includes debt-to-income ratio limits and documentation requirements. The maximum loan amount is set based on the October-to-October changes in median home price, above which a mortgage is considered a jumbo loan, which typically has higher rates associated with it.

In general, any loan which does not meet guidelines is a nonconforming loan. This is because both Fannie Mae and Freddie Mac only buy loans that are conforming to sell to the secondary market, making the demand for a nonconforming loan much less than conforming loans. It is more difficult for lenders to sell nonconforming loans. As such, these loans tend to cost more to consumers, typically ¼ to ½ of a percent.

Fiscal policy is action by Congress to increase or decrease income taxes. To slow the economy and halt inflation, Congress can increase income tax rates, limiting the amount people can spend or save. To stimulate the economy, the government can lower taxes to give people more money to spend, save or invest.

Monetary policy is regulation of the supply and flow of money and credit available in order to promote economic growth with stability. Monetary policy is controlled by the Federal Reserve System.

Three types of transactions normally occur in the secondary mortgage market:

Mortgage warehousing, where a lender (usually a mortgage banker) assembles a number of loans into a portfolio and offers the package as security for a short- term loan or line of credit from another lender, such as a commercial bank, giving the primary lender funds with which to operate until the loans can be sold Buying and selling individual mortgage loans Forming a group or pool of mortgage loans and issuing securities backed by the pool.

The Federal Reserve System (the Fed) monitors economic and financial conditions, such as the volume of bank deposits and withdrawals, the cost of money and credit, unemployment levels, inflation rates and world economic conditions, and applies various controls or pressures to influence the supply of money and credit available in the economy. To achieve its goals, the Fed uses three basic tools: Reserve requirements Discount rates Open market operations

The Fed establishes reserve requirements for all member banks. Member banks must set aside and keep a certain percentage of their assets as reserves. When the Fed increases its reserve requirements, banks have less money to lend, interest rates rise and borrowing and spending slow down. When the Fed decreases the reserve requirement, banks have more money to lend, causing interest rates to decrease and borrowing and spending to increase. Generally, the Fed makes changes in reserve requirements only as a last resort, since even minor changes have a dramatic impact on the money supply. The Fed will loan money to member banks to enable those banks to have adequate funds in reserve. The interest rate the bank pays the Fed for these funds is the discount rate. The Fed may decrease the discount rate to encourage bank borrowing and reduce bank expenses so that banks are able to lend more money at lower interest rates. The Fed might increase the discount rate when it wants to discourage bank borrowing and decrease the supply of funds banks have available to lend. Open market operations refers to the purchase and sale of U.S. Treasury securities, such as Treasury bills and notes. This is perhaps the most flexible and frequently used tool of the Fed for expanding or slowing the economy. The Fed, through the Federal Reserve Bank of New York, trades securities almost daily in order to influence the availability and cost of money and credit. When the Fed buys government securities from the public, it stimulates the economy because the cash paid to the sellers is deposited into the sellers' bank accounts. This increases the banks' reserves, allowing the banks to extend more credit to borrowers. However, if the Fed is selling securities, buyers will withdraw funds for payment from their banks, decreasing reserves in their banks, making less credit and lending available through the banking system. This activity also affects the federal funds rate. This is the interest rate a bank with surplus reserves will charge for an overnight loan to a bank needing additional funds to meet its reserve requirement.

FANNIE MAE

The largest investor in the secondary market is Fannie Mae (FNMA). FNMA was originally created to buy FHA Title II mortgages to keep the market for FHA loans liquid and stabilize the mortgage market by increasing the amount of money available for credit financing of housing. Today, Fannie Mae's primary responsibility is to maintain an active secondary market for mortgages. To do this, it purchases FHA and VA mortgages and conventional fixed- and adjustable-rate first and second mortgages secured by one- to four-family homes. Lenders wishing to sell loans to Fannie Mae will pay a fee to Fannie Mae for a commitment that Fannie Mae will purchase a certain dollar volume of loans at a certain yield over a specified period of time (e.g., 90 days, 180 days). These may be loans that have not yet been made, as well as loans currently in the lender's portfolio.

To limit the expansion of the economy and put the brakes on inflation, the Fed might: sell government securities. raise reserve requirements. raise the discount rate.

To stimulate the economy by relieving a tight money market and encouraging banks to reduce interest rates, the Fed might: buy government securities. lower reserve requirements. lower the discount rate.

FREDDIE MAC

Today Freddie Mac is authorized to buy mortgages from all types of lenders. It purchases mostly conventional mortgages but will also purchase FHA and VA loans. Like Fannie Mae, Freddie Mac issues and guarantees mortgage-backed securities secured by loans in its portfolio.

FANNIE MAE

Under the Fannie Mae mortgage-backed securities plan, lenders may sell a pool of mortgages in exchange for a like amount of securities (called participation certificates) that represent individual interests in the pool of loans. The lender may keep the securities or sell them to investors. Mortgage payments received from the mortgagors, less servicing costs and certain fees, are passed through to those holding the securities. Fannie Mae will guarantee full and timely payment of principal and interest to those holding the securities.

The federal Department of Veterans Affairs (VA) loan program was created to assist veterans in purchasing homes. A VA loan is available only to an eligible veteran, reservist, or National Guard member to finance a home he intends to occupy. The loan may be used to: buy or build a one- to four-family home, including a townhouse or condominium unit. improve a home. refinance an existing home loan. buy a manufactured home and/or lot on which to place such a home.

VA loans are not made by the VA. They are made by private lending institutions. Although these institutions are not directly regulated by the VA, they do need VA approval to participate in the program. The VA will guarantee the lender against loss on a portion of the loan if the borrower defaults and the lender must foreclose.

FREDDIE MAC

When loans are sold in the secondary mortgage market, the purchaser may pay the seller the amount owed on the loan, or more or less, depending on the interest rate and whether it is fixed or variable; the time remaining until the loan will be paid off; and the yield or return the purchaser desires. A loan sold for more than the outstanding balance because its interest rate is above current market rates is said to sell at a premium. Selling loans for less than the balance (at a discount) is called discounting.

Inflation occurs when there is more money to spend on a limited number of available items. As demand for these items pushes their price up, the result is a decrease in the purchasing power of the dollar. This will cause investors to place their money into equity assets such as real estate, which typically experience an increase in their prices in times of inflation, to reflect the loss in value of the dollar.

When there is deflation, the purchasing power of the dollar is increased because there are more goods in relation to the money available for buying them.

Mortgage companies make money by charging:

an application fee for securing the application. a loan origination fee, generally in an amount equaling one to two percent of the loan amount as its commission for processing the loan package. a servicing fee of a quarter to three-quarters percent of the loan balance each year for servicing the loan.

Mortgage bankers will often contract with the lending institutions for which they originate loans to service the loans they have sold. Mortgage servicing consists of:

collecting principal and interest payments due on the mortgage; collecting impounds or reserves for property taxes and insurance; paying the appropriate bills when due; handling problems with late or delinquent payments and, if necessary, foreclosing.