Ch. 12 - Financing: Loan Types

Mark gets a home loan and the lender will charge him 3 points at closing. If the loan is for $68,000, what will Mark be assessed in points?

$2,040

VA LOANS

A VA-guaranteed loan is yet another alternative for a little-or- no-down-payment loan. These loans are available to eligible veterans and their spouses. Eligibility for a VA loan varies according to the length of service and the time period during which the veteran served on active duty. Persons who serve in the National Guard or in the Reserves may also be eligible for a VA loan. Unlike an FHA loan, which is insured, a VA loan is guaranteed. However, like the FHA, the VA does not loan the money directly (usually) and the guarantee provides added security for the lender. In the event of a default, the VA would pay the amount of the guarantee to the lender if the foreclosure on the property didn't bring enough money to cover the balance due on the loan. VA loans are also assumable. If the loan was made prior to March 1, 1998, the loans are assumable for a small processing fee. If the loan was made after March 1, 1998, the VA must approve the assumption agreement. For all assumed loans, the original veteran borrower is still liable for the repayment of the loan unless the VA approves a release of liability. The VA will issue a release if both of the following conditions are met. The buyer assumes all of the veteran's liabilities on the loan. The VA and the lender approve the buyer and approve the assumption agreement. Note: The release from the VA does not release the veteran's liability to the lender. The veteran must negotiate directly with the lender for that release. A veteran must apply to the VA for a certificate of eligibility to determine his or her eligible status and to determine the amount of the loan the VA will guarantee. The certificate doesn't assure the veteran will get the loan. It only states the maximum amount for which the veteran is eligible. The VA doesn't set a maximum on the amount of the loan a veteran can get - only the amount of the loan that it will guarantee. If a veteran qualifies for a loan higher than the guarantee, the veteran will pay the difference as a down payment on the property. The VA also requires an appraisal of the property the veteran is seeking to purchase. The VA then issues a certificate of reasonable value (CRV) on the property. The CRV places a ceiling on the amount of the loan that is allowed for that property. If the purchase price is less than the amount stated in the CRV, the borrower does not have to make any down payment. However, if the price of the property exceeds the amount on the CRV, the veteran will have to pay the difference in cash.

BLANKET MORTGAGE

A blanket mortgage loan covers more than one piece of property. Land developers commonly use blanket mortgages when they buy a plot of land and divide it into many separate lots. A blanket loan usually includes a clause called a partial release clause. This clause allows the borrower to obtain a release of any individual lot from the lien by repaying a certain part of the loan. The lender will issue the partial release for the one lot, with the provision that the mortgage will continue to cover the remaining lots.

Which statement is true?

A borrower can request the cancellation of PMI payments when the equity reaches 20% of the appraised value.

BRIDGE LOAN

A bridge loan is a short-term loan that covers the period between the end of one loan and the beginning of another. Bridge loans are typically used in two situations: To cover the time period between the end of a construction loan and the issue of a permanent loan on a property. When a person needs to borrow money on his or her unsold home (a second mortgage of sorts) to fund the acquisition of a new home. This is useful when a seller will not accept a property sale contingency.

BUYDOWN

A buydown is a financing technique used to reduce the monthly payment for a borrower during the initial years of the loan. A lump sum payment is made to the lender at closing, usually by a builder as an incentive to the buyer or by a family member trying to help out. That payment serves to reduce the interest rate on the loan for the first few years. At the end of that time, the rate rises. The lender assumes the borrower's income will also have risen during these years and he or she will be able to make the increased payments.

Greg and Joyce purchased a home from the builder who offered to pay $5,000 at closing as an incentive to get them to buy. What kind of mortgage might they get?

A buydown mortgage.

SECOND MORTGAGE

A mortgage on a property that has no prior mortgage is known as a first mortgage. If an owner takes out another loan for additional money, the new loan is a second mortgage. The second mortgage is subordinate to the first mortgage and, because second mortgages represent a greater risk to the lender, they are usually given at a higher interest rate.

PACKAGE LOAN

A package loan is one that includes all the personal property and appliances that are installed on the property. This type of loan has been used extensively in the sale of furnished condominiums. The loan will include furniture, draperies, carpeting, kitchen appliances, washer and dryer, freezers and other items as part of the purchase price for the residence.

What kind of problem can result from a straight loan?

A straight loan is an interest-only loan. If the property doesn't appreciate in value over time, the borrower could end up with less in proceeds on the sale than what he needs to pay off the loan.

WRAPAROUND LOAN

A wraparound loan allows a borrower who has an existing loan to get another loan from a second lender without paying off the first loan. The second lender issues a new larger loan to the borrower at a higher interest rate. The new loan is a combination of the first loan and the second loan. The borrower makes the new higher payments to the second lender, and then the second lender pays the first lender out of those funds. A wraparound loan is often used in a refinancing situation or for the purchase of a home when a buyer cannot prepay the existing mortgage. Note: A wraparound mortgage is only possible if the original loan documents allow it.

A growing equity mortgage:

Allows quick repayment of the loan through accelerated payments.

OPEN-END LOAN

An open-end loan is an expandable loan which gives a borrower a limit up to which he or she may borrow. Each incremental advance must be secured by the same mortgage, and any advances may not exceed the original borrowing limit. The interest rate on the original amount borrowed is fixed. But the interest rate on any future advances can be at the prevailing rate at the time of the advance. An open-end loan is usually less expensive than the conventional home improvement loan. It allows the borrower to "expand" the mortgage to increase the debt to the original amount. Farmers have used this type of loan to meet their seasonal operating expenses, hopefully paying off the advance after they harvest their crops.

FHA-INSURED LOANS

As we just discussed, conventional loans are the most common loan type available, and most homes are financed through uninsured or insured conventional loans. However, the government still does play a active role in providing loans for property purchases. The Federal Housing Administration (FHA) provides low down-payment loans to qualified buyers. The Department of Housing and Urban Development (HUD) oversees the FHA. The loans FHA provides are high loan-to-value ratio loans; so FHA insures the loans in order to make them available to higher risk individuals. Important Note: FHA does not build homes or loan money directly. They insure loans made by approved lending institutions. FHA-insured loans protect lenders against any loss they would suffer from a borrower's default.

Which loan covers the period of time between the end of one mortgage and the beginning of another?

Bridge

CALVET LOANS

California provides another alternative in the form of a special assistance program for farm and home purchases. The California Department of Veterans Affairs (CDVA), Division of Farm and Home Loans, administers the program, and the loans are referred to as CalVet loans. These loans are available to California residents who have met the veteran requirements. Eligibility requirements have been expanded to the point that almost any veteran who wants to purchase a home in California would be eligible. Unlike the insured FHA loan or the guaranteed VA loan, the CalVet loan is actually a land contract. When a veteran is approved for a CalVet loan, the state purchases the property and resells it to the veteran using a contract of sale. The state retains the title to the property until the loan is paid off, after which California will issue a grant deed to transfer legal title to the veteran.

A blanket mortgage:

Covers more than one piece of property.

What are grant programs typically used for?

Down payment assistance.

What is the difference between an FHA loan and a VA loan?

FHA insures loans and VA guarantees them.

Which of these statements is true about a CalVet loan?

If the loan is VA guaranteed, no down payment is required.

What's the difference between a lease purchase and a lease option?

In a lease purchase arrangement, a tenant enters into two agreements simultaneously - an agreement to purchase and a lease. A lease option is a clause in a lease that gives the tenant the right to purchase the property under specific conditions - usually at a predetermined price and within a set period of time.

Which of these is also called a contract for deed?

Installment land sales contract

What kinds of limits are placed on the interest rate in an adjustable rate mortgage?

Interest rate caps limit the amount of interest the borrower can be charged. Periodic caps limit the amount the rate can change at any one time. Overall (or aggregate) caps limit the amount the interest can increase over the life of the loan.

CONSTRUCTION LOAN

Lenders give construction loans to finance the construction of improvements to property, such as homes, apartments and office buildings. The lender commits to the full amount of the loan, but disburses payments over the life of the construction project. The payments are made to the general contractor or the owner for the parts of the construction completed since the last payment. But before making a payment, the lender will inspect the completed work and ask the contractor to submit proof that the mechanic has waived the lien rights for the work the payment is covering. Interest rates on construction loans are usually higher than on other loans because the risk is greater. Risks include: Inadequate protection against mechanics' liens. Potential delays in construction completion. Financial failure of contractors or subcontractors. The borrower pays interest on only the money that has been actually disbursed up to the payment date. These loans are short-term. The borrower can get a permanent loan, usually called a takeout loan, which pays off or "takes out" the lender of the construction loan, when the construction is complete. Alternatively, a borrower may be able to convert the construction loan to a permanent fixed mortgage if the lender offers that option.

BORROWER FEES

Loan Origination Fee This fee is typically 1 percent of the loan amount, although it could be higher. It covers the lender's cost for generating the loan. Points This is a one-time service charge to the borrower for making the loan. Points represent prepaid interest and the lender charges them to get additional income on the loan. Points are paid at closing and are usually equal to 1 percent of the loan amount. Two (2) points on a $75,000 loan would be $1,500. ($75,000 x .01 x 2 points) Discount Points (Discount Charges) These charges are designed to offset any losses the lender might suffer when selling the loan to the secondary mortgage market. Discount points are a means of raising the effective interest rate of the loan. The rule of thumb is 1/8 percent for each discount point. So a charge of 4 points would increase a 7 ¼ percent mortgage to a 7 ¾ percent yield. 4 points x 1/8 percent = 4/8 = ½ percent 7 ¼ + ½ = 7 ¾

GRANT PROGRAMS

Not technically a loan, grant programs provide buyers with a "gift" of money to use toward their down payment or closing costs which never has to be paid back. Some popular programs include AmeriDream, Nehemiah, Housing Action Resource Trust (HART) and Partners in Charity. Some lenders also accept "gift letters," which acknowledge that the down payment money was a gift from a relative and does not need to be repaid. Grant programs are also known as down payment assistance.

HOME EQUITY LOAN

Owners have the ability to borrow against the equity they have built up in their home. Homeowners can use a home equity loan for: Purchasing high dollar items. Taking a vacation. Consolidating other loans or credit card debt. Paying medical expenses. Paying college tuition. Making home improvements. A home equity loan is an alternative to refinancing. It can be given as a fixed amount or it can be a line of credit that the homeowner can borrow against as he or she needs.

Which of the following is a low loan-to-value ratio?

Sandy and Bill are putting 30% down on their home purchase.

In which of the following types of loans is the payment allocated only to interest?

Straight

REPAYMENT PLANS

Straight Loan Also known as an interest-only loan, the monthly payments are allocated only to interest. No principal is paid off. At the end of the term, the borrower must be able to pay off the entire principal amount or get another loan. These loans have become very popular in recent years. The attraction is due to the fact that the payments are typically lower than with other loan types. An interest-only loan could be a wise choice for someone who plans to own the property for a short time and believes the property will appreciate during that time. Conversely, it could be very risky. If the property does not appreciate in value, the borrower could end up with less in proceeds on the sale than what he needs to pay off the loan. Amortized Loan With this loan payment plan, a borrower makes a periodic (usually monthly) payment of principal plus interest. These payments result in the loan being paid off gradually over time. Amortized loans are usually fixed-interest, long-term loans of 15 to 30 years. At the end of the loan term, the full amount of the principal and all of the interest are totally paid off and the balance is zero. With a fully amortized loan, the borrower has the same payment amount every month. The payment goes first to the interest and then to the principal. Over the life of the loan, the amount going toward interest decreases, while the amount going to principal increases. With a straight amortized loan, the borrower pays a different amount with each payment. A fixed amount goes to the principal with each payment. The interest amount changes as the principal balance declines. Adjustable-Rate Mortgage With an adjustable-rate mortgage (ARM), the interest rate is linked to an economic index. The loan starts at one rate of interest, but then it fluctuates up or down over the life of the loan as the index changes. The loan agreement describes how the interest rate will change and when. The interest rate the borrower pays is usually the index rate plus a margin. The margin is the lender's "mark-up." It represents the lender's cost of doing business. The margin usually stays the same over the life of the loan. An adjustment period establishes how often the lender can change the rate - monthly, quarterly or annually. Adjustable-Rate Mortgage Interest rate caps limit the amount of interest the borrower can be charged. There are two types of caps: Periodic caps limit the amount the rate can change at any one time. Overall (or aggregate) caps limit the amount the interest can increase over the life of the loan. A payment cap limits how much the monthly payment can increase. While this appears to be a good thing, it could be a problem if the payment cap prevents the payment from covering the interest. When that happens, the unpaid interest is added back to the loan, generating even more interest and debt. If this trend continues, the borrower will make many payments but end up owing more than he or she did at the beginning of the loan. This is called negative amortization. Sometimes lenders offer conversion options. This would allow the borrower to convert the ARM to a fixed-rate loan at certain times during the life of the loan. Balloon Payment Loan A balloon payment loan is a long-term loan that has one large final payment due when the loan matures. The major problem with a balloon payment loan is that the borrower has to come up with a large sum of money at the end of the term. Many borrowers believe that if they have been a good credit risk and have made payments on time, the lender will extend the balloon payment for another term. This could happen, but lenders are not obliged to make an extension and could choose to require the full payment when the note comes due. Balloon Payment Loan Balloon payment loans are partially amortized loans. This means that the monthly payments are not large enough to fully amortize the loan by the end of the term, leaving the large balloon payment due. For example, a loan for $125,000 at 5% can be computed on a 30-year amortization schedule but be paid over a term of 20 years. That means the payment amount will be figured as if the loan were a 30-year loan, but the loan will mature and the final balloon payment will be due at the end of the 20th year. In this example, the monthly payment (principal plus interest) will be $671.03. At the end of year 20, the balloon payment due will be $63,265.33 (the amount of principal still left on the loan). Balloon payment loans are loans with a "call" provision stipulating that at a predetermined future date, the total remaining balance of the loan is due and payable in full. In lending parlance, the loan "balloons" on the call date where the balance must be paid off via refinancing or other means. Balloon loans as such can be interest-only loans, amortized loans, purchase money mortgages, fixed or variable rate loans, or negative amortization loans. They are simply loans which contain the balloon provision stipulating that the remaining balance must be retired at a predetermined time in the future. A simple example of a balloon loan is a 5-year interest-only loan for $200,000 @ 6% interest. In this scenario, the borrower will pay $12,000 per year, or $1,000 per month for 5 years. At the end of the 5-year term, the loan balance of $200,000 is due and payable in full. Two other less common repayment plans are the growing equity mortgage and the reverse annuity mortgage. Growing Equity Mortgage (GEM) The growing equity mortgage is a fixed-rate loan in which payments increase by a predetermined amount each year, reducing the outstanding balance of the loan. This accelerated payment plan allows repayment of the loan much more quickly. For example, a 30-year loan can be paid off in 15 to 20 years. This type of loan is often used when a borrower expects that his or her income will keep up with the increase in the payments. Reverse Annuity Mortgage (RAM) This type of loan is quite different from the others. With a reverse annuity mortgage, the lender is making payments to the borrower. This system allows older property owners to receive regular monthly payments from the equity in their paid-off property without having to sell. The borrower pays a fixed rate of interest and then repays the loan either when the home sells or from the borrower's estate upon his or her death. Now that we have discussed the types of repayment plans available, let's do a short exercise and then talk about the types of loans that exist.

Lenders can charge all of the following except which fee when a borrower gets a loan?

Survey fee

CONVENTIONAL LOANS - UNINSURED

The conventional loan is the most common type of loan and is generally viewed as the most secure. Most conventional loans require the borrower to make a down payment of 20% or more, making the loan 80% or less of the property's sale price. Conventional loans are typically uninsured. The mortgage itself provides the only security for the loan. To protect its interests, the lender relies on the appraisal of the property and the borrower's ability to repay the loan, as indicated by the borrower's credit reports. When writing conventional loans, many lenders follow the underwriting standards that are provided by Freddie Mac and Fannie Mae, so that they can sell their loans in the secondary mortgage market. We'll be discussing Freddie Mac, Fannie Mae and the secondary market later in this chapter.

Which of the following is not true about reverse annuity mortgages?

The loan must be repaid before the borrower's death.

How much is the loan origination fee and what does it cover?

The loan origination fee is typically 1% of the loan amount. It covers the lender's cost for generating the loan.

SALE AND LEASEBACK

The sale and leaseback arrangement is typically used by commercial enterprises to free up money that has been tied up in the real estate to use as working capital in the business. The owner of the real estate sells the property and then leases it back from the buyer. The buyer becomes the owner and the former owner becomes the tenant. These arrangements are very complicated and should be undertaken only with proper and adequate legal and tax advice.

Define the term loan-to-value ratio.

The term loan-to-value ratio means the ratio of debt to the value of the property. If the loan-to-value ratio is low, the borrower is paying a higher down payment on the property. If the loan-to-value ratio is high, the borrower is making a low down payment.

What is the major difference between a CalVet loan and other loans?

Unlike other loans, the CalVet loan is actually a land contract. When a veteran is approved for a CalVet loan, the state purchases the property and resells it to the veteran using a contract of sale. The state retains the title to the property until the loan is paid off, after which California will issue a grant deed to transfer legal title to the veteran.

CONVENTIONAL LOANS - INSURED

What happens when a borrower can't afford a 20% down payment on a home? Are they out of luck? No. A borrower can get a conventional loan with a lower down payment by insuring the loan through a private mortgage insurance program (PMI). A lower down payment means a higher loan-to-value ratio. Lenders need to minimize their risk; so they require additional security in the form of insurance. The lender purchases the insurance, which typically protects 25% to 35% of the loan, from a private mortgage insurance company. The lender passes the cost to the borrower by charging a fee at closing plus an additional monthly fee while the insurance is in force. Using this process, a borrower may be able to get a loan for up to 97% (or even 100%) of the appraised value of the property.

TYPES OF LOANS

When a borrower is shopping for a mortgage, the most common types of loans available are: Conventional FHA Insured VA Guaranteed Cal Vet Land Contract (available only in California) Before we discuss each type, we need to define the term loan-to-value ratio. This term means the ratio of debt to the value of the property. When talking about mortgages, the value is the sale price or the appraised value, whichever is less. If the loan-to-value ratio is low, that means the borrower is paying a higher down payment on the property. Lenders like this, since the higher the down payment, the lower the risk for the lender.

When is a lender required to terminate a borrower's private mortgage insurance?

When is a lender required to terminate a borrower's private mortgage insurance?

Define a purchase money mortgage.

With a purchase money mortgage, the buyer borrows from the seller in addition to the lender. This is sometimes done when a buyer cannot qualify for a bank loan for the full amount; so the seller "takes back" a portion of the purchase price as a second mortgage. A purchase money mortgage can also be a first mortgage.

INSTALLMENT LAND SALES CONTRACT

With an installment land sales contract, also called a contract for deed, the buyer does not receive legal title until the final payment is made. The seller keeps legal title until the debt is paid in full. The buyer receives equitable title until the debt is fully paid. The buyer agrees to give the seller a down payment and to make regular payments of principal and interest for some agreed-upon number of years. The buyer also agrees to pay real estate taxes and insurance premiums and to maintain the repairs and upkeep of the property. Many installment contracts contain a provision that allows the seller to cancel the contract, keep all payments and evict the buyer if the buyer defaults. But many states require the seller to refund at least a part of the buyer's payments in that situation.

Describe a reverse annuity mortgage.

With this type of mortgage, the lender makes payments to the borrower. Popular among senior citizens who are on fixed incomes and would like to benefit from their home's equity without having to sell.