California Real Estate Chapter 10

Fixed & Adjustable Interest Rates

"A fixed-rate loan is repaid over its term at an unchanging rate of interest. Ex. The interest rate is set at 6% when the loan is made, and the borrower pays 6% interest on the unpaid principal balance throughout the loan term. When market interest rates are relatively low and stable, fixed-rate loans work well for borrowers and lenders. But in periods when market rates are high and volatile, neither borrowers nor lenders are comfortable with fixed-rate loans. High interest rates price many borrowers out of the market. And if market rates are fluctuating rapidly, lenders prefer not to tie up their funds for long periods at a set interest rate. A type of loan that addresses both of these issues is the adjustable-rate mortgage (ARM), sometimes called a variable-rate loan. An ARM permits the lender to periodically adjust the loan's interest rate so that it accurately reflects changes in the cost of money. If market rates climb, the borrower's interest rate and monthly payment go up; if market rates decline, the borrower's interest rate and payment go down." "Depending on economic conditions and other factors, lenders may offer ARMs at a lower initial interest rate than the rate they're charging for fixed-rate loans. Ex. A lender might offer fixed-rate loans at 6% and ARMs at 5.25%."

Conforming Loan Limits

"A loan generally won't be eligible for purchase by Fannie Mae or Freddie Mac if the loan amount exceeds the applicable conforming loan limit. (There are different maximums for properties with one, two, three, or four dwelling units.) The conforming loan limits are based on median housing prices nationwide, and they may be adjusted annually to reflect changes in median prices. Conventional loans that exceed the conforming loan limits are known as jumbo loans. Lenders typically charge higher interest rates and apply stricter underwriting standards when making jumbo loans.

Loans Covered by TILA

"A loan is a consumer loan if it's used for personal, family, or household purposes. A consumer loan is covered by the Truth in Lending Act if it is to be repaid in more than four installments, or is subject to finance charges, and is either: -for $50,000 or less, or -secured by real property Thus, any mortgage loan is covered by the Truth in Lending Act as long as the proceeds are used for personal, family, or household purposes (such as buying a home or sending children to college)."

Mortgage broker

"A mortgage broker simply negotiated loans, bringing borrowers together with lenders in exchange for a commission. Once a loan had been arranged, the mortgage broker's involvement ended. In contrast, a mortgage banker actually made loans (using an investor's funds or borrowed funds), sold or delivered the loans to an investor, and then (in many cases) serviced the loans to the end of their terms, in exchange for servicing fees."

Income

"Another primary consideration for the underwriter is whether the loan applicant's monthly income is enough to cover the proposed monthly mortgage payment in addition to all of the applicant's other expenses. So the underwriter needs to determine how much income the applicant has. Not all income is equal in an underwriter's eyes, however. To be taken into account in deciding whether the applicant qualifies for the loan, income must meet standards of quality and durability. In other words, it must be from a dependable source, such as an established business, and it must be likely to continue for some time. Income that meets the tests of quality and durability is generally referred to as the loan applicant's stable monthly income." Ex. A regular salary from permanent employment would count as stable monthly income, and so would Social Security retirement benefits. On the other hand, neither occasional overtime pay from a permanent job nor wages from a temporary job would be considered stable monthly income, because they couldn't be relied upon to continue. Once the underwriter has calculated the loan applicant's stable monthly income, the next step is to measure its adequacy: Is the stable monthly income enough so that the applicant can afford the proposed monthly mortgage payment? To answer this question, underwriters use income ratios. The rationale behind the ratios is that if a borrower's expenses exceed a certain percentage of his monthly income, he may have a difficult time making the payments on the loan. There are two main types of income ratios: -A housing expense to income ratio measures the proposed monthly mortgage payment against the applicant's stable monthly income. -A debt to income ratio measures all of the applicant's monthly obligations (the proposed mortgage payment, plus car payments, child support payments, etc.) against the stable monthly income. "For these calculations, the monthly mortgage payment includes: -principal, -interest, -taxes, and -insurance (often abbreviated PITI). Each ratio is expressed as a percentage; for example, a loan applicant's housing expense to income ratio would be 29% if her proposed mortgage payment represented 29% of her stable monthly income. Whether that ratio would be considered too high would depend on the lender and on the type of loan applied for. Each of the major residential financing programs (conventional, FHA, and VA) has its own income ratio limits. -"An underwriter evaluating an application for an FHA loan will apply two ratios to determine the adequacy of the applicant's income, a housing expense to income ratio and a debt to income ratio. The FHA's maximum income ratios are higher than the ones typically set for conventional loans. This means that an FHA borrower's mortgage payment and other monthly obligations can be a larger percentage of his income than a conventional borrower's. Although FHA programs are targeted at low- and middle-income buyers, there's no maximum income limit. A person with a high income could qualify for an FHA loan, as long as the requested loan didn't exceed the maximum loan amount for the area."

Funds for Closing

"At closing an FHA borrower must have sufficient funds to cover the minimum cash investment, any discount points she has agreed to pay, and certain other closing costs. (Note that secondary financing generally can't be used for the minimum cash investment, unless the source of the second loan is a nonprofit or governmental agency, or a family member.) An FHA borrower usually isn't required to have reserves after closing."

FHA Loan Amounts

"FHA programs are primarily intended to help low- and middle-income home buyers. So HUD sets maximum loan amounts, limiting the size of loans that can be insured under its programs. FHA maximum loan amounts vary from one place to another because they are based on median housing costs in each area. An area where housing is expensive has a higher maximum loan amount than a low-cost area does. However, there's also a "ceiling" for FHA loan amounts that applies nationwide; no matter how high prices are in a particular area, FHA loans can't exceed that ceiling. As a result, FHA financing tends to be less useful in areas where housing is exceptionally expensive. The FHA ceiling is tied to the conforming loan limits for conventional loans, and it is subject to annual adjustment. The size of an FHA loan for a particular transaction is limited not only by the maximum FHA loan amount in the area where the home is located, but also by the minimum cash investment requirement, which we'll discuss next."

Loan Costs

"For the majority of buyers, the primary consideration in choosing a lender is how much the loan they need is going to cost. While the interest rate has the greatest impact, lenders impose other charges that can greatly affect the cost of a loan. Two of the most significant are origination fees and discount points. These are often lumped together and referred to simply as "points." The term "point" is short for "percentage point." A point is one percentage point (one percent) of the loan amount. For example, on a $100,000 loan, one point would be $1,000; six points would be $6,000."

Caps

"If market interest rates rise rapidly, so will an ARM's index, which could lead to a sharp increase in the interest rate the lender charges the borrower. Of course, a higher interest rate translates into a higher monthly payment. This creates the potential for payment shock. In other words, the monthly payments on an ARM might increase so dramatically that the borrower can't afford them. To help protect borrowers from payment shock and lenders from default, ARMs have interest rate and payment caps. An interest rate cap limits how much the lender can raise the interest rate on the loan, even if the index goes way up. A mortgage payment cap limits how much the lender can increase the monthly payment."

Trigger terms

"If the ad mentions other loan terms known as trigger terms (such as the monthly payment amount or the amount of any finance charge), then the rest of the terms of repayment must also be disclosed. Ex. If an ad says, "Buyer can assume seller's loan—monthly payment only $1,525," it will violate the Truth in Lending Act if it doesn't go on to reveal the APR, the repayment period, the number of payments, and other information."

Qualifying the Property

"In addition to deciding whether the buyer is a good risk, the underwriter also has to consider whether the property that the buyer wants to purchase is a good risk. Is the property worth enough to serve as collateral for the loan amount in question? In other words, if foreclosure became necessary, would the property sell for enough money to pay off the loan? To answer these questions, the underwriter relies on an appraisal report ordered by the lender. The appraisal report provides an expert's estimate of the property's value."

California Finance Disclosure Requirements

"In addition to the Truth in Lending Act (a federal law), there are some state laws that help ensure that California home buyers get the information they need to make an informed decision about financing. These laws include the Mortgage Loan Broker Law and the Seller Financing Disclosure Law.

Buydown

"In some cases, the seller is willing to pay the discount points on the buyer's loan in order to help the buyer qualify for financing. Even when the lender isn't charging discount points, the seller may offer to pay points to make the loan more affordable. This type of arrangement is called a buydown: the seller pays the lender points to "buy down" the interest rate on the buyer's loan."

Mortgage payment cap

"Limits how much the lender can increase the monthly payment."

Partially amortized

"Loan requires regular payments of both principal and interest, but those payments aren't enough to repay all of the principal; the borrower is required to make a large balloon payment (the remaining principal balance) at the end of the loan term."

The Loan Application Process

"Once a buyer has compared loan costs and selected a lender, the next step is applying for the loan. The buyer fills out a loan application form and provides the lender with supporting documentation (usually with the help of a mortgage loan originator, such as a loan officer or a mortgage broker). The application is then submitted to the lender's underwriting department, which evaluates the application and ultimately approves or rejects the proposed loan."

Underwriting the Loan

"Once a loan application has been submitted and the information has been verified, the loan is ready for underwriting. Loan underwriting is the process of evaluating both the applicant and the property she wants to buy to determine whether they meet the lender's minimum standards. The person who conducts the evaluation is called a loan underwriter or credit underwriter. The guidelines that the underwriter uses to decide whether a proposed loan would be an acceptable risk (in other words, whether the applicant qualifies for the loan) are called underwriting standards or qualifying standards. A lender is generally free to set its own underwriting standards. In practice, though, most lenders apply underwriting standards set by the major secondary market agencies, Fannie Mae and Freddie Mac. And for FHA and VA loans, standards set by HUD or the VA must be used."

Loan origination

"Processing loan applications and making loans"

Private Lenders

"Real estate limited partnerships, real estate investment trusts, and other types of private investment groups put a great deal of money into real estate. They often finance large residential developments and commercial ventures such as shopping centers and office buildings. They don't offer loans to individual home buyers, however. From the home buyer's point of view, the most important type of private lender is the home seller. Sometimes sellers provide all of the financing for the purchase of their homes, and it's quite common for sellers to supplement the financing their buyers obtain from an institutional lender. In fact, sellers are the most common source of second (or junior) mortgages for home purchases. Sellers are an especially important source of financing when institutional loans are hard to come by or market interest rates are high."

Mutual mortgage Insurance

"The FHA serves as a giant mortgage insurance agency. Its insurance program, sometimes referred to as the Mutual Mortgage Insurance Plan, is funded with premiums paid by FHA borrowers."

Balloon Payments

"The Mortgage Loan Broker Law also prohibits balloon payments in Article VII loans that are to be paid off in less than three years. And when the property is an owner-occupied home, a balloon payment is prohibited if the loan term is less than six years. (These rules don't apply to seller financing, however.) For the purposes of this law, a balloon payment is one that is more than twice as large as the smallest payment required by the loan agreement."

Commissions, Costs, and Terms

"The Mortgage Loan Broker Law limits the commissions and costs that a real estate agent may charge the borrower for arranging an "Article VII loan" secured by residential property with one to four units. An Article VII loan is either: -a first deed of trust for less than $30,000, or -a junior deed of trust for less than $20,000 "For these loans, the maximum commissions the loan broker can charge are: -for a first deed of trust: -5% of the principal if the loan term is less than three years, or -0% of the principal if the loan term is three years or more. -for a junior deed of trust: -5% of the principal if the term is less than two years, -10% of the principal if the term is at least two years, but less than three years, or -15% of the principal if the term is three years or more. The costs of making these loans (such as the appraisal and escrow fees) CAN'T exceed 5% of the loan amount, or $390, whichever is greater. But the costs charged to the borrower must NEVER exceed $700 and must NOT exceed the actual costs."

Loans Exempt from TILA

"The Truth in Lending Act applies only to loans made to natural persons, so loans made to corporations or organizations aren't covered. Loans for business, commercial, or agricultural purposes are also exempt. So are loans in excess of $50,000, unless the loan is secured by real property. (Real estate loans for personal, family, or household purposes are covered regardless of the loan amount.) Most seller financing is exempt, because extending credit isn't in the seller's ordinary course of business. As a result of recent legislation, the $50,000 limit will be adjusted annually, based on the Consumer Price Index.

Right of Rescission

"The Truth in Lending Act provides for a right of rescission in connection with certain types of mortgage loans. When the security property is the borrower's current principal residence, the borrower may rescind the loan agreement up until three days after signing it, receiving the disclosure statement, or receiving notice of the right of rescission, whichever comes latest. If the borrower never receives the disclosure statement or the notice, the right of rescission doesn't expire for 3 years. The right of rescission generally applies only to home equity loans and to refinancing with a new lender. There's no right of rescission for a loan financing the purchase or construction of the borrower's residence. And there's no right of rescission for refinancing from the same lender that made the loan it's replacing, unless the lender is advancing additional funds ("cash out" refinancing). In that case, the right of rescission applies only to the additional amount."

Advertising Under TILA

"The Truth in Lending Act strictly controls advertising of credit terms. Its advertising rules apply to anyone who advertises consumer credit, not just lenders. Ex. A real estate agent advertising financing terms for a listed home has to comply with TILA and Regulation Z. It's always legal to state the cash price or the annual percentage rate in an ad. If the APR is stated, the interest rate can also be included. But if the ad mentions other loan terms known as trigger terms (such as the monthly payment amount or the amount of any finance charge), then the rest of the terms of repayment must also be disclosed. Ex. If an ad says, "Buyer can assume seller's loan—monthly payment only $1,525," it will violate the Truth in Lending Act if it doesn't go on to reveal the APR, the repayment period, the number of payments, and other information. However, general statements such as "low downpayment, "easy terms," or "affordable interest rate" don't trigger the full disclosure requirement.

Rate Adjustment Periods

"The borrower's interest rate isn't adjusted every time the index changes. Each ARM has a rate adjustment period, which determines how often its interest rate is adjusted. A rate adjustment period of one year is the most common. An ARM also has a payment adjustment period, which determines how often the borrower's monthly mortgage payment is increased or decreased (reflecting changes in the interest rate). For most ARMs, payment adjustments are made at the same intervals as rate adjustments."

Disclosure Statement

"The disclosure statement required by the Mortgage Loan Broker Law must be on a form approved by the Real Estate Commissioner. A different form is required for nontraditional mortgage products, loans that allow negative amortization or allow the borrower to defer repayment of principal or interest. The statement discloses all of the costs involved in obtaining the loan, and the actual amount the borrower will receive after all of the costs and fees are deducted from the loan. The borrower must receive the statement before signing the note and security instrument, or within three days of the lender's receipt of the borrower's loan application, whichever is earlier. A disclosure statement is required whenever a real estate agent negotiates a loan or performs services for borrowers or lenders in connection with a loan. It's required for loans secured by commercial property as well as for residential loans. The disclosure statement must be kept on file by the real estate agent for at least 3 years. In a loan transaction that's subject to the Real Estate Settlement Procedures Act, the good faith estimate required by RESPA may also satisfy the Mortgage Loan Broker Law's disclosure statement requirement."

Assumption

"The security instruments used for most conventional loans include an alienation clause, which means the borrower can't sell the property and arrange for the buyer to assume the loan without the lender's permission. Typically, the lender will evaluate the buyer with the same qualifying standards that it applies in a new loan transaction. If the lender approves the assumption, it will charge an assumption fee, and it may also adjust the interest rate to the prevailing rates at that time."

Characteristics of FHA Loans

"The typical FHA-insured loan has a 30-year term, although the borrower may have the option of a shorter term. The property purchased with an FHA loan may have up to four dwelling units, and it must be the borrower's primary residence. All FHA loans must have first lien position. The downpayment required for an FHA loan is often considerably less than it would be for a conventional loan financing the same purchase. Regardless of the size of the downpayment, mortgage insurance is required on all FHA loans. Prepayment penalties aren't allowed. An FHA loan can be paid off at any time without penalty."

Timing of Disclosures

"When a lender receives a written application for a consumer loan that would be secured by the borrower's dwelling—whether it would be a purchase loan, a home equity loan, or refinancing—the lender must give the applicant a TILA disclosure statement at the time of application, or deliver or mail it to her within 3 business days. Until this requirement has been fulfilled, the lender is not allowed to charge the applicant any fees, except a fee for obtaining her credit report. Mortgage loan applicants must receive the TILA disclosure statement at least seven business days before closing, so that they have time to consider the information provided. And if any of the original estimates turn out to be inaccurate, the lender must provide corrected information at least three business days before closing."

Hybrid ARMs

"With a hybrid ARM, the interest rate is fixed for a specified number of years at the start of the loan term, and then the rate becomes adjustable. Ex. A 3/1 hybrid ARM has a fixed rate during the first three years, with annual rate adjustments after that. A 5/1 ARM has a five-year fixed-rate period, and so on. As a general rule, the longer the initial fixed-rate period, the higher the initial interest rate.

How an ARM Works

"With an ARM, the borrower's interest rate is determined initially by the cost of money at the time the loan is made. Once the rate has been set, it's tied to one of several widely recognized indexes, and future interest adjustments are based on the upward and downward movements of the index."

Services the loans

"collecting and processing the loan payments on behalf of the investor"

Annual percentage rate

(APR) (Effective rate of interest) The Truth in Lending Act requires lenders to calculate and disclose the loan's annual percentage rate. The APR is the complete cost of the loan stated as an annual percentage. "Under the Truth in Lending Act, the relationship between the total cost of the loan and the amount borrowed, expressed as an annual percentage." "The annual percentage rate (APR) expresses the total cost of the loan as an annual percentage of the amount borrowed. This key figure enables a prospective borrower to compare loans more accurately than the interest rate alone. The APR is sometimes referred to as the effective rate of interest, as opposed to the nominal rate (the interest rate stated on the face of the promissory note). In addition to the total finance charge and the APR, the disclosure statement must list: -the amount financed, -the total of all payments, -the number of payments, and -the payment amount(s). It must also provide other information, such as whether the borrower will be charged a prepayment penalty if the loan is paid off early."

Adjustable-rate mortgage

(ARM (Variable-rate loan) An adjustable-rate mortgage allows the lender to adjust the loan's interest rate in response to market rate fluctuations. "A loan that allows the lender to periodically adjust the loan's interest rate to reflect changes in market interest rates." "An ARM permits the lender to periodically adjust the loan's interest rate so that it accurately reflects changes in the cost of money. If market rates climb, the borrower's interest rate and monthly payment go up; if market rates decline, the borrower's interest rate and payment go down."

Automated Underwriting

(AU) Automated underwriting is analysis of a loan application using a computer program that makes a preliminary recommendation for or against loan approval. "Analysis of a loan application with a computer program that makes a preliminary recommendation for or against approval." "Within the limits set by the underwriting standards they apply, underwriters draw on their own experience and judgment in deciding whether to recommend that a particular loan be approved or denied. For this reason, underwriting is often described as an art, not a science. However, automated underwriting (AU) has moved the underwriting process at least somewhat closer to the scientific end of the spectrum. In automated underwriting, a computer program performs a preliminary analysis of the loan application and the applicant's credit report and makes a recommendation for or against approval. A human underwriter then evaluates the application in light of the AU recommendation. AU systems are based on statistics regarding the performance of millions of loans—whether the borrowers made the payments on time or defaulted. Analysis of these statistics provides strong evidence of which factors in a loan application make default more or less likely. AU can streamline the underwriting process, as it often requires significantly less paperwork. This enables lenders to make approval decisions more quickly."

Credit History

(Credit reputation) Underwriters use credit reports and credit scores to evaluate a loan applicant's credit history and attitude toward debt. "The first major component of creditworthiness is credit history, or credit reputation. An underwriter typically requests credit reports on the loan applicant from more than one credit reporting agency. The reports indicate how reliably the applicant has paid bills and other debts, and whether there have been any serious problems such as bankruptcy or foreclosure. In addition to reviewing credit reports, underwriters also use credit scores to help assess how likely it is that a loan applicant will default on the proposed loan. A credit reporting agency calculates an individual's credit score using the credit report and a statistical model that correlates different types of negative credit information with actual loan defaults. Credit problems can be an indication of financial irresponsibility, but sometimes they result from a personal crisis such as loss of a job, divorce, or hospitalization. A loan applicant with a poor credit history should explain any extenuating circumstances to the lender." "The activities of credit reporting agencies are regulated under the federal Fair Credit Reporting Act and the California Consumer Credit Reporting Agencies Act. Under the California law, a credit reporting agency must give consumers a copy of their credit information upon request. If an agency fails to comply, a consumer may sue the agency for actual damages, punitive damages of up to $5,000, attorney's fees, and court costs. Consumers have the right to dispute information in their credit reports. The agencies must investigate and make corrections where necessary"

Loan underwritier

(Credit underwriter) "The person who conducts the evaluation"

FHA-Insured Loans

(Federal Housing Administration) "The Federal Housing Administration (FHA) was created by Congress in 1934 in the National Housing Act. The purpose of the act, and of the FHA, was to generate new jobs through increased construction activity, to exert a stabilizing influence on the mortgage market, and to promote the financing, repair, improvement, and sale of real estate nationwide. An additional by-product of the FHA housing program was the establishment of minimum housing construction standards. Today the FHA is part of the Department of Housing and Urban Development (HUD). Its primary function is insuring mortgage loans; the FHA compensates lenders who make loans through its programs for losses that result from borrower default. The FHA does not build homes or make loans. In effect, the FHA serves as a giant mortgage insurance agency. Its insurance program, sometimes referred to as the Mutual Mortgage Insurance Plan, is funded with premiums paid by FHA borrowers. Lenders who have been approved by the FHA to make insured loans either submit applications from prospective borrowers to the local FHA office for approval or, if authorized by the FHA to do so, perform the underwriting functions themselves. Lenders who are authorized to underwrite their own FHA loan applications are called "direct endorsement lenders." "Lenders who don't underwrite their own FHA loans forward applications to the local FHA office for underwriting and approval. Note that the FHA doesn't accept applications directly from prospective borrowers. Borrowers must begin by applying to a lender such as a bank or a mortgage company for an initial loan commitment. As the insurer, the FHA is liable to the lender for the full amount of any losses resulting from the borrower's default and a subsequent foreclosure. In exchange for insuring a loan, the FHA regulates many of the terms and conditions on which the loan is made."

Loan-to-Value Ratios

(LTV) A loan-to-value ratio expresses the relationship between the loan amount and the property's appraised value or sales price (whichever is less). A loan with a low loan-to-value ratio represents less risk for the lender than a high loan-to-value ratio loan. "The loan-to-value ratio (LTV) for a particular transaction expresses the relationship between the loan amount and the value of the property. The lower the LTV, the smaller the loan amount and the bigger the downpayment." "Example: If a lender makes an $80,000 loan secured by a home appraised at $100,000, the loan-to-value ratio is 80%. The loan amount is 80% of the property's value, and the buyer makes a 20% downpayment. If the lender loaned $75,000 secured by the same property, the LTV would be 75% and the downpayment 25%. The downpayment represents the borrower's initial investment or equity in the property. (A property owner's equity is the difference between the property's market value and the amount of the liens against it.) The lower the loan-to-value ratio, the greater the borrower's equity. Appreciation of the property benefits the borrower, since any increase in the property's value increases the borrower's equity interest." "The loan-to-value ratio affects the degree of risk involved in the loan—both the risk of default and the risk of loss in the event of default. A borrower who has a substantial investment in the property—a significant amount of equity—will try harder to avoid foreclosure. And when foreclosure is necessary, the lender is more likely to recover the entire debt if the LTV is relatively low. If a lender makes a loan with a 100% LTV, it will recover the outstanding loan balance and all of its costs in a foreclosure sale only if property values have appreciated and the property sells for significantly more than its original purchase price. This is because the foreclosure process itself costs the lender a considerable amount of money. The higher the LTV, the greater the lender's risk. (In fact, lenders may apply special rules to high-LTV loans because of the extra risk they pose.) So lenders use loan-to-value ratios to set maximum loan amounts." "Example: If a lender's maximum LTV for a certain type of loan is 75%, and the property's appraised value is $100,000, then $75,000 would be the maximum loan amount. Lenders actually base the maximum loan amount on the sales price or the appraised value, whichever is less. Thus, if the $100,000 property in the example above were selling for $95,000, the maximum loan amount would be $71,250 (75% of $95,000)." -The loan amount for a particular transaction is determined not just by the FHA loan ceiling for the local area, but also by the FHA's rules concerning loan-to-value ratios. The maximum loan-to-value ratio for an FHA loan depends on the borrower's credit score. If the borrower's credit score is 580 or above, the maximum LTV is 96.5%. If his score is 500 to 579, the maximum LTV is 90%. Someone with a score below 500 isn't eligible for an FHA loan. The difference between the maximum loan amount for a transaction and the appraised value or sales price (whichever is less) is called the borrower's minimum cash investment. In a transaction with maximum financing (a 96.5% LTV), the borrower must make a minimum cash investment of 3.5%.

FHA Insurance Premiums

(MIP) "Mortgage insurance premiums for FHA loans are commonly referred to as the MIP. For most FHA loans, the borrower pays both a one-time premium and annual premiums. The one-time premium may be paid at closing, or else financed along with the loan amount and paid off over the loan term."

Mortgage Loan Originators

(MLO) A person who is compensated for negotiating or taking applications for residential mortgage loans is a mortgage loan originator (MLO). Examples include loan officers at financial institutions and independent mortgage brokers. MLOs must be licensed or registered through a nationwide system. "Whether home buyers seeking financing apply to a bank, a thrift, a credit union, or a mortgage company, they're likely to receive assistance from a mortgage loan originator, or MLO. This might be a loan officer at a bank, a mortgage broker who works for a mortgage company, or a real estate agent acting as an independent mortgage broker, for example. The MLO typically discusses financing options with the buyers, helps them fill out a loan application form, gathers the necessary documentation, and submits the completed application package for processing and underwriting." The S.A.F.E. Act requires MLOs to be licensed and/or registered through the Nationwide Mortgage Licensing System and Registry. Mortgage loan originators who work for a federally insured depository institution or a subsidiary have to register, but do not have to be licensed; most other MLOs must be registered and state-licensed. "A real estate licensee who provides only real estate brokerage services generally is not considered to be an MLO and therefore is exempt from the requirements of the S.A.F.E. Act. However, a real estate licensee who receives any compensation from a lender, a mortgage broker, or another mortgage loan originator is not exempt."

Mortgage Companies

(Mortgage bankers) Mortgage companies, also called mortgage bankers, are not depository institutions. Instead, they act as intermediaries between home buyers and large investors. After making a loan on an investor's behalf or selling a loan to an investor, the mortgage company often services the loan. "Unlike banks, thrifts, and credit unions, mortgage companies aren't depository institutions, so they don't lend out depositors' funds. Instead, they often act as loan correspondents, intermediaries between large investors and home buyers applying for financing." "A loan correspondent lends an investor's money to buyers and then services the loans (collecting and processing the loan payments on behalf of the investor) in exchange for servicing fees. Banks and thrifts sometimes act as loan correspondents, but mortgage companies have specialized in this role. Mortgage companies frequently act on behalf of large investors such as life insurance companies and pension funds. These investors control vast amounts of capital in the form of insurance premiums and employer contributions to employee pensions. This money generally isn't subject to sudden withdrawal, so it's well suited to investment in long-term mortgages. Since these large investors typically operate on a national scale, they have neither the time nor the resources to understand the particular risks of local real estate markets or to deal with the day-to-day management of their loans. So instead of making loans directly to borrowers, insurance companies, pension plans, and other large investors often hire local loan correspondents. They generally prefer large, long-term commercial loans and stay away from high-risk, short-term construction loans." "Mortgage companies also borrow money from banks on a short-term basis and use the money to make (or originate) loans, which they then package and sell to the secondary market agencies and other private investors. Using short-term financing to make loans before selling them to permanent investors is referred to as warehousing." "Banks and thrifts generally keep some of the loans they make "in portfolio," instead of selling them to investors. In contrast, mortgage companies don't keep any of the loans they make. The loans are either made on behalf of an investor or else sold to an investor. In many cases, insurance companies, pension funds, and other large investors now simply buy loans from mortgage companies instead of using them as loan correspondents. The number of mortgage companies increased rapidly during the 1990s, and they eventually came to dominate the residential finance market as savings and loans once had. Mortgage companies played a major role in the subprime lending boom, and recent problems in the subprime market have had a greater impact on mortgage companies than on ther types of residential lenders, diminishing their market share." "Mortgage companies are sometimes called mortgage bankers. Traditionally, a distinction was made between mortgage bankers and mortgage brokers. A mortgage broker simply negotiated loans, bringing borrowers together with lenders in exchange for a commission. Once a loan had been arranged, the mortgage broker's involvement ended. In contrast, a mortgage banker actually made loans (using an investor's funds or borrowed funds), sold or delivered the loans to an investor, and then (in many cases) serviced the loans to the end of their terms, in exchange for servicing fees. As a result of changes in the mortgage industry, there is no longer a clear-cut distinction between these two roles, and the more general term "mortgage company" is typically used instead of "mortgage banker" in most contexts."

Savings Banks

(Mutual Savings Banks) (MSB) "Like S&Ls, savings banks also got their start in the nineteenth century. They offered financial services to small depositors, especially immigrants and members of the working class. They were called mutual savings banks (MSBs) because they were organized as mutual companies, owned by and operated for the benefit of their depositors (as opposed to stockholders). Traditionally, MSBs were similar to savings and loans. They served their local communities. Their customers were individuals rather than businesses, and most of their deposits were savings deposits. Although the MSBs made many residential mortgage loans, they didn't concentrate on them to the extent that S&Ls did. The MSBs were also involved in other types of lending, such as personal loans. Today savings banks can be organized as mutual companies or stock companies. Residential mortgages continue to be an important part of their business."

Private Mortgage Insurance

(PMI) For a conventional loan with an LTV over 80%, the borrower is usually required to purchase private mortgage insurance, or PMI. The insurance will reimburse the lender for losses incurred if the borrower defaults. "Private mortgage insurance; insurance designed to protect lenders from the greater risks of high-LTV conventional loans." "Private mortgage insurance (PMI) is issued by private insurance companies, as opposed to the government's FHA mortgage insurance program. PMI is designed to protect lenders from the greater risk of high-LTV loans. The insurance makes up for the reduced borrower equity. PMI is usually required on all conventional loans that have an LTV over 80%—in other words, whenever the borrower's downpayment is less than 20%. When insuring a loan, the mortgage insurance company actually assumes only a portion of the risk of default. It typically covers the upper 20% or 25% of the loan amount, not the entire loan amount. The higher the LTV, the higher the coverage requirements and the premiums, since the risk of default is greater. Ex. A loan with a 95% LTV will have a higher coverage requirement than a 90% loan." "If the borrower eventually defaults and foreclosure results in losses for the lender, the lender (at the insurer's option) will either sell the property or relinquish it to the insurer, then make a claim for reimbursement of losses up to the policy limit. Losses may take the form of unpaid principal and interest, property taxes, attorney's fees, sale costs, and the cost of maintaining the property during foreclosure and resale. As a borrower pays off a loan, the loan-to-value ratio decreases. With a lower LTV, the lender's risk of loss is reduced, and eventually the private mortgage insurance has fulfilled its purpose. Under the federal Homeowners Protection Act, lenders must cancel PMI once a loan has been paid down to 80% of the property's original value, if the borrower requests cancellation. When the loan balance reaches 78%, cancellation is required whether or not it's requested."

Underwriting standards

(Qualifying standards) "The guidelines that the underwriter uses to decide whether a proposed loan would be an acceptable risk (in other words, whether the applicant qualifies for the loan)"

Mortgage Loan Broker Law

(Real Property Loan Law) (Article VII of the Real Estate Law) The Mortgage Loan Broker Law requires a disclosure statement to be given to a loan applicant by a real estate agent acting as a loan broker. It also limits the amount of the commission and fees that can be charged by a mortgage loan broker for certain loans. Real estate agents sometimes help buyers obtain financing. Under California law, a real estate agent who arranges or negotiates a loan for compensation is considered to be acting as a mortgage loan broker. The agent must comply with the Mortgage Loan Broker Law, also known as the Real Property Loan Law, or Article VII of the Real Estate Law. The Mortgage Loan Broker Law requires real estate agents acting as loan brokers to give borrowers a disclosure statement. And for loans secured by residential property with up to four units, the law restricts the size of the fees and commissions that may be paid by the borrower or received by the loan broker. The following is only an overview of some of the law's main provisions."

Loan Term

(Repayment period) The loan term or repayment period is the length of time allowed to the borrower in which to repay the loan. The standard term for home loans is 30 years. "A mortgage loan's term (also known as the repayment period) has a significant impact on both the monthly mortgage payment and the total amount of interest paid over the life of the loan. The longer the term, the lower the monthly payment, and the more interest paid. Since the 1930s, the standard term for a mortgage loan has been 30 years. This long repayment period makes the monthly payments affordable, which reduces the risk of default. Although 30-year loans continue to predominate, 15-year loans are also popular. A 15-year loan has higher monthly payments than a comparable 30-year loan, but the 15-year loan offers substantial savings for the borrower in the long run. Lenders frequently offer lower interest rates on 15-year loans, because the shorter term means less risk for the lender. And the borrower will save thousands of dollars in total interest charges over the life of the loan. A 15-year loan also offers free and clear ownership of the property in half the time." "However, for many borrowers, the higher monthly payments for a 15-year loan mean that they'd have to buy a much less expensive property than a 30-year loan would allow them to afford. Ex. Bob has a choice between a 30-year loan at 6.5% and a 15-year loan at 6%. Based on his stable monthly income, he can afford to make monthly principal and interest payments of $3,000. This is enough to amortize a $475,000 loan at 6.5% over 30 years, but it will amortize only about $355,500 at 6% over 15 years. In other words, Bob could qualify for a $475,000 loan under the 30-year plan, but will be able to borrow only $355,500 if he chooses the 15-year option. There are alternatives to 15- and 30-year loans. For some borrowers, a "20-year loan is a good compromise between the two, with some of the advantages of each. And while 30 years is the maximum repayment period in many loan programs, some programs allow borrowers to choose a 40-year term, in order to maximize their purchasing power.

Savings and Loans

(S&Ls) "Savings and loans (S&Ls) started out in the nineteenth century strictly as residential real estate lenders. Over the years they carried on their original function, investing the majority of their assets in purchase loans for single-family homes. By the mid-1950s, they dominated local residential mortgage markets, becoming the nation's largest single source of funds for financing homes. Many factors contributed to the dominance of savings and loans. One of the most important was that home purchase loans had become long-term loans (often with 30-year terms). S&Ls used the savings deposits of their customers as their main source of loan funds. Since most of the funds held by S&Ls were long-term deposits, S&Ls were comfortable making long-term home loans. While savings and loans are involved in other types of lending, home mortgage loans remain their main focus. However, due to the increasing involvement of other types of lenders, S&Ls no longer dominate the residential finance market."

Secondary Financing

(Supplementary second loan) When a buyer takes out a second mortgage loan to pay for the downpayment or closing costs required for the first loan, it's called secondary financing. The primary lender will allow secondary financing only if it complies with certain rules. "A second loan to help pay the downpayment or closing costs associated with the primary loan." "Sometimes a buyer obtains two mortgage loans at once: a primary loan to pay for most of the purchase price, and a second loan to pay part of the downpayment or closing costs required for the first loan. This supplementary second loan is called secondary financing. Secondary financing may come from an institutional lender, the seller, or a private third party. In most cases, the primary lender will allow secondary financing only if it complies with certain requirements. Ex. The borrower must be able to qualify for the combined payment on the first and second loans. The borrower usually has to make a minimum downpayment out of her own funds. And the second loan must be payable at any time, without a prepayment penalty."

Truth in Lending Act

(TILA) The Truth in Lending Act is a federal law that helps borrowers compare loan costs. It applies to consumer loans. Loans made for business, commercial, or agricultural purposes are exempt. The act requires lenders to give loan applicants a disclosure statement, and it also places restrictions on consumer loan advertising. "An origination fee, discount points, and other charges may increase the cost of a mortgage loan significantly. They also make it more difficult to compare the cost of loans offered by different lenders. Ex. Suppose one lender charges 7% interest, a 1% origination fee, and no discount points, while another charges 6.75% interest, a 1% origination fee, and two discount points. It isn't easy to tell at a glance which of these loans will cost the borrower more in the long term. (The second loan is just slightly less expensive.)" "The Truth in Lending Act (TILA) is a federal consumer protection law that addresses this problem of comparing loan costs. It requires "lenders to disclose the complete cost of credit to consumer loan applicants, and it also regulates how consumer loans are advertised. The Truth in Lending Act is implemented by Regulation Z, a regulation issued by the Federal Reserve Board. The requirements of TILA and Regulation Z are enforced by the regulatory agencies that supervise financial institutions and by the Federal Trade Commission."

Thrift Institutions

(Thrift institutions) (Thrifts) Thrift institutions include savings and loan associations and savings banks. Their traditional function was providing savings accounts and home purchase loans to individuals, and residential financing continues to be an important part of their business. "Savings and loan associations and savings banks are often grouped together and referred to as thrift institutions, or thrifts. Like commercial banks, thrifts are chartered by either the federal government or a state government."

Credit underwriter

**See Loan underwriter

Mortgage bankers

**See Mortgage companies

Guidance on Nontraditional Mortgage Products

**See Subprime Lending

Statement on Subprime Lending

**See Subprime Lending

Thrifts

**See Thrift institutions

Qualifying standards

**See Underwriting standards

Conventional Loans

A conventional loan is an institutional mortgage loan that is not insured or guaranteed by a government agency such as the FHA or the VA. "A conventional loan is simply any institutional loan that isn't insured or guaranteed by a government agency. Ex. FHA-insured loans are not conventional loans, because they are backed by a government agency, the Federal Housing Administration. The rules for conventional loans presented here reflect the criteria established by the secondary market agencies that purchase conventional loans, Fannie Mae and Freddie Mac. When a loan doesn't meet secondary market criteria, it's considered nonconforming and usually can't be sold to the secondary market agencies. Most lenders want to be able to sell their loans on the secondary market, so they tailor their standards for conventional loans to match those set by Fannie Mae or Freddie Mac."

Rate Lock-ins

A lender may be willing to lock in a loan's interest rate for a specified period. In some cases, a lock-in fee will be charged. A lock-in is an advantage for the borrower if market interest rates are rising. "A prospective borrower may want to have the interest rate quoted by the lender "locked in" for a specified period. Unless the interest rate is locked in, the lender can change it at any time until the transaction closes. If market interest rates are rising, the lender is likely to increase the interest rate on the loan. That could cost the borrower a lot of money over the long term, or else actually price the borrower out of the transaction altogether. On the other hand, locking in the interest rate is generally not desirable when market interest rates are expected to go down. A lender will typically charge the borrower the locked-in rate even if market rates drop in the period before closing. Most lenders charge the borrower a fee to lock in the interest rate. The fee is typically applied to the borrower's closing costs if the transaction closes. If the lender rejects the borrower's application, the fee is refunded; it will be forfeited to the lender, though, if the borrower withdraws from the transaction."

Net Worth

A loan applicant's net worth is determined by subtracting her debts and other liabilities from her assets. The applicant must have enough money to cover the downpayment and closing costs, and may also be required to have reserves left over. "An individual's total personal assets minus his total personal liabilities." "The third prong of the underwriting process is evaluating the applicant's net worth. An individual's net worth is determined by subtracting her total personal liabilities from her total personal assets. If a loan applicant has built up a significant net worth from earnings, savings, and other investments, that's an indication of creditworthiness. The applicant apparently knows how to manage her financial affairs. Getting an idea of the loan applicant's financial skills isn't the only reason for investigating her net worth, however. The underwriter needs to make sure that the applicant has sufficient funds to cover the downpayment, the closing costs, and other expenses incidental to the purchase of the property. In addition, it's desirable for a loan applicant to have cash reserves left over after closing. Reserves provide some assurance that she would be able to a handle financial emergency, such as unexpected bills or a temporary interruption of income, without defaulting on the mortgage. Some lenders require an applicant to have sufficient reserves to cover a certain number of mortgage payments. Even when reserves aren't required, they strengthen the loan application."

Origination Fees

A loan origination fee is used to cover the lender's administrative expenses. It is stated as a percentage of the loan amount. The fee is ordinarily paid by the buyer. "Processing loan applications and making loans is called loan origination. A loan origination fee is designed to pay for the administrative costs the lender incurs in processing a loan; it is sometimes called a service fee, an administrative charge, or just a loan fee. Institutional lenders charge an origination fee in almost every mortgage loan transaction. It's ordinarily paid by the buyer. Ex. The buyer is borrowing $200,000, and the lender is charging 1.5 points (1.5% of the loan amount, or $3,000) as an origination fee. The buyer will pay this $3,000 fee to the lender in order to obtain the loan."

Fully amortized

A loan to be completely repaid, principal and interest, by a series of regular equal installment payments "Most mortgage loans are fully amortized"

Mortgage evaluation

A mortgage evaluation is a report based on the underwriting analysis, summarizing the characteristics of the borrower, the property, and the loan. Once the underwriting analysis has been completed, a report summarizing the characteristics of the prospective borrower, the property, and the proposed loan is prepared. This summary, sometimes called a mortgage evaluation, is submitted to a loan committee, which will make the final decision on whether to approve the loan.

Nonconforming

A nonconforming loan is a conventional loan that doesn't meet the underwriting standards established by Fannie Mae and Freddie Mac and therefore isn't eligible for sale to those agencies. A type of zoning variance where a parcel of land may be given an exception from current zoning ordinances due to improvements made by a prior owner or before the current zoning ordinances made the desired use non-conforming under local law.

Owner-Occupancy

An FHA borrower must intend to occupy the property purchased with the loan as his primary residence. Owner-occupant borrowers are considered less likely to default than non-occupant borrowers (investors). In some cases, a lender will impose stricter rules on investors than on owner-occupants. "Residential lenders make a distinction between owner-occupied homes and investment properties. An owner-occupied home, as the term suggests, is one that the owner (the borrower) plans to live in himself, either as his principal residence or as a second home. An investment property is a house that the owner/investor intends to rent out to tenants. Owner-occupants are considered less likely to default than non-occupant borrowers. Owner-occupancy isn't a requirement for conventional loans, except for loans made through certain special programs (affordable housing programs, for example). In some cases, however, a lender will apply stricter rules to investors than to owner-occupants. For instance, a lender might set 95% as its maximum LTV for owner-occupants, but limit investors to a 90% LTV."

Stable monthly income

An underwriter will only consider a loan applicant's stable monthly income, which is income that meets standards of quality and durability. "Income that satisfies the lender's standards of quality and durability." Gross monthly income from any source considered reliable and likely to continue for a sustained period, generally a history of two years, which is anticipated to continue for at least three years "Income that meets the tests of quality and durability is generally referred to as the loan applicant's stable monthly income"

Commercial Banks

Commercial banks are the largest source of investment funds in the U.S. They provide financial services to businesses (including short-term business loans), but they also have a significant share of the residential finance market. "A commercial bank is either: -a national bank, -chartered (authorized to do business) by the federal government, or -a state bank, chartered by a state government. Commercial banks are the largest source of investment funds in the United States. As their name implies, they were traditionally oriented toward commercial lending activities, supplying short-term loans for business ventures and construction activities. In the past, residential mortgages weren't a major part of commercial banks' business. That was partly because most of their customer deposits were demand deposits, subject to withdrawal on short notice or without notice, like the money in checking accounts. So the government limited the amount of long-term investments commercial banks could make. But eventually banks began accepting more and more long-term deposits; demand deposits now represent a considerably smaller share of banks' total deposits than they did at one time. While banks have continued to emphasize commercial loans, they have also diversified their lending, with a substantial increase in personal loans and home mortgages, especially to already-existing customers. They now have a significant share of the residential finance market."

Credit Scores

Computer-generated analysis of factors characteristic or indicative of repayment; the most common one was developed by Fair, Isaac, and Company (FICO)

Loan

Consumer loan if it's used for personal, family, or household purposes"

Credit Unions

Credit unions are financial institutions that generally serve only members of a particular group. They have traditionally emphasized consumer loans, but they also make residential mortgage loans. "Credit unions are depository institutions, like banks and thrifts. But unlike banks and thrifts, credit unions often serve ONLY MEMBERS of a particular group, such as the members of a union or a professional association, or the employees of a large company. Credit unions traditionally provided small personal loans to their members. In recent years, many credit unions have emphasized home equity loans. (A home equity loan is a mortgage on the borrower's equity in the home she already owns.) Now many credit unions also make home purchase loans."

Discount Points

Discount points are paid to the lender at closing in exchange for a lower interest rate. One point is 1% of the loan amount. Discount points are sometimes paid by the seller, to help the buyer qualify for the loan. "A fee that a lender may charge to increase the upfront yield on the loan." "Lenders charge discount points to increase their upfront yield on a loan. (The yield is the return or profit on the investment.) By charging discount points, a lender not only gets interest throughout the loan term, but also collects an additional sum of money up front, when the loan is funded. As a result, the lender is willing to make the loan at a lower interest rate than it would have without the discount points. In effect, the lender is paid a lump sum at closing so the borrower can avoid paying more interest later. A lower interest rate also translates into a lower monthly payment. Discount points aren't charged in all residential loan transactions, but they're quite common. The number of discount points charged depends partly on how the loan's interest rate compares to market interest rates. Typically, a lender offering an especially low rate charges more points to make up for it. Example: A lender analyzes market conditions and determines that it would currently take approximately six discount points to increase the lender's yield on a 30-year loan by 1%. Based on that estimate, the lender offers borrowers an interest rate 1% below market but charges six discount points to make up the difference. The lender would charge borrowers three points if they want a rate that's 0.5% below market, or nine points for a rate that's 1.5% below market. As the example suggests, the number of discount points required to increase a lender's yield on a loan by one percentage point varies depending on market conditions, the length of the loan term, and other factors. To find out exactly how many points a particular lender will charge for a specified interest rate reduction in the current market, it's necessary to ask the lender." "In some cases, the seller is willing to pay the discount points on the buyer's loan in order to help the buyer qualify for financing. Even when the lender isn't charging discount points, the seller may offer to pay points to make the loan more affordable. This type of arrangement is called a buydown: the seller pays the lender points to "buy down" the interest rate on the buyer's loan."

FHA Qualifying Standards

FHA rules allow a borrower to have higher income ratios than would usually be permitted with conventional financing. Along with other less stringent qualifying rules and the low downpayment requirements, that makes it easier to qualify for an FHA loan than a conventional loan. "As with any institutional mortgage loan, the underwriting for an FHA-insured loan involves the analysis of the applicant's credit history, income, and net worth. But the FHA's underwriting standards aren't as strict as the Fannie Mae/Freddie Mac standards used for conventional loans. The FHA standards make it easier for low- and middle-income home buyers to qualify for a mortgage."

Preapproval

If a home buyer is approved for a loan before shopping for the property, it's called preapproval. As long as the buyer chooses a home that's under the lender's price limit and meets the lender's standards, the loan will be approved. "Traditionally, buyers would first find the house that they wanted and then apply for a loan. Now, however, getting preapproved for a mortgage loan is considered the standard practice in many areas. To get preapproved, prospective buyers submit a loan application to a lender before starting to house-hunt. If the lender approves the application, the buyers are preapproved for a specified maximum loan amount. Preapproval lets the buyers know in advance, before shopping, just how expensive a house they can afford. If a house meets the lender's standards and is in the established price range, the buyers will be able to buy it. This spares the buyers the disappointment of initially choosing a house that turns out to be too expensive and having the loan request turned down. Preapproval also helps streamline the closing process once the buyers have found the right house."

Loan Commitment

If a lender decides to approve a loan application, it issues a loan commitment, agreeing to make the loan on specified terms. "Once the underwriting analysis has been completed, a report summarizing the characteristics of the prospective borrower, the property, and the proposed loan is prepared. This summary, sometimes called a mortgage evaluation, is submitted to a loan committee, which will make the final decision on whether to approve the loan. If the committee's decision is favorable, the lender issues a loan commitment, agreeing to make the loan on specified terms."

Penalties for Violation

If a real estate agent negotiates a loan in violation of the Mortgage Loan Broker Law, she must refund any compensation she received. The refund must be made within 20 days after a written demand from the borrower is delivered or mailed to the agent (the loan broker). If the 20-day deadline isn't met, the borrower can sue the loan broker for actual damages or for twice the amount of the broker's compensation, whichever is more, plus costs and attorney's fees.

Qualifying the Buyer

In evaluating a loan applicant's financial situation, an underwriter must consider many factors. These factors fall into three main groups: 1. credit history, 2. income, and 3. net worth

Seller Financing Disclosure Law

In seller-financed transactions involving an arranger of credit, the Seller Financing Disclosure Law requires the buyer and the seller to disclose information to each other. The arranger of credit is responsible for making sure they comply. "The Seller Financing Disclosure Law is also called the Residential Purchase Money Loan Disclosure Law. When a seller carries back a purchase money loan on residential property, this state law requires certain disclosures to be made to both the buyer and the seller if an "arranger of credit" is involved. An arranger of credit, for the purposes of this law, is anyone (other than the buyer or seller) who: -is involved in negotiating the credit agreement, -participates in preparing the documents, or -is directly or indirectly compensated for arranging for the financing or the property sale that is facilitated by the financing." "There's an exception for escrow agents and for attorneys representing either party—these aren't considered arrangers of credit. But if an attorney or a real estate agent is a party to the transaction, he is considered an arranger of credit if neither party is represented by a real estate agent.

Basic Loan Features

In this section, we'll look at the basic features of a home mortgage loan. These include the loan term, the amortization, the loan-to-value ratio, a secondary financing arrangement (in some cases), and a fixed or adjustable interest rate. A lender is likely to present a home buyer with a number of options concerning these various loan features. Each of them has an impact on how large a loan the buyer will qualify for, and ultimately on how expensive a home the buyer can purchase. -"These include the loan term, the amortization, the loan-to-value ratio, a secondary financing arrangement (in some cases), and a fixed or adjustable interest rate. A lender is likely to present a home buyer with a number of options concerning these various loan features. Each of them has an impact on how large a loan the buyer will qualify for, and ultimately on how expensive a home the buyer can purchase."

Disclosure Requirements

In transactions that are subject to TILA, lenders are required to give prospective borrowers a disclosure statement. Two especially important figures that must appear on the statement are the total finance charge and the annual percentage rate. The total finance charge is the sum of all fees and charges the borrower will pay in connection with the loan. In addition to the interest on the loan, any of the following that are going to be paid by the borrower would be included in the total finance charge: -origination fee, -discount points, -finder's fee, -service fees, -mortgage insurance premiums, and -mortgage broker's compensation In real estate: -loan transactions, -appraisal fees, -credit report charges, -inspection fees, and -title fees aren't included in the total finance charge. Also, any charges that will be paid by someone other than the borrower—points paid by the seller, for example—aren't included." -"When the Seller Financing Disclosure Law applies to a transaction, the required disclosures must be made before the buyer signs the note or the security instrument. The seller must make disclosures to the buyer, and the buyer must make disclosures to the seller. The arranger of credit is responsible for ensuring that each party discloses all required information to the other. The statute contains a long list of required disclosures. Here are some of them:" 1. the terms of the note and the security instrument; 2. a description of the terms and conditions of senior encumbrances (such as a first deed of trust that the buyer will be assuming); 3. whether the financing will result in a balloon payment (if so, the buyer must be warned that it may be difficult to obtain refinancing to cover the balloon payment); and 4. employment, income, and credit information about the buyer, or else a statement that the arranger of credit has made no representations regarding the buyer's creditworthiness. As an example of a form that could be used to comply with this law, a CAR Seller Financing Addendum and Disclosure form"

Loan correspondents

Intermediaries between large investors and home buyers applying for financing

Preapproved

More thorough process, lender commits in writing to funding the loan

Types of Mortgage Lenders

Most home buyers finance their purchase with a loan from one of these sources of residential financing: -commercial banks, -thrift institutions, -credit unions, and -mortgage companies At one time, financial institutions in the United States were quite specialized. Each type of institution served a different function; each had its own types of services and its own types of loans. In recent decades, federal deregulation of depository institutions removed many of the restrictions that differentiated them. To a great extent, all depository institutions can now be regarded as "financial supermarkets," offering a wide range of services and loans—including residential mortgage loans. There still are differences between the various types of mortgage lenders, in terms of lending practices and government regulations." "Those differences don't necessarily affect a loan applicant who wants to finance the purchase of a home, however. A home buyer decides between two lenders because of the types of loans they're offering, the interest rates and fees they're charging, and the quality of service they provide, not because one is a savings and loan and the other is a mortgage company. Even so, it's worthwhile to have a general understanding of the different types of mortgage lenders."

Interest rate cap

On adjustable rate mortgage, limit on the amount that the interest rate increase each adjustment period.

Payment shock

Phrase used to describe when borrowers experience the shock when monthly payment on the loan increased dramatically occurs mainly an interest only loans

Conventional Qualifying Standards

Qualifying standards applied to conventional loan applicants include minimum credit scores and maximum housing expense and debt to income ratios. Some lenders also impose specific requirements concerning cash reserves. "Fannie Mae and Freddie Mac have detailed guidelines for evaluating a conventional loan applicant's credit history, income, and net worth. The agencies set minimum credit scores for the loans they buy. Also, a borrower whose credit score is above the minimum, but still comparatively low, is usually charged a risk-based loan fee called a delivery fee or loan-level price adjustment (LLPA). This fee can be substantial. Additional LLPAs may be charged based on other special risk factors in a transaction; for example, an LLPA might be charged because the loan has an adjustable interest rate. (The risk of default is greater with an ARM, because of the potential for payment shock.) To determine if an applicant's stable monthly income is sufficient, an underwriter may consider both the housing expense to income ratio and the debt to income ratio." Ex. Suppose a lender's maximum housing expense to income ratio is 28% and maximum debt to income ratio is 36%. If an applicant's housing expense to income ratio is 26% (under the lender's limit), but her debt to income ratio is 40% (over the lender's limit), then the lender probably won't approve the loan unless there are special considerations. In some cases, the underwriter will consider only the debt to income ratio. Because the debt to income ratio takes all of the applicant's monthly obligations into account, it's considered a more reliable indicator of creditworthiness than the housing expense to income ratio. Some lenders require an applicant for a conventional loan to have the equivalent of two months of mortgage payments in reserve after making "the downpayment and paying all their closing costs. For loans with LTVs over 90%, a lender might require three months of mortgage payments in reserve."

Residential Financing Programs

Residential financing programs can be divided into 2 main groups: 1. conventional loans and 2. government-sponsored loans We'll look first at conventional loans, and then at 4 government-sponsored loan programs: 1. the FHA-insured loan program, 2.the Rural Housing Service loan program, 3. the VA-guaranteed loan program, and 4. the Cal-Vet loan program As you'll see, each of these has its own qualifying standards and its own rules concerning the downpayment and other aspects of the loan."

Subprime Lending

Subprime lending involves making loans that carry greater risk than prime (or standard) loans. Subprime lenders often charge higher interest rates and fees to compensate for the increased risk in making these loans. "What happens to home buyers whose credit history doesn't meet standard underwriting requirements? Some of them may be able to obtain a loan by applying to a subprime lender. Subprime lending involves making riskier loans than prime (or standard) lending. Although many of the buyers who get subprime mortgages have blemished credit histories and mediocre credit scores, that's not always the case. For example, subprime financing may also be necessary for buyers who: -can't (or would rather not have to) meet the income and asset documentation requirements of prime lenders; -have good credit but carry more debt than prime lenders allow; or -want to purchase nonstandard properties that prime lenders don't regard as acceptable collateral." "Subprime lenders apply more flexible underwriting standards and, in exchange, typically charge much higher interest rates and fees than prime lenders. In addition to having high interest rates and fees, subprime loans are more likely than prime loans to have features such as prepayment penalties, balloon payments, and negative amortization. These features help subprime lenders counterbalance some of the extra risks involved in their loans, although they can also cause trouble for the borrowers. A boom in subprime lending began in the late 1990s and continued into the new century. However, a significant number of the subprime loans made during the boom turned out to be poor risks. Many of them called for monthly payments that were initially low but increased sharply a few years into the loan term, and the borrowers couldn't handle the sudden increases (a problem known as "payment shock"). The resulting foreclosure epidemic that began in 2008 has affected not just the mortgage industry but the economy as a whole." "The secondary market agencies and various government agencies have responded to the crisis by taking steps to discourage high-risk subprime lending. Among other things, the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators issued two publications, one called the Statement on Subprime Lending, the other called Guidance on Nontraditional Mortgage Products. California law now requires state-licensed lenders and mortgage brokers to adopt policies and procedures intended to achieve the objectives set forth in those publications.

S.A.F.E. Act

The Secure and Fair Enforcement for Mortgage Licensing Act is a federal law that requires mortgage loan officers to be licensed or registered through a nationwide system. "Under the definition established in the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, known as the S.A.F.E. Act, a mortgage loan originator is any individual who, for compensation or gain, takes a residential mortgage loan application or offers or negotiates the terms of a residential mortgage loan. Mortgage loan originators who work for a federally insured depository institution or a subsidiary have to register, but do not have to be licensed; most other MLOs must be registered and state-licensed. "A real estate licensee who provides only real estate brokerage services generally is not considered to be an MLO and therefore is exempt from the requirements of the S.A.F.E. Act. However, a real estate licensee who receives any compensation from a lender, a mortgage broker, or another mortgage loan originator is not exempt."

Interest only

The borrower's regular payments during the loan term cover the interest accruing on the loan, without paying any of the principal off. The entire principal amount—the amount originally borrowed—is due at the end of the term

Coverage of the Law

The disclosure law applies when the seller gives the buyer credit for all or part of the purchase price, if: 1. the transaction concerns residential property with up to four units, 2. the credit arrangements involve a finance charge or provide for more than four payments (not including the downpayment), and 3. an arranger of credit is involved. "A transaction is exempt if it's already covered by another disclosure law, such as the Truth in Lending Act, the Real Estate Settlement Procedures Act, or the Mortgage Loan Broker Law."

Index

The interest rate on an ARM is tied to an index, a published indicator of changes in market rates. Increases and decreases in the index rate are the basis for changes in the loan's interest rate. "A published rate used as a reliable indicator of the current cost of money" An index is a published statistical rate that is a reliable indicator of changes in the cost of money. Examples include the one-year Treasury bill index and the Eleventh District cost of funds index. At the time a loan is made, the lender selects the index it prefers, and thereafter the loan's interest rate will rise and fall with the rates reported for the index.

Application Form

The loan application for residential mortgage loans requires applicants to supply information about their personal circumstances, housing expenses, employment, income, and assets and liabilities. "A mortgage loan application form asks the prospective borrower for detailed information about her finances. The lender requires this information because it wants its loans to be profitable investments. A loan is unlikely to be profitable if the borrower doesn't have the financial resources to make the payments reliably, or if the borrower has a habit of defaulting on debts. The application helps the lender identify and turn down potential borrowers who are likely to create collection problems. Most mortgage lenders use the Uniform Residential Loan Application form developed by Fannie Mae and Freddie Mac. The form requires all of the following information:" 1. Personal information, such as the applicant's social security number, age, education, marital status, and number of dependents. 2. Current housing expense (monthly rent or house payment, including principal and interest, property taxes, hazard insurance, any mortgage insurance, and any homeowners or condominium association dues). 3. Employment information (such as job title, type of business, and duration of employment) concerning the applicant's current position and, if he's been with the current employer for less than two years, concerning previous jobs. 4. Income from all sources, including employment (salary, wages, bonuses, and/or commissions), investments (dividends and interest), and pensions. 5. Assets, which may include money in bank accounts, stocks and bonds, real estate, life insurance, retirement funds, cars, jewelry, and other personal property. 6. Liabilities, including credit card debts, car loans, real estate loans, spousal maintenance or child support payments, and unpaid taxes." "The lender will verify the applicant's information concerning income, assets, and liabilities (for example, by contacting his employer and his bank)."

Minimum cash investment

The required downpayment for an FHA loan is called the minimum cash investment. The amount of cash needed to close an FHA transaction can be significantly less than the amount needed for a conventional loan. The difference between the max loan amount and the appraisal value or sales price (whichever less). reserves not required

Points

The term "point" is short for "percentage point." A point is one percentage point (one percent) of the loan amount. For example, on a $100,000 loan, one point would be $1,000; six points would be $6,000."

Warehousing

Using short-term financing to make loans before selling them to permanent investors

Margin

When an ARM is made, the lender sets a margin for the loan. The margin is the difference between the index rate and the actual rate the borrower is charged. It covers the lender's administrative expenses and provides a profit. "The difference between the index value on an ARM and the interest rate the borrower is charged." Since the index is a reflection of the lender's cost of money, it's necessary to add a margin to the index to ensure sufficient income for administrative expenses and profit. The lender's margin might be 2% or 3%, or somewhere in between. The index plus the margin equals the interest rate charged to the borrower. Example: 3.5% Current index value + 2.25% Margin = 5.75% Borrower's interest rate It's the index that fluctuates during the loan term and causes the borrower's interest rate to increase and decrease; the lender's margin remains constant.

Negative Amortization

When unpaid interest is added to a loan's principal balance, it's called negative amortization. With an ARM, negative amortization occurs if the monthly payment amount doesn't keep pace with the interest rate increases. "When unpaid interest is added to a loan's principal balance." "If an ARM has certain features, payment increases may not keep up with increases in the loan's interest rate, so that the monthly payments don't cover all of the interest owed. The lender usually handles this by adding the unpaid interest to the loan's principal balance; this is called negative amortization. Ordinarily, a loan's principal balance declines steadily, although gradually. But negative amortization causes the principal balance to go up instead of down. The borrower may owe the lender more money than he originally borrowed. Today, most lenders structure their ARMs to avoid negative amortization and lessen the chance of default and foreclosure."

Conventional LTVs

While 80% has traditionally been considered the standard loan-to-value ratio for a conventional loan, higher LTVs are very common. Many lenders make conventional loans with LTVs up to 95%. "Traditionally, the standard loan-to-value ratio for a conventional loan has been 80% of the appraised value or sales price of the home, whichever is less. Lenders feel confident that a borrower who makes a 20% downpayment with his own funds is unlikely to default; the borrower has too much to lose. And even if the borrower were to default, a foreclosure sale would be likely to generate at least 80% of the purchase price. While an 80% LTV may still be regarded as the traditional standard, today many conventional loans have much higher loan-to-value ratios. Many lenders allow LTVs up to 95%; and loans with a 97% LTV may be available through special programs (although conventional loans with LTVs that high are increasingly rare). Because the lender's risk is greater when the borrower's downpayment is smaller, lenders require borrowers to obtain private mortgage insurance for any conventional loan with an LTV over 80%. (Private mortgage insurance is discussed below.) Some lenders also charge higher interest rates and larger loan fees for conventional loans with higher LTVs. The rules for loans with LTVs over 90% tend to be especially strict.

Amortization

With an amortized loan, part of each payment is applied to reduce the principal balance, and the rest is interest. Most mortgage loans are fully amortized, so that the regular payments are sufficient to pay off the entire debt by the end of the loan term. "Most mortgage loans are fully amortized. A fully amortized loan is repaid within a certain period of time by means of regular payments that include a portion for principal and a portion for interest. As each payment is made, the appropriate amount of principal is deducted from the debt and the remainder of the payment, which represents the interest, is retained by the lender as earnings or profit. With each payment, the amount of the debt is reduced and the interest due with the next payment is recalculated based on the lower principal balance. The total payment remains the same throughout the term of the loan, but every month the interest portion of the payment is reduced and the principal portion is increased. The final payment pays off the loan completely; the principal balance is zero and no further interest is owed." Ex. A $500,000 loan at 5.75% interest can be fully amortized over a 30-year term with monthly principal and interest payments of $2,917.86. If the borrower pays $2,917.86 each month, then the loan will be fully repaid (with interest) after 30 years." "There are two alternatives to fully amortized loans: -partially amortized loans and -interest-only loans. A partially amortized loan requires regular payments of both principal and interest, but those payments aren't enough to repay all of the principal; the borrower is required to make a large balloon payment (the remaining principal balance) at the end of the loan term." Ex. A $500,000 partially amortized mortgage at 5.75% interest calls for regular monthly payments of $2,917.86 for principal and interest, with a loan term of five years. Because the monthly payments are more than enough to cover the interest accruing on the loan, some of the principal will be repaid during the five-year term. But since it would take 30 years to fully repay the loan at this rate, most of the principal (roughly $464,000) will still be unpaid after five years. This amount will be due as a balloon payment. To pay it, the borrower will have to refinance the property or come up with the funds from some other source. With an interest-only loan, the borrower's regular payments during the loan term cover the interest accruing on the loan, without paying any of the principal off. The entire principal amount—the amount originally borrowed—is due at the end of the term." Ex. A five-year, $500,000, interest-only loan at 5.75% interest requires monthly payments of $2,395.83, the amount needed to cover the monthly interest accruing on the loan. At the end of the five-year term, the borrower owes the lender the full amount of the principal ($500,000). The term "interest-only loan" is also used to refer to a loan that's structured to allow interest-only payments during a specified period at the beginning of the loan term. At the end of the initial period, the borrower must begin making amortized payments that will pay off all of the principal and interest by the end of the term. This type of interest-only loan was very popular during the subprime boom, since the low initial payments enabled buyers to purchase a more expensive home than they otherwise could have. For many buyers, however, these loans eventually backfire. When the interest-only period ends, they can't afford the amortized payments, and the payment shock ultimately results in foreclosure.