REAL 4000 Quiz 3

Exculpatory Clause

Clause negotiated in the note that releases the borrower from liability for fulfillment of the contract; Referred to as Nonrecourse Loans - While they relieve the borrower of personal liability, they don't release the property as collateral for the loan - In practice, mod standard home loans & income-property mortgage loans from commercials banks have personal liability while most nonbank income-property mortgage loans do not

Escrow Clause

a.k.a. Impound Clause; Requires a borrower to make monthly deposits into an escrow account of money to pay such obligations as property taxes, community development district (CDD) obligations, casualty insurance premiums, or community association fees - Lender can use these escrowed funds only for the purpose of paying the expected obligations on behalf of the borrower

2 leading procedures among states of the U.S. in treatment of defaulted mortgages:

1) In states requiring judicial foreclosure, the sale of the foreclosed property must be thru a court-administered public auction 2) In states having the power of sale, sometime referred to as nonjudicial closure, either the mortgagee (lender) or the trustee (for a deed of trust) conducts sale of the property; In using this power, the mortgagee or trustee must abide by statutory guidelines that protect the borrower: Typically, they must give proper legal notice to the borrower, advertise the sale properly, & allow a required passage of time before the sale - The power of sale is advantageous to the lender because: In almost all cases, it's faster & cheaper than a court-supervised auction; & Further, with a deed of trust, the borrower has no statutory right of redemption, which further shortens the process, ending it with finality at sale of the property

3 reasons why a borrower may regard quantitative analysis of the refinancing decision as overstating the benefits

1) Income tax deductions may reduce the benefit of refinancing 2) Rates may fall subsequent to refinancing, providing an even more beneficial opportunity 3) The experience of refinancing may be time-consuming and stressful for many homeowners --> Thus, the net benefit computations are "upper bounds" on the benefit of refinancing

Home Equity Loan

A form of second mortgage, home equity loans owe their popularity to lower interest rates, longer terms than other consumer debt, tax-favored status, & easy availability, not to mention aggressive marketing by lenders > Although traditionally used to finance home improvements, home equity loans have become all-purpose loans

Partially Amortizing

A loan may pay down partially over a certain number of years, but may require an additional [large] payment of principal with the last scheduled payment

Nonamortizing

A loan that requires interest but no regularly scheduled principal payment prior to the last payment

Negative Amortization (2)

A loan's scheduled payment is insufficient to pay all of the accumulating interest, causing some interest to be added to the outstanding balance after each payment shortfall, increasing the loan amount

Role of FHA in Reverse Mortgages

A vital step in the development of reverse mortgages was the creation of reverse mortgage insurance (1987 creation of the FHA Home Equity Conversion Mortgage program) > Set the framework, in large part, for acceptable forms of the mortgage > Provides guidelines for maximum loans that depend on the age of householders & the value of the resident; It provides for a variety of acceptable disbursement plans, including lump sum, annuity (level payment), and credit line > Provides mortgage insurance for reverse mortgages originated by FHA-approved lenders (more specifically, if the proceeds from the sale of the home aren't sufficient to pay the amount owed, HUD will pay the lender the amount of the shortfall) - The Economic & Housing Recovery Act of 2008 enacted several changes that may bolster the growth of HECMs; Raised the loan limits to correspond w/ GSE loan limits, Limited upfront fees, & Prohibited lender tie-in contracts for other financial services

Assumable Loan

An Assumable Loan means that the buyer can preserve the existing loan by signifying the note, & thus assuming the obligation (Federal Housing Administration & Veterans Affairs loans are assumable, as long as the buyer can qualify for the loan)

The actual interest rate charged per month is the...

Annual stated contract interest rate divided by 12, multiplied by the beginning-of-month balance - Payment is due on the first day of the following month

Rate Caps

Any change to an ARM adjustable rate commonly is restricted by 2 kinds of limits, or caps: Periodic Caps & Overall Caps - Periodic caps limit change in the interest rate from one change date to the next - Overall caps limit change over the life of the loan - Typically, the caps are binding for both increases & decreases in the index

Piggyback Mortgages

Conventional home mortgage loans exceeding 80% of value generally require private mortgage insurance, so there's incentive to keep the loan within that limit, but many buyers can't pay 20% down > Second mortgage lenders responded w/ the piggyback loan, a second mortgage created simultaneously w/ the first mortgage for 10% of value or more - thus, the borrower could obtain 90% financing or greater while avoiding the cost of private mortgage insurance - The piggyback could be fixed or adjustable rate, w/ a relatively high interest rate & a term much shorter than the term of the underlying first mortgage

Foreclosure (2)

Costly process to all involved: - First, the legal search & notification can be costly, time consuming, & risky in that it may be difficult to identify all claimants to the property - Second, the sale of the property typically is a distressed sale for a number of reasons: The property often suffers deterioration, or deliberate abuse, it tends to be tainted & less marketable, normal market exposure of the property isn't feasible, the title is sufficiently questionable so that debt financing for the purchase usually isn't available, and, in many cases, the mortgagor may still be able to exercise the statutory right of redemption - Consequently, the price received at a foreclosure sale tends to be low - Finally, the negative public exposure & the time involve dust be counted as a cost for all parties involved; The net recovery by a lender from a foreclosed loan seldom is higher than 80% of the outstanding loan balance & commonly is much less; As a result, mortgage lenders traditionally have had a strong incentive to avoid loans w/ high foreclosure risk, and it's not surprising that their lending practices traditionally have tended to err on the side of safety

Thrifts

Depository institutions that evolved primarily to collect and invest household savings; Usually the term encompasses (former) savings and loan associations and savings banks, but not credit unions > Thrifts invested largely in home mortgage loans, and for well over a century, until about 1980, were the backbone of home mortgage finance in the United States

Short Sale

If a homeowner in mortgage distress owes more than the value of the home & is unable to make the loan manageable by refinancing or modifying the mortgage, the next recourse often is a SHORT SALE - Owner gives a letter of appeal to the lender, with whatever documentation the lender requires, establishing the case of distress; - If the lender accepts the appeal, the owner must obtain a contractual offer from a buyer; If the lender decides that the offer is acceptably close to fair market value, the buyer pays the lender, & the seller is relieved of some or all of the outstanding balance on the mortgage - This doesn't relieve the seller of any other outstanding obligations on the home, such as owner association fees or a second mortgage, so the owner must either satisfy those obligations or negotiate separately for a resolution that is acceptable to the creditor - The short sale solution has several attractions: It usually enables a better sale price & a faster sale than foreclosure, and it's more likely to provide the lender a clean end to the case than foreclosure or deed-in-lieu of foreclosure; Legal costs should also be lower; It thus benefits both borrower & lender; In addition, it is less damaging to the borrower's credit, allowing her to be eligible for another mortgage loan in, say, 2 years rather than 7, as with foreclosure

Due-on-Sale Clause

If a property is sold, either in fact or in substance (i.e. thru a lease w/ an option to buy), a due-on-sale clause gives the lender the right to "accelerate" the loan, requiring the borrower to pay it off - Protects the lender from degradation in the quality or reliability of the person(s) paying the loan - The presence or absence of a due-on-sale clause is a major distinguishing feature between basic classes of home mortgage loans - So-called conventional home loans almost always contain a due-on-sale clause, giving the lender the right to terminate the loan at sale of the property - By contrast, Federal Housing Administration & Veterans Affairs loans are assumable, as long as the buyer can qualify for the loan... -->

Subprime Loans

Loans made to homeowners who don't qualify for standard home loans, which commonly have very costly prepayment penalties that "locked in" the borrower to a very high interest rate

Primary Mortgage Market

Loan origination market, in which borrowers & lenders come together - Numerous institutions supply money to borrowers in the primary mortgage market, including savings & loan associations, commercial banks, credit unions, & mortgage banking companies - Increasingly, this lending has been done thru a mortgage broker

Mortgage Bankers

Mortgage bankers combine a small portion of equity w/ vast amounts of borrowed capital to originate loans; They then sell the loans as rapidly as possible, either by issuing mortgage securities or by selling the loan to someone else to do so; The home loans originated by mortgage bankers are usually either FHA or VA loans or are conforming loans that meet the purchase requirements of Fannie Mae and Freddie Mac; The guarantee or insurance and underwriting standards for these loans mitigate much of the default risk of home mortgage loans for lenders, allowing the loans to be more easily sold to investors in the secondary market > The mortgage banking process creates 2 valuable financial assets: the loan and the rights to service the loan > The process begins with the loan application of a borrower; The loan always is sold, but thru a variety of ways; Since the servicing rights are the profit center of mortgage banking, they may be retained or sold, depending partly on the size of the firm

Secondary Mortgage Market

Mortgage originators can either hold loans in their portfolios or sell them in the secondary mortgage market - The largest purchasers of residential mortgages in the secondary mortgage market are Fannie Mae & Freddie Mac; These government-sponsored enterprises (GSEs) were created by acts of Congress to promote an active secondary market for home mortgages by purchasing mortgages from local originators - The existence of a well-functioning secondary market makes the primary mortgage market more efficient; If mortgage originators are able to sell their mortgage investments quickly, they obtain funds to originate more loans in the primary market - The GSEs have played a leading role in the home mortgage market; The menu of loans that the GSEs are willing to buy has heavily influenced the menu of loans that lenders are willing to operate

Mortgage Brokers

Operates quite differently from a mortgage banker in that a broker doesn't actually make loans - Instead, a mortgage broker specializes in serving as an intermediary between the borrow (customer) and the lender (client) > Many mortgage brokers serve as correspondents for large mortgage bankers who desire to do business in an area where the volume of business doesn't justify the expense of staffing a local office; Frequently, the broker is a small, or even medium-size, bank, thrift, or CREDIT UNION

Payments

Payments on standard mortgage loans are almost always monthly; - Further, most standard, fixed rate home loans are level payment & fully amortizing (they have the same monthly payment throughout, & the payment is just sufficient to cover interest due plus enough principal reduction to bring about full repayment of the outstanding balance at exactly the end of the term) - "Amortizing" refers to repayment through a series of balance reductions

Chapter 13 Bankruptcy

Similar to Chapter 11, but applies to a household - Allows the petitioner to propose a repayment plan to the court - In principle, the plan may not interfere w/ the claims of a mortgagee upon the debtor's principal residence, but it's likely to forestall any foreclosure proceeding & to allow any arrearages on the loan at the time of the bankruptcy filing to be paid back as part of the debtor's rehabilitation plan; Thus, the lender suffers delay in recovery, if not worse

Payment Cap

Some lenders offer ARM home loans w/ caps on payments rather than on the interest rate - Enables the lender to enjoy the advantage of unconstrained interest rate adjustments while protecting the borrower against the shock of large payment changes - e.g. While the actual interest rate may be allowed to adjust w/o limit, the payment may be capped at increases of no more than 5% in a single year; Thus, if the payment in the initial year of a loan w/ annual payment adjustments is $1,000 and there is a 5% payment cap, then the maximum payment in year 2 is $1,050 regardless of how much the interest rate (index plus margin) increases

Mortgage

Special contract by which the borrower conveys to the lender a security interest in the mortgaged property - Because the property is being pledged by the action of the borrower, the borrower is referred to as the "mortgagor," or grantor of the mortgage claim - The lender, who receives the mortgage claim, is known as the mortgagee

Bankruptcy & Foreclosure

The risk of bankruptcy tends to travel w/ the risk of foreclosure since both can result from financial distress - When the financial condition of a firm or individual is such that total assets sum to less value than total liabilities, bankruptcy is a possibility - While traditional bankruptcy has little effect on foreclosure, more modern forms can interfere significantly - 3 types of bankruptcy must be distinguished, known by their section in the Federal Bankruptcy Code: Chapter 7, liquidation; Chapter 11, court supervised "workout"; Chapter 13, "wage earner's proceedings"

Commercial Banks

The core business of commercial banks has been to make short-term loans to businesses for inventory financing and other working capital needs; But a very important adjunct of this business always has been to meet the real estate finance needs of business customers, including financing their homes; While many banks expanded their home mortgage lending business beyond business customers, rarely did they make it a dominant element of their business > Larger commercial banks have traditionally provided funds for real estate finance in two other ways besides home mortgages: 1) They make short-term construction loans that provide funds for the construction of multifamily, commercial, and industrial buildings; The timing and risks of construction lending aren't unlike business inventory lending, and therefore tend to be natural for banks; Thus, they have traditionally dominated the commercial construction lending business 2) Some large commercial banks also have specialized in providing short-term funds to mortgage banking companies to enable them to originate mortgage loans and hold the loans until the mortgage banking company can sell them in the secondary mortgage market; This type of financing is termed "warehousing" because the mortgage bankers put up the originated loans as security for the bank financing and the loans are "stored" (at the bank or with a trustee) for a relatively short time > We return to the question of how banks flourished while thrifts died: First, banks were better able to survive the asset-liability mismatch that ravaged the thrifts; They always were more diversified due to the nature of their business, and note that many of their real estate assets were of much shorter maturity than the dangerously long-lived fixed-rate home mortgage loans > A second major help to banks during this time was deregulation and resulting bank consolidation; The same initial legislation that deregulated thrifts, DIDMCA, began a series of empowerments to commercial banks that ultimately led the industry to a profound transformation; Powers that banks had lost by the reforms of the early '30s slowly were regained they a complex sequence of state legislative actions, Congressional actions, and regulatory changes; This transformation in their governing framework was essentially completed in '94; In the process, banks regained powers to engage in insurance and securities businesses, in real estate investment and envelopment, and gained the ability to engage in interstate branching, acquisitions, and mergers; In mortgage lending, it seems that these new powers set banks up to get themselves into deep distress 10 years later > Parallel to the broadening of bank powers came significant changes in the workings of bank regulation; Historically, the regulatory framework of banking was labyrinthine; State chartered banks generally were regulated by their state, the FDIC, and the Federal Reserve System (Fed); Federally chartered banks were regulated by the Office of the Controller of the Currency, by the FDIC, and by the Fed > This system was to replete w/ duplication of requirements and conflicting rules; Thus, a crucial part of the transformation was elimination of much of the duplication and inefficiency in regulation, permitting larger, more complex, multistage operations; Out of this transformation in bank powers and bank regulation, completed in the mid-'90s, came the megabucks of today hungry for aggressive new ventures > The birth of megabucks had major implications for home mortgage lending; Several megabucks identified megascale residential mortgage banking as a business opportunity of choice; Wells Fargo, Bank of America, J.P. Morgan Chase & Co., Citigroup, and other banking groups devoured or created mortgage banking subsidiaries that now are among the largest mortgage lenders in the country, and have reached unprecedented levels of market share

Margin

The lender's "markup," which is added to the index of the adjustable rate - Determined by the individual lender & can vary with competitive conditions & w/ the risk of the loan - Normally is constant throughout the life of the loan - Margins frequently are lower for home equity loans made by banks

Option ARM

The loan allowed the borrower to switch among a variety of payment arrangements > One common form allowed the borrower to select from a fully amortizing payment, interest only, or a minimum payment; It's the minimum payment that distinguishes the loan, & is the one that most borrowers are reported to have selected > The minimum payment was based on an extremely low interest rate, well below the actual rate charged; The payment would increase in yearly steps, but unpaid interest would cause the balance to grow; After around 5 years, the payment would adjust to a fully amortizing level to pay off the new, larger balance; This final payment increase typically was severe, & often unmanageable for the borrower, compelling her to refinance - This minimum option had a toxic attraction that allowed it to do far more harm than good

Lien Theory

The mortgage gives the lender the right to rely on the property as security for the debt obligation defined in the note, but this right only can be exercised in the event of default on the note

Equity of Redemption

The mortgagor's right to stop the foreclosure process by producing the amount due & paying the costs of the foreclosure process - This right traditionally extends up to the time of actual sale of the property, and in 20 states, has been extended further, to some time beyond the sale of the foreclosed property

Pipeline Risk

The period between loan commitment and loan sale exposes mortgage bankers to considerable risk called the pipeline risk > Assume during a given week that a lender commits or originate and fund a number of 30-year fixed-payment mortgages; These commitments are added to the originator's MORTGAGE PIPELINE (a term used to describe loans from the time a lender has made a commitment to lend thru the time loans are sold to an investor) > Also, assume borrowers choose to lock in a 5% contract rate when they receive the commitment; The approved borrowers often have 45-60 days to close ("take down") the loans - If mortgage interest rates decline, some of the borrowers may choose not to close the loan at the end of the 45-60 days because, in the meantime, they have obtained a lower rate from another lender - This potential loss of borrowers is called pipeline FALLOUT RISK > If interest rates rise after the lender makes the commitment at 5%, a larger percentage of loans in the pipeline will close because borrowers will be unable to find a better deal; However, rising rates bring another risk: The contract rate at closing will be less than the current market rate & the mortgage banker will have to sell the newly originated loan at a discount (for LESS than the amount originated) - This threat is called INTEREST RATE RISK > Interest rate risk & resulting price declines over the loan pipeline cycle can be disastrous to a mortgage banking firm; Many firms have disappeared overnight by not being prepared for it, THUS, mortgage bankers seek to hedge the risk; One hedging technique is to purchase a FORWARD COMMITMENT from a secondary market investor w/ a prespecified future selling price; This commitment obligates the secondary market investor to purchase, and the mortgage banker to sell, a pre specified dollar amount of a certain type of loan > Mortgage bankers know from experience that only part of the loan commitments they issue will be taken down by the borrowers; For this reason, they often purchase standby forward commitments from secondary market investors that given them the right, but not from obligation, to sell a certain dollar amount of a certain loan type to the issuer of the standby commitment; If a larger than expected portion of the loans in the mortgage banker's pipeline are taken down by borrowers, perhaps because interest rates have risen, the option to sell the mortgages is exercised by the mortgage banker; However, if mortgage rates have fallen over the commitment period and an unexpectedly large amount of pipeline fallout occurs, the mortgage banker isn't obligated by the standby commitment to deliver mortgages that aren't in hand > The top part represents the portion of the pipeline the lender is confident will be taken down by borrowers, regardless of changes in interest rates (this portion exposes the lender to interest rate risk, but since it's predictable in the amount, it can be hedged by obtaining forward commitments, which effectively presell the loans); The bottom portion of the pipeline represents the loans the lender strongly expects not to be taken down (this portion doesn't need to be hedged at all); The middle portion of the pipeline is the most complex - it exposes the lender to interest rate risk if interest rates rise, but to fallout risk if rates fall, Thus, the lender can't simply "sell forward" this portion of the loans as with the first portion - The mortgage banker is willing to buy a costly standby forward commitment to be protected against interest rate increases, and not have to deliver if this portion of the pipeline isn't taken down by borrowers - Experience & an understanding of current interest rate expectations dictate the relative size of the 3 rectangles - Management of the pipeline risk is uniquely critical to the safety of a mortgage banking firm - Therefore, the person responsible for it is a crucial individual in the company, & typically very well rewarded for bearing this responsibility

Mortgage vs. Deed of Trust

The two types of contracts generally have identical elements except for one provision: Power of Sale

Demise of Thrifts

The system of thrifts worked exceedingly well in the years following WWII to finance the post-war exodus of households from the central cities to their dream homes in the suburbs; Despite a fatal vulnerability, an asset-liability maturity mismatch, the world of thrifts was rosy because interest rates remains low and stable > But the thrifts became victims of their own system; When Congress created deposit insurance to save depository institutions from the financial panic of the Great Depression, in return for this salvation it also cocooned them in a vast array of regulations to assure their "safety and soundness" -- These regulations, which fiercely protected the local thrifts and banks, also preserved the localized system of real estate finance into the late '70s > However, the economic world changed dramatically during the '70s; Names like Sony, Toshiba, Honda, Toyota, and others largely unrecognized in the US became household words > Suddenly the US economy and financial system were far more international than Congress, financial regulators, or even depository managers have ever conceived, which brought tides in the flows of capital funds never before seen, and interest rate volatility previously unknown -- This change converged w/ an overheated economy in the late '70s tat began to fuel the fires of inflation; Meanwhile, as housing demand boomed - What better way to hedge inflation than to buy a bigger house? - Thrifts were creating record numbers of 30-year, fixed-rate home loans, funded by short-term local deposits, and the good times rolled like never before > But the shit hit the fan in the late '70s when money market funds were born and savers suddenly could get a decent return on their short-term savings from Wall Street -- Disintermediation raged as huge blocks of savings were diverted from thrifts to Wall Street, and then, in 1979, the good times collapsed > The Federal Reserve saw fit to "declare war" on inflation by restricting the growth of the money supply, and the result was catastrophic to the old housing finance system in the US; Suddenly, thrifts, gorged w/ new 30-year fixed-rate home loans, saw the cost of their deposits rise to, and even go above, the yield on their loan portfolios > In substance, a large percentage of thrifts were permanently crippled or dead at that point; Their net worth would be ravaged before rates began to fall in the mid-'80s, and most were left weak and vulnerable, if not desperate, thereafter > But savings associations were "money machines" that, thanks to deposit insurance, could continue to attract savings and pay interest out of their mortgage loan cash flows even as they "bled to death" thru capital losses -> For the next decade, thrifts went they an inexorable and turbulent demise, and as they fell, they created widespread "collateral damage" to overwhelmed regulators, to pressured members of Congress, and to taxpayers > In 1989 Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which took major steps to establish depository institution accountability; The act finally created long-called-for risk-based capital standards for depository institutions requiring them to hold more capital as they hold riskier assets; Its goal was to supplant the conventional regulatory approach of attempting to suppress risky behavior thru restrictions - an approach that was always one step behind the actions of banks or thrift managers, and that ignored the incentives to engage in the risky behavior; FIRREA affected many aspects of the mortgage lending business, including the portfolio (asset) requirements of regulated lenders, the licensing of real estate appraisers, and the minimum capital requirements of depository institutions > As a result of the closing of weak thrifts and the strengthening of capital requirements, the industry of the late '70s shrank drastically in numbers, asset size, and its share of mortgage lending; The experience of the thrifts points out the interdependency of financial systems and the larger economic environment

Chapter 7 Bankruptcy

Traditional form of bankruptcy wherein the court simply liquidates the assets of the debtor & distributes the proceeds to creditors in proportion to their share of the total claims - Because Ch. 7 involves a quick liquidation of assets, it doesn't disturb liens, & the power to foreclose remains; In short, Ch. 7 proceeding typically won't seriously threaten the security interest of a mortgagee

Description of Property

Unambiguous; by metes & bounds, by government rectangular survey, or by recorded subdivision plat lot & block #

Title Theory

Under traditional English common law, a mortgage temporarily conveyed title of the property to the mortgagee/lender - Has been largely replaced by the more modern Lien Theory...

Purchase-Money Mortgage (PMM)

Whenever a mortgage is created simultaneously with the conveyance of title, it's a purchase-money mortgage - The term usually refers to a mortgage from a buyer to a seller; Most frequently this is a second mortgage - Such mortgages often occur in transactions involving single-family homes > Their primary functions are to provide purchasers w/ higher loan-to-value ratios than they're able or willing to obtain from a traditional mortgage lender, to provide purchasers w/ a lower cost of financing than is generally available, or to provide both

Hazardous Substances Claus and Preservation & Maintenance Clause

- A lender wants to protect the loan security from damage due to negligence or excessive risk taking by the borrower; Therefore, the borrower is prohibited from using or storing any kind of toxic, explosive, or other "hazardous substance" on the property beyond ordinary, normal use of such substances - In addition, the borrower is required to maintain the property in essentially its original condition - Failure to meet either of these provisions constitutes default

Acquiring a Property with an Existing Debt

- As long as the buyer doesn't add his/her signature to the note, the buyer takes on no personal liability, although the property still serves as a security for the loan & can be foreclosed in the event of default; In this case, the buyer is said to purchase the property "SUBECT TO" the existing loan; The seller remains personally liable for the debt and is said to "stand in surety" for the obligation, which means that in the case of default, a lender who fails to obtain satisfaction from the current owner or from the property can go "up the line" to the original borrower; - The seller or original borrower may not be comfortable with this contingent liability from the loan; A solution is to have the buyer add his/her signature to the original note, and obtain from the lender a RELEASE OF LIABILITY from the note; In this case, the buyer is said to assume the old loan, that is, to ASSUME LIABILITY for the note - An important characteristic of a loan is whether or not a subsequent owner of the property can preserve it; a feature known as ASSUMABILITY, which is a major distinguishing feature between the broad types of home loans

Deed of Trust

- Commonly used in place of a mortgage - The borrower conveys a deed of trust to a trustee, who holds the deed on behalf of both borrower & lender - If the loan obligation is paid off in accordance w/ the note, the trustee returns the deed to the borrower; But if the borrower defaults, the trustee usually can exercise the power of sale to dispose of the property on behalf of the lender - Compared to a mortgage, the power of sale process offers significant advantages to a lender

What the NOTE tells you:

- Computation of the interest rate (if adjustable) - Whether a loan can be paid off early (& at what cost) - Whether there's a personal liability for a mortgage - What fees can be charged for late payments - Whether the loan must be repaid upon sale of the property - Whether the lender has the right to terminate the loan, calling it due

Major Clauses in a Standard Home Loan Mortgage

- Description of the Property - Insurance Clause - Escrow Clause - Acceleration Clause - Due-on-Sale Clause - Hazardous Substances Clause and Preservation & Maintenance Clause

Term

- If a loan isn't fully amortizing, it will have 2 terms: 1) A Term for Amortization that determines the payment, as the schedule of interest and principal payments, just like a fully amortized loan 2) Term to Maturity that determines when the remaining balance on the loan must be paid in full (often called a Balloon Loan); Balloon Loans have become the dominant form of mortgage loan for income-producing property

Late Fees

- Late fees on standard home loans typically are around 4-5% of the late monthly payment; Almost universally, they're assessed for standard home loans of payments received after the 15th of the month the payment is due - On subprime loans, and on nonstandard loans in general, late fees can be larger

A Mortgage is a loan that always creates 2 documents:

- Note (defines the exact terms & conditions of the loan; details financial rights & obligations between borrower & lender) - Mortgage (a.k.a. deed of trust; pledges the property as security for the debt)

Typical terms of private mortgage insurance

- Premiums on PMI can be paid by the borrower in a lump sum at the time of loan origination or in monthly installments added to the mortgage interest rate - Mortgage insurance rates vary with the perceived riskiness of the loan: Higher loan-to-value ratio, longer loan term, & weaker credit record of the borrower all result in a higher mortgage insurance premium - Premiums on loans for 2nd homes or for investment property are higher than owner-occupied residences, while premiums on loans due to corporate relocation are lower - A "cash-out" refinancing loans (i.e., one that is larger than the loan it replaces) requires a higher insurance premium - Cancellation of PMI coverage may be allowed if the borrower has a record of timely payments & the remaining loan balance is less than 80% of the current market value of the home; A new appraisal, paid for by the borrower, is typically required as proof of the increase in the value of the property - Under the Homeowners Protection Act of 1998, a borrower w/ a good payment record has the right to terminate PMI when the loan reaches 80% of the original value of the residence; The PMI company is required to terminate insurance when the loan reaches 78% of the original value of the residence

Government-Sponsored Mortgage Programs

- Some government programs make loans directly to homebuyers in the primary market (examples at the fed era level include certain home loan programs of the US Dept. of Agriculture's Rural Housing Services) - In addition, state governments issue tax-exempt debt to support loans with below-market interest rates for first-time homebuyers; Many state & local housing agencies also offer low-interest loan programs to low- and moderate-income households - The most prominent government-sponsored housing finance programs that operate in the primary market at the national level are the Federal Housing Administration (FHA) default insurance program and the Veterans Affair (VA) programs that provides guarantees on loans made by private lenders to qualified veterans

Nonforeclosure Responses to Default

- Sometimes when a homeowner misses a mortgage payment, the problem can be mitigated by improved household financial management; In this case, credit counseling, together w/ possible reorganization of consumer credit obligations, may be a far more constructive & less costly solution than legal action for both borrower & lender - A more definite response to missed payments may be to allow a temporary reduction of payments; As long as some regular payment is being made, the lender might also allow a missed payment to be deferred -- However there are practically & legal risks in this response; If it's clear that the household will not be able to rectify its financial problem, the solution will only allow losses to compound; Further, any agreement to change the payment schedule on the loan may be interpreted by a court as a "recasting" of the loan, which can be interpreted by a court as the creation of a new, replacement mortgage, and since the determination of priority among liens (i.e., security claims) generally is by date of creation, this could have disastrous consequences to the lender

Section 203 Loans

- The FHA insures mortgages for various types of properties; Some of the programs, for example, insure loans for low-income housing, nursing homes, cooperative apartments, & condominiums > The most widely used FHA programs insures single-family home mortgages, known as Section 203 Loans - FHA loans are available from a variety of lenders, including banks, savings and loan associations, mortgage companies, & credit unions - Because FHA-insured loans are made with higher LTVs and because the FHA assumes the entire risk of default, premiums charged by the FHA are usually higher than otherwise comparable private mortgage insurance premiums

Interest-Only (I-O) and Balloon Mortgages

- The I-O mortgage requires no monthly principal payment, & the balance remains at the original amount > With the interest-only balloon mortgage, the borrower must pay off the loan after 5-7 years with a "balloon" payment equal to the original balance; The I-O balloon can have a fixed or adjustable interest rate - In contrast to the true I-O balloon is a variety of interest-only amortizing mortgages & balloon amortizing mortgages: 1) With one form, there's a period of up to 15 years of interest-only payments at a fixed interest rate, then the payment is reset to fully amortize the loan over the remaining term; During the amortizing period, the interest rate may be either fixed or adjustable 2) A second variant is the five- or seven-year balloon mortgage w/ payments based on a fixed interest rate & amortized over 30 years; Since the loan is shorter term than a fully amortized mortgage, the rate will be lower; As a safety measure, Freddie Mac & Fannie Mae require that the borrower be able to refinance at maturity into a standard level payment loan at the then market interest rate

Refinancing Rules of Thumb

- The borrower should refinance when the interest rate spread between the existing glean and a new loan reaches 2 percentage points or some other level - Divide the total cost of refinancing by the monthly payment reduction; The information used for the payback period is the same info used for our net benefit calculation, so it shouldn't be surprising that the payback period and our net benefit approach are completely consistent with each other

Personal Liability

- When borrowers sign a note, they assume personal liability for fulfillment of the contract - If the borrowers fail to meet the terms of the note, they're in a condition of Default, and can be sued - Because the lender has this legal recourse against the mortgagor in case of default, these loans often are called Recourse Loans (recourse is less commonly available w/ loans on commercial real estate; for commercial loans, the note is often written so as to avoid personal liability on the part of the mortgagor, or borrower)

Change Date

- When the Rate is Recomputed at the Change Date, the new index value may be the latest published value, a value from a certain number of days earlier, or an average of a recent period (a common choice is to use the latest weekly average available a certain # of days before the change date) - Generally, home mortgage lenders must notify borrowers of interest rate changes at least 30 days in advance

Right of Prepayment

1) The note may be silent on the matter; In this case, the right of prepayment will depend on the law of the state where the property is located; Under the traditional law of mortgages, there is no right to prepay a mortgage before its term, unless explicitly stated; however, some states have enacted statutes to reverse this common law tradition (by statute, the borrower automatically has the right to prepay a mortgage unless it's explicitly prohibited) 2) A simpler case is where the note is explicit on the right of prepayment; In this case, the provisions of the note will prevail (most standard home loans give the borrower the right to prepay any time, without penalty; however, in recent years prepayment penalties have become more common in larger home loans, & they frequently occurred in subprime home mortgage loans)

Conforming & Nonconforming Conventional Loans

A conforming loan is one that meets the standards required for purchase in the secondary market by Fannie Mae or Freddie Mac - Although both of these GSEe were privately owned & issued stock, they remained subject to government oversight, and Congress sets the maximum size of home mortgages they are allowed to purchase from originating lenders - To conform to the underwriting standards of the GSEs, a loan must use standard GSE documentation, including the application form, mortgage, note, & appraisal form; It must not exceed a certain percentage of the property's value, monthly payments on the loan must not exceed a certain percentage of the borrower's income, & the loan must not exceed $417,000 on single-family homes in most localities > Loans that fail one or more of these underwriting standards are termed Nonconforming Conventional Loans - Loans that generally conform, but exceed the dollar limit, are called Jumbo Loans - Because conforming loans can be much more readily bought & sold in the secondary mortgage market (i.e., they're more liquid), they carry a lower contract interest rate than otherwise comparable nonconforming loans; Over the last several years, this interest rate advantage averaged approximately 0.25 percentage points; However, following disruptions in the non-GSE secondary mortgage market about mid-2007, this spread increased to over 1.50 percentage points (Thus, on a $500,000 loan, this could translate into monthly payments that are larger by as much as $625; In addition, quoted rates & fees on nonconforming loans are much less uniform from lender to lender & region to region)

If a short sale is not feasible...

Another option is a DEED IN LIEU OF FORECLOSURE; That is, the lender may allow the borrower simply to convey the property to the lender - This option is less favorite to the lender than a short sale, but still has several attractions: It's faster than foreclosure; Less costly than foreclosure; And, of special value for loans on commercial property, Creates less public attention to the event (public perception of the property may be especially important for retail & hospitality properties, for which adverse publicity may taint the tenants & damage their business) - Acception a deed in lieu of foreclosure has significant risks since financial problems tend to travel in packs: The mortgage is likely to have other financial problems apart from the property, but which can generate additional liens, and whatever liens have been imposed on the property subsequent to the creation of the mortgage will remain with the property, & the lender has no choice but to accept the property subject to these liens - The worst risk in accepting a deed in lieu of foreclosure is bankruptcy: The same conditions of stress that caused default on the mortgage may well lead the borrower finally to declare bankruptcy; If this occurs within a year after conveyance of the deed in lieu of foreclosure, the courts can treat the conveyance as an improper disposition of assets, deeming it unfair to other credits, but the deed in lieu of foreclosure will erase the lender's priority claim to the property as security for the debt, so when the bankruptcy court reclaims the property, the lender ends up as simply one more in the line of creditors seeking relief thru the court

Loan Commitments & Funding

If the borrower is applying for a level-payment mortgage, the lender usually offers the applicant several choices on when to "lock in" the contract interest rate; These choices may include the time the loan application is taken, when the lender commits to fund the loan, or when the mortgage loan is acquired (called the closing) - The major traditional source of funding for mortgage bankers is bank "warehouse" lines of credit; These enable the mortgage bankers to originate far more home loans than their equity capital alone would support; When the loans are sold in the secondary mortgage market, the bank line of credit is paid down and the process starts again

Negative Amortization

It's possible for the interest charges to increase more than the payment cap will allow; - The unpaid interest must be added to the original balance, causing the loan balance to increase, a result that's known as Negative Amortization)

Adjustable Rate Mortgage (ARM)

Mortgage loans that use an adjustable interest rate - Common in real estate & many home loans, & used in virtually all home equity credit line mortgage loans - A number of components must be defined in the note: the index, margin, method of computing the index, adjustment period, date of change in the interest rate, & determination of any "caps" or limits on interest rate changes

Teaser Rates

Most ARM home loans have been marketed w/ a temporarily reduced interest rate known as a Teaser Rate - This reduction usually applies for a short time (e.g. 1 year) - The presence of a teaser rate creates a question about how the periodic caps works: Does the cap apply to the teaser rate, or does it apply only to the index plus margin? (Depends on how the note is written, & the borrower must examine the wording of the note to find the answer)

Forms of Loans

Banks & savings institutions dominate home equity lending, but credit unions, finance companies, brokerage houses, and insurance companies also offer these loans, which come in 2 forms: 1) Closed-End Loan (A fixed amount is borrowed all at once & repaid in monthly installments over a set period, such as 10 years) 2) Open-End Line of Credit (Money is borrowed as it's needed, drawn against a maximum amount that's established when the account is opened; Interest is paid on the balance due, just as with a credit card; This type of credit commonly requires a minimum monthly payment equal to a percentage of the outstanding balance, which gives the debt a much longer term that consumer debt; Normally, the interest rate is adjustable, most commonly based on the prime rate published in the WSJ, plus a margin ranging from 0-1.5%; Open-end lenders frequently provide a book of special checks that allows the borrower to tap the line of credit as if it were a checking account; This form of loan commonly is referred to as a HELOC, a home equity line of credit > The borrowing limit is set by a total mortgage loan-to-value (LTV) ratio, such as 75 or 80%; The maximum home equity loan is the amount that increases total mortgage debt up to that LTV limit) --> Tax Advantages: Interest on consumer debt, such as loans to finance the acquisition of automobiles, college tuition, & household appliances and electronics, is NOT tax deductible, BUT interest on home equity loans up to $100,000 is generally 100% deductible for federal & many state tax returns

Deficiency Judgment

Because a mortgage loan involves both a note & a mortgage, the lender may have the option, in addition to foreclosure, of simply suing the defaulting borrower on the note; This right of recourses exists, at least under some conditions, for 40 states & D.C. - In principle, funds not recovered thru foreclosure can be recovered thru a DEFICIENCY JUDGMENT - In practice, however, this seldom happens; Many loans on income-producing properties are non recourse, placing the borrower beyond legal reach; Further, lenders recognize that a defaulted borrower usually has extensive financial problems & doesn't possess the net worth to compensate the lender beyond what's recoverable from sale of the property

Equal Credit Opportunity Act

Because of a long history of both deliberate and unconscious discriminatory practices in home mortgage lending, Congress enacted the ECOA in 1974, which serves to prohibit discrimination in lending practices on the basis of race, color, religion, national origin, sex, marital status, age, or because all or part of an applicant income derives from a public assistance program - Numerous kinds of information are restricted from consideration in evaluating a loan application, including the childbearing plans of a female applicant, whether income is from part-time or full-time employment, & whether there's a telephone listing in the name of the applicant; Further, the lender can't ask for info about a spouse who isn't part of the loan application

Importance of the FHA

Before the FHA was established in '34, the typical home loan war relatively short term (5-15 years) and required principal repayment in full at the end of the term of the loan - that is, loans were non amortizing > The FHA was organized to demonstrate the feasibility of home lending with long-term amortized loans thru insurance protection for lenders participating in the program; In short, the FHA programs created the single most important financial instrument in modern US housing finance: the level-payment, fully amortizing loan, and further, thru its power to approve or deny loans, the FHA heavily influenced housing & subdivision design standards throughout the US during the middle of the 20th century - Today, FHA mortgage insurance is still an important tool thru which the federal government expands home ownership opportunities for first-time homebuyers and other borrowers who wouldn't otherwise qualify for conventional loans at affordable terms; It continues to play a potentially important role in housing finance innovation with its nascent him equity conversion mortgage (HECM) program

Chapter 11 Bankruptcy

Court-supervised workout for a troubled business - Once a court accepts the petition of a debtor firm, creditors are suspended from pursuing legal action against the assets of the firm; This follows the view that competition among creditors likely will dismantle an otherwise viable business, which would benefit all the creditors if left intact - Under the supervision of the court, the debtor will propose a workout plan, which is presented to creditors for acceptance; If the creditors can't agree on the plan, a major concern is that the court will then impose a plan on the creditors that's even less acceptable - As part of the workout plan, the court is likely to forestall the possibility of foreclosure on defaulted real estate; The resulting delay can affect the defaulted lender in numerous adverse ways, the principal one being a delay in any possible recovery of funds; Also, the period in which payments are lost is extended, & the value of the property may deteriorate due to neglect

Private Mortgage Insurance (PMI)

Protects a lender against losses due to default on the loan; It gives no other protection - that is - it doesn't protect against legal threat to the lender's mortgage claim, nor does it protect against physical hazards; It indemnifies the lender, but not the borrower - Lenders generally require private mortgage insurance for conventional loans over 80% of the value of the security property - Private mortgage insurance companies provide such insurance, which usually covers the top 25-35% of loans; In other words, if a borrower defaults & the property is foreclosed & sold for less than the amount of the loan, the PMI will reimburse the lender for a loss up to the state percentage of the loan amount; Thus, the net effect of PMI from the lender's perspective is to reduce default risk

Real Estate Settlement Procedures Act

Enacted initially in 1974, was a response to the confusion & potential for exploitation of homebuyers applying for home financing - The law applies if a buyer obtains a new first mortgage home loan from a lender having deposit insurance from the U.S. government (including virtually all banks, savings & loan associations, and credit unions), if the loan is insured by the FHA or guaranteed by the VA, or if the loan will be sold in the secondary market to Fannie Mae or Freddie Mac - Its requirements include: > A standard format closing statement for most home mortgage loan closings (HUD-1 Settlement Statement) > Presentation of a booklet explaining closing fees & the HUD-1 Settlement Statement > A good-faith estimate of closing costs, to be provided within 3 business days of the loan application > The opportunity to examine the closing statement at least 24 hours in advance of the loan closing > Prohibition of "kickbacks" and referral fees between the lender & providers of services in connection w/ the loan closing (appraisals, property inspections, document preparation, surveys, hazard insurance, mortgage insurance, & title insurance) - In addition, RESPA prohibits a lender form specifying the source of title insurance to be used for the loan - Finally, RESPA limits escrow deposits for interest, property taxes, hazard insurance, community association dues, or other items; 1st, it limits the deposits at closing; 2nd, it limits the regularly monthly deposit that follows

Usage

Purchase-money mortgages are used to finance many kinds of property: Landowners often partially finance the sale of large tracts for development w/ a PMM > They take cash for a portion of the sale price, but finance the remainder themselves; The PMM is paid off from the proceeds of lots as they're developed & sold; The landowner, in effect, is a partner of the developer

FHA-Insured Loans

FHA mortgage insurance covers any lender loss after conveyance of title of the property to the US Dept. of Housing & Urban Development (HUD) - FHA targets loans to borrowers in slightly weaker financial circumstances that the typically prime conventional borrower, including first-time homebuyers and other households with moderate income - FHA allows a high loan-to-value ratio, requiring only that the borrower contribute 3.5% of the lesser of actual sale price or appraised value as a cash down payment for an owner-occupied residence; This is in contract to 10% or more for prime conventional loans in today's risk-sensitive mortgage market - Similarly, FHA is more forgiving of past financial failures of loan applicants, generally requiring no more than 2 years (rather than 4) to elapse after the borrower declares bankruptcy and 3 years (rather than up to 7) after the borrower goes thru foreclosure - The main limitations of FHA loans are limits on their maximum size & their higher insurance premiums - FHA insurance requires 2 premiums: the UFMIP (up-front mortgage insurance premium) and the MIP (annual mortgage insurance premium); The UFMIP normally is financed - that is - included in the loan - In addition the UFMIP, the owner-occupant borrower normally will pay an annual MIP that depends on the loan-to-value ratio & the term of the loan; This annual premium is based on the average outstanding balance of the loan during the year; The monthly premium payment is simply the annual payment divided by 12; This premium decreases each year as the outstanding balance decreases - The premiums are automatically canceled when the loan-to-original value reaches 78%, provided that MIP payments have been made for at least 5 years; For loans of 15 years or less, however, this cancelation is irrespective of how long the MIP has been paid > In no case does this automatic cancelation of the MIP cause discontinuation of insurance coverage; FHA is required each year to advise the borrower of these cancelation provisions; The monthly premiums paid by borrowers are deposited by FHA into the Mutual Mortgage Insurance Fund, which reimburses lenders in case of foreclosure; As with private mortgage insurance, FHA insurance increases the borrower's cost of the mortgage

Default

Failure to meet the requirements of the note (and, by reference, the mortgage) constitutes default, which can range in degree of seriousness - Violations of the note that don't disrupt the payments on the loan tend to be viewed as the "technical" defaults; While these violations may require some administrative response, they don't compel legal action (e.g. if for some reason hazard insurance were to lapse, the borrower must restore it, but that problem alone wouldn't warrant legal action) - When payments are missed (typically for 90 days), however, the lender normally treats the default as serious; In this case, the ultimate response is the process of FORECLOSURE, a costly & time-consuming action for all concerned, & traditionally it was a last resort used sparingly, but in the housing bust since 2006, have reached levels not seen since the Great Depression) - Our discussion assumes that the default is on a loan still held by the original lander; By contrast, many of the difficulties relating to foreclosure today derive from scrutinization of the loans involved -- Securitization has resulted in ambiguity concerning who controls the loan (lender? servicer? security trustee? investor?) and what alternative solutions are contractually possible

Adjustable Rate Mortgages

Fixed-rate, level-payment mortgages serve lenders & borrowers well when mortgage interest rates are relatively low & stable; Unfortunately during the late 1970s & 1980s, interest rates on LPMs increased dramatically; Beginning in the mid-'70s, mortgage rates also became more volatile > This increase in the level & volatility of mortgage rates caused 2 major problems: First, the higher required monthly payments on a LPM made housing less affordable; Second, the increased volatility of mortgage rates made lenders nervous (Savings & loans (S&Ls) and other depository institutions were in the business of making long-term LPMs using short-term deposits and savings; When interest rates, both short term and long term, accelerated in the late '70s and early '80s, the average spread that many LPM lenders were earning on their fixed-rate mortgage investments actually became negative; This negative spread contributed to the eventual failure of many S&Ls

Prepayment Penalty

For most mortgage loans on commercial real estate, the right of prepayment is constrained thru a prepayment penalty - Earlier generation income-property loans often specified a prepayment penalty as a percentage of the remaining balance at the time of prepayment - More recent practice has been to specify a Yield Maintenance Prepayment Penalty; In this approach, a borrower wishing to prepay must pay the balance, plus a lump sum representing the value (as defined in the note) of the interest income that will be lost by the lender due to prepayment - Still more recently, an even more demanding prepayment barrier has been used: a Defeasance Requirement, where a borrower wishing to prepay must usually provide the lender with some combination of U.S. Treasury securities producing interest income that replaces the cash flows of the loan being paid off

Maturity Imbalance Problem

Funding long-term LPMs with short-term deposits & savings creates a severe maturity imbalance problem for depository institutions because their assets (e.g. mortgages) are very long term, whereas their liabilities (e.g. saving deposits & certificates of deposit) are short term - To address the maturity imbalance problem and to avoid or reduce their exposure to the interest rate risk associated with making LPMs, many lenders began searching for alternatives to the LPM > For depository lenders, the most compelling alternative home mortgage is the Adjustable Rate Mortgage (ARM); Not only has it become a core product for their business, but ARMs have evolved significantly in recent years to make them more attractive to home borrowers

Hybrid ARM

In the '70s, traditional home lenders turned to adjustable rate mortgages for protection from increasingly turbulent interest rates, which was a near perfect solution to their asset-liability imbalance problem; However, it was a rather unattractive solution for the typical homebuyer, who then faced the threat of increasing payments if interest rates rose -- After nearly 20 years, lenders finally found an effective compromise in the HYBRID ARM > It begins w/ a fixed interest rate, but converts to a standard ARM; It differs from an I-O mortgage in that the payment is always set to amortize the loan over the remaining term, so it always includes principal payment > With the typical 3-1 hybrid ARM, the interest rate charged is fixed of 3 years, then adjusts each year thereafter; The hybrid ARM has been offered w/ fixed interest for 2, 3, 5, 7, or 10 years; Not surprisingly, the interest rate charged during the initial interval usually is higher as the fixed-rate period is longer > Since the '70s, the 2 main forms of home mortgage loans were fixed rate & ARM; This put the borrower & lender in a "zero-sum" contest where the lender's gain in risk reduction thru creating ARMs was the home borrower's loss; By contrast, the hybrid ARM offers more of a win-win solution > The borrower has a fixed payment during the early years of homeownership when financial vulnerability is greatest while the lender retains, in large part, the ability to have the loan's interest rate rise if market rates go up; Further, this arrangement comes to the borrower w/ the advantage that the initial fixed interest rate is significantly lower than the standard fixed rate because it's for a much shorter time than 30 years

Acceleration Clause

In the event a borrower defaults on the loan obligation, an acceleration clause enables the lender to declare the entire loan balance due & payable - If this weren't so, the default would apply only the amount overdue; As a result the cost of legal action against the borrower would almost always exceed what would be recovered - it would never pay to sue in case of default, and the mortgage would be meaningless

Consumer Financial Protection Bureau (CFPB)

Independent oversight agency created by Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010 w/ responsibility to oversee & enforce federal consumer financial protection laws; enforce anti-discrimination laws in consumer finance; restrict unfair, deceptive, or abusive acts or practices; receive consumer complaints; promote financial education; and watch for emerging financial risks for consumers - A first undertaking of CFPB was to redesign documents central to home mortgage closings; The aim is to create integrated replacements for the Truth-in-Lending Disclosure from TILA and the Good Faith Estimate and HUD-1 Settlement Statement from RESPA - The CFPB also has authority to prohibit the predatory lending practices that were common to subprime lending from the late 1990s-2007

Index

Index rate is a market-determined rate that is the "moving part" in the adjustable interest rate (in principle, could be any regularly reported market interest rate that can't be influenced by either borrower or lender) - With ARMS home loans, the most common index rates include U.S. Treasury Constant Maturity Rates (most commonly 1 year in maturity), LIBOR, & a Cost-of-Funds Index for depository lenders - Occasionally, a home mortgage index rate may be used as well, such as the national average rate for new loans on existing homes - Home equity credit line loans, commonly offered by banks, rely on the commercial bank "prime rate" as published regularly in the WSJ - Finally, a common index is a LIBOR rate (London Interbank Offering Rate; short-term interest rate for U.S. dollar denominated loans among foreign banks based in London), especially for loans in income-producing property

Real Estate Debt without a Mortgage

It's possible to have a secured real estate loan w/o a mortgage thru the use of a CONTRACT FOR DEED, or LAND CONTRACT; As the name suggests, this is a contract for sale of a property w/ the special provision that the actual delivery of a deed conveying ownership will occur well after the buyer takes possession of the property - The idea of the contract for deed is that a seller can finance the sale thru installment payments, and, by retaining title, have recourse in case of default - Contrasts w/ the standard real estate sale where both conveyance of possession & conveyance of title occur at the closing; With the contract for deed, the deed is conveyed only after the bulk of the installment payments have been made - With a contract for deed, the effect of default varies: In the most favorable case for a seller, they can simply evict the would-be buyer & have full recovery of the property; - However, this is by no means the typical case because many courts have given greater recognition to the claims of buyers under contracts for deeds, especially when a personal residence is involve; Then the court may require that a defaulted contract for deed be treated as a mortgage, requiring a foreclosure proceeding - In general, the rights, obligations, & recourses of the parties in a contract for deed depend significantly on the jurisdiction & the nature of the property involved - POSITIVES: The contract for deed can facilitate financing in situations deemed too risky for standard mortgage financing; In financing marginal housing, there's some evidence that the land contract is a major means of financing for home purchases in which neither the dwelling nor the borrower can qualify for normal mortgage financing - NEGATIVES: Because it can be created hastily, there often few, if any, protections or standards built into the arrangement -- It frequently involves unsophisticated buyers who tend to overlook the need for legal & financial advice; Too often the transaction will go forward without a title search & without sufficient legal guidance, so the buyer has no way to know whether the seller can actually deliver clear title, and, further, unless the contract is recorded in public records, there's little to prevent the seller from subsequently mortgaging the property to someone else, placing the buyer at risk

Reverse Mortgage

Many older, retired households suffer from constrained income & a resulting reduction in their quality of life > Over 80% of older households are homeowners, often with little or no mortgage debt on their residence, but when when income is constrained, they remain unwilling to sell their homes for many reasons; In short, a very significant percentage of older households are "house poor," with little income, but substantial illiquid wealth in their home... > A REVERSE MORTGAGE is designed to mitigate this problem; It offers additional monthly income to these homeowners thru various loan disbursement plans, using the home as security for the accumulating loan > Essentially, a reverse mortgage allows homeowners to liquify a portion of their housing equity w/o having to sell the house & move - In a fixed-term, level-payment reverse mortgage (RAM), a lender agrees to pay the homeowner a monthly payment, or annuity, and to be repaid from the homeowner's equity when he/she sells the home or obtains other financing to pay off the RAM > A fixed-term RAM provides a fixed payment for a certain period of time, the borrower receives the entire loan proceeds at closing and then immediately begins to make monthly payments of interest & principal, the loan proceeds are distributed to the borrower in periodic amounts, interest in the loan begins to accumulate immediately, but no payments of any kind are made on the loan until the borrowers, or the heirs, pay off the loan w/ proceeds from the sale of the house (or other assets from the borrower's estate) - MORTALITY RISK: The main risk of a reverse mortgage is that the outstanding balance ultimately will exceed the value of the property; If the property is sold or the homeowner dies prior to the end of the loan term, the loan is designed so that the sales proceeds should be sufficient to pay off the accumulated balance; However, is the owner is still living & occupying the resident at the end of the loan term, then default is likely; But to foreclose would cause distress for the homeowner and severe negative publicity for the lender, so foreclosure isn't a practical option > To address this "mortality risk," several departures from the fixed-payment, fixed-term RAM have emerged; In one, the payments to the homeowner cease at the end of the loan term, but the owner is allowed to stay in the house as long as he/she wishes; Interest on the unpaid mortgage balance simply continues to accrue at the contract rate, ultimately raising the specter of the loan balance exceeding the value of the property; The lender must either limit the initial loan to an overly conservative amount to minimize this risk, or the lender must find another way to manage the risk, such as insurance, which is where FHA becomes crucial to reverse mortgage lending

Megamortgage Banking

Operates in 4 modes: 1) Traditional "face-to-face" (retail) lending 2) Wholesale purchases of loans from smaller mortgage bankers & smaller banks (called correspondent banks) 3) Internet lending 4) Lending thru mortgage brokers > In all of this, they exploit the most advanced electronic communications system: Some large traditional mortgage banking firms have simply eliminated their retail operations, turning primarily to wholesale, broker operations, and the Internet for their business

Home Ownership & Equity Protection Act (HOEPA)

Passed out of concern for abusive, predatory practices in subprime lending - that is, lending to homebuyers with limited financial knowledge & inability to qualify for standard mortgage financing (e.g. extremely high interest rates, extremely high fees, aggressive selling of optional insurance & "debt protection," severe prepayment penalties to prevent prepayment of loans, short-term balloon payments to force subsequent refinancing, use of undisclosed negative amortization to disguise costs, a general lack of disclosures, & a pattern of encouraging distressed borrowers to refinance into still another abusive loan) - Frequently, these loans are based only on the amount of home equity of the borrower, w/o consideration of the borrower's income & ability to make payments - About all that can be said for HOEPA is that it was woefully ineffective in limiting the abuse it was intended to control

Demand Clause

Permits a lender, from time to time, the demand prepayment of the loan - This clause is common w/ loans from commercial banks; If the bank determines after periodic review that the borrower's creditworthiness has deteriorated, the bank may exercise a demand clause - While a demand clause is rare in fixed-term, standard home loans (prohibited, in many), it's quite common in "home equity" credit line loans from commercial banks

Prime Conventional Mortgages

Predominant form of prime conventional mortgage remains the (fixed-rate) level-payment mortgage (LPM) - Important distinction between prime conventional mortgage loans is the difference between Conforming & Nonconforming

Dodd-Frank Wall Street Reform & Consumer Protection Act of 2010

Previously, regulation of mortgage lending was balkanized into multiple authorities (Federal Reserve, Department of Treasury, HUD, Freddie Mac & Fannie Mac, and state governments, among others), but this act created an independent oversight agency, the Consumer Financial Protection Bureau (CFPB), w/ responsibility to oversee & enforce federal consumer financial protection laws; enforce anti-discrimination laws in consumer finance; restrict unfair, deceptive, or abusive acts or practices; receive consumer complaints; promote financial education; and watch for emerging financial risks for consumers - Gives the CFPB control over all of the previous laws discussed & integrates, for the first time, the regulation of home mortgage lending into one authority

Insurance Clause

Requires a borrower/mortgagor to maintain property casualty insurance acceptable to the lender joint control in the use of the proceeds in case of major damage to the property

Suprime and Alt-A Loans

SUBPRIME LOANS were adjustable rate mortgages, with a very large percentage being 2-28 hybrid, interest only, or option ARM; Whichever loan design was involved, a common characteristic was an initial payment that was sufficiently low to cause negative amortization, and, at some point, a payment increase so severe as to compel the borrower to seek refinancing > In short, subprime loans were generally designed to be refinanced in order to avoid a sharply increased payment; Since the typical borrower had weak credit, the replacement was likely to be another subprime loan > Because all of these loans bore a relatively high interest rate, the negative amortization could be severe, exacerbating the payment spike problem inherent in the loans, and tending to perpetuate a high loan-to-value ratio > Since the loan-to-value ratio typically started quite high, w/ negative amortization the ability to refinance depended on significant appreciation of the property ALT-A LOANS generally were more "standard" in their terms that subprime loans w/ notably less of the forced refinancing character > They tended to be standard conventional loans w/ one or more borrower requirements relaxed, such as allowing a very high loan-to-value ratio, allowing lower than normal cash down payment, allowing weaker than normal borrower credit scores, or, most commonly, requiring little or no documentation of the borrower's financial circumstances > In short, Alt-A loans differed from prime conventional loans almost entirely by the use of more relaxed borrower requirements; Not surprisingly, these loans were characterized by a higher interest rate, as well

Conventional Mortgage Loan

The most common type of home loan; Refers to any standard home loan that's not insured or guaranteed by an agency of the US government; Thus, it includes all standard home loans except those known as FHA (Federal Housing Administration) and VA (Veterans Affairs) loans - 2 polar types of conventional mortgage loans: Prime & Subprime, with an intermediate groups of loans known as "alt-A" - Conventional mortgages can be either fixed rate or adjustable rate

Statutory Right of Redemption

The period after the sale of foreclosed property during which the mortgagor can still utilize his right of equity of redemption - Varies among states, typically between 6 months & a year, however, it can range from a few days to as much as 3 years

Servicing

The primary source of revenue in mortgage banking is the right to service the loans created - Loan servicing includes collecting the monthly payment from the borrower & remitting principal and interest payments to the investor(s) - It also includes ensuring that the borrower's monthly escrow payments for hazard insurance & property taxes are sufficient to allow the servicer to pay in full the annual insurance premium and property taxes on behalf of the borrower when they're due - Services are also responsible for sending out notifications if borrowers are delinquent w/ their payments... - and managing default, even foreclosure, should it arise

Foreclosure

The ultimate recourse of the lender - A court-supervised process of terminating all claims of ownership by the borrower, & all liens inferior to the foreclosing lien; This can enable the lender to bring about free & clear sale of the property to recover the outstanding indebtedness - It's a delicate process because only those claimants who are properly notified & engaged in the foreclosure suit can lose their claims to the property, THUS, there is a risk that persons with a claim on the property will remain undiscovered or will be improperly treated in the process, which would result in a defect in the title at a foreclosure sale - Another concern in foreclosure is the presence of Superior Liens - In general, liens have priority according to their date of creation, w/ earlier liens being superior; In addition, local government always has a lien on real estate for property tax obligations that is automatically superior to any private lien; Foreclosure can't extinguish a superior lien, therefore, the foreclosing lender must be sure that obligations secured by superior liens (i.e., property taxes, assessments, community development district obligations, earlier mortgages) are met; Otherwise, the lender can become subject to a subsequent foreclosure initiated by the holder of the superior lien - Lien priority is a major concern to a lender because the highest priority lien receives all net proceeds from the foreclosure sale until that obligation is fully satisfied; Only then does the 2nd lien claimant receive any satisfaction - More commonly, net proceeds from foreclosure are less than the amount of the 1st mortgage, & the 2nd mortgagee receives nothing, thus, a 2nd mortgage is significantly less secure than the superior mortgage; Subsequent liens are progressively even less secure

Truth-in-Lending Act

Title 1 of the Consumer Credit Protection Act of 1968, which requires important disclosures concerning the cost of consumer credit - Perhaps the best known of its provisions is the required computation of the APR for most consumer loans, including home mortgage loans; In addition, the law requires disclosure of numerous other aspects of the terms of a home mortgage loan, including the following: > Whether the loan contains a "demand feature" > Whether the loan can be assumed > Whether the loan has a variable rate > Whether property hazard insurance is a required condition of the loan > Whether there are late charge provisions > Whether the loan has a prepayment charge (penalty) - Finally, under TILA, the borrower has the right to rescind certain types of loans secured by his/her principal residence for 3 days following consummation of the loan; That is, the borrow can cancel the loan contract completely (applies as long as the loan isn't for purchasing or constructing a principal residence, isn't for a business purpose, & isn't to refinance a prior loan for these purposes from the same lender)

VA-Guaranteed Loans

VA-guaranteed loans help veterans obtain home mortgage loans w/ favorable terms for which they might not otherwise qualify - For a private lender making a loan to a qualified veteran, the VA guarantee protects against default loss up to a maximum percentage of the loan amount; This guarantee begins at 50% of the amount of the loan for loans up to $45,000 and declines in steps to 25% for loans in excess of $144,000 (thus, for a loan of $144,000, the guarantee is $36,000) - The maximum guarantee is specified as 1/4 of the maximum allowable loan purchased by Freddie Mac & Fannie Mae; Since lenders are reluctant to have the guarantee be less than 25% of the loan amount, this effectively sets the maximum VA loan equal to the maximum current loan amount for the 2 GSEs > If a veteran defaults, the VA will reimburse the lender for any loss up to the guaranteed amount after the property has been foreclosed & sold > The VA will guarantee loans to eligible veterans up to 100% of a property's value; For this, the VA charges a funding fee that is a percentage of the loan, with the percentage based on the down payment & the service classification of the veteran; The funding fee can be added to the loan amount but closing coasts can't be included in the amount of the loan; In areas where eligible veterans can't obtain loans from approved VA lenders, the VA can make direct loans to them

Mortgage Banking and Mortgage Brokerage

Where thrifts and banks are portfolio lenders that use the savings deposits to fund and hold mortgage loans as investments, mortgage companies neither collect deposits nor hold mortgages as investments; Instead, their business is mortgage creation > Mortgage bankers originate mortgages, providing the origination services and initial funding, and then sell them as quickly as possible; This process is frequently referred to as "originating to distribute" > Mortgage brokers simply bring borrowers and lenders together, but never own the resulting loans nor fund them > With the rise of securitization, mortgage banking became the natural method for doing mortgage lending: The mortgage bankers would originate loans and sell them by pooling them into securities; To find lending opportunities, mortgage bankers frequently turned to mortgage brokers; Because of the importance of their process in modern mortgage lending we'll examine mortgage banking more closely, and contrast it with the companion function of mortgage brokering