Chapter 16 - Finance: Types of Loan Programs
interest is either
(a) the income earned for lending money, or (b) the rent paid to borrow money.
Fannie Mae/Freddie Mac Suitable Property
1-4 family unit principal residences Single-family second homes 1-4 family investor properties (non-owner occupied) Co-ops, condos, PDs, and leaseholds
List properties that are suitable for Fannie Mae/Freddie Mac loans.
1-4 family unit principal residences Single-family second homes 1-4 family investor properties (non-owner occupied) Co-ops, condos, PDs, and leaseholds
Describe a conventional non-conforming.
A conventional non-conforming loan (also called a portfolio loan) does not meet the Fannie Mae or Freddie Mac lending guidelines.
Differentiate between a debt-to-income ratio and a loan-to-value ratio.
A debt-to-income ratio (DTI) is a ratio derived by dividing the borrower's total monthly obligations (including housing expense) by his or her gross monthly income. A loan-to-value ratio (LTV) is the ratio of the loan amount to the property's appraised value or selling price, whichever is less.
Differentiate between fixed-rate loans and adjustable-rate loans.
A fixed-rate loan has two distinct features—fixed interest for the life of the loan and level payments. An adjustable-rate loan or adjustable-rate mortgage (ARM) is a loan with an interest rate that adjusts in accordance with a movable economic index.
Describe the features of GPMs.
A graduated payment mortgage (GPM) is a fixed-rate loan with initial payments that are lower than the later payments. GPMs have negative amortization.
purchase money loan
A loan that is used to purchase property used strictly for financing the purchase of real property. Any loan made at the time of a sale, as part of the sale, is a purchase money loan Even a seller carryback or a second loan used to finance part of the purchase of a property are purchase money loans. Most loans used to purchase property are closed-end loans
What is the difference between a purchase money loan and a hard money loan?
A loan used to purchase property is a purchase money loan. Any loan used to take cash out of a property is a hard money loan.
Which type of loan could result in a balloon payment?
A partially amortizing loan
PITI
A payment that includes the principal, interest, taxes, and insurance calculated by determining the monthly principal and interest payment for a loan and adding the monthly amount for property taxes and hazard insurance. You may use a financial calculator or go online to a website such as piticalc.com to calculate the principal and interest payment for a home loan. To calculate the property tax component, divide the amount of the annual tax by 12 to get the monthly installment: $200. To calculate the monthly insurance payment, divide the total yearly premiums by 12. The combined sum will equal the total PITI. The sales price of the home is $200,000, and the buyers are putting 20% down. The monthly principal and interest (P&I) payment for a $160,000 loan for 30 years at a 4% interest rate is $763.86. If, in our example, the property tax is 0.75% (.0075) of the sales price ($125 per month) and hazard insurance is $50 per month, the total monthly PITI is $938.86.
What is a teaser rate?
A teaser rate is a low, short-term introductory interest rate designed to tempt a borrower to choose a loan.
Define amortization.
Amortization is the liquidation of a financial obligation on an installment basis.
hard money loan
Any loan used to take cash out of a property draw on the equity in a property. Ex. Pat owes $90,000 on a house valued at $180,000 and wants $30,000 to add a family room. Pat can refinance the loan for $120,000, pay off the existing loan, and have $30,000 to add the family room. This type of loan includes home equity loans, home equity lines-of-credit, and swing loans. Cash-out refinancing is not the same as a home equity loan. Cash-out refinancing replaces an existing loan with a new one. A home equity loan is a second loan against the equity in your home.
nontraditional mortgage product.
Any mortgage product other than a 30-year, fixed-rate mortgage
Give two reasons when subprime financing may be necessary.
Borrowers in the subprime category include those who have low credit scores or no credit score, income that is difficult or impossible to verify, an excessively high debt-to-income ratio, or a combination of these factors.
List three names for conforming loans.
Conforming loans are called "A" paper loans, prime loans or full documentation (full doc) loans.
When Subprime Financing May Be Necessary
Credit scores less than 620 No credit rating Good credit, but debt-to-income ratios exceeding limits allowable to qualify for a prime loan
Describe the purpose of Fannie Mae and Freddie Mac underwriting guidelines.
Fannie Mae and Freddie Mac underwriting guidelines determine which properties are suitable, set maximum loan limits, and set debt-to-income ratios for conforming loans.
federal agencies that participate in government-backed real estate financing
Federal Housing Administration (FHA), the Department of Veterans Affairs (VA) United States Department of Agriculture (USDA).
Describe the difference between interest and compound interest.
Interest is the fee the lender charges for the use of their money. Compound interest is the interest that interest earns.
Name two types of conventional non-conforming loans.
Jumbo loans and subprime loans
Direct Endorsement (DE) lenders.
Lenders who have met certain FHA standards
Benefits of FHA-Insured Loans
Low down payment. = The down payment on FHA loans varies with the amount of the loan. Typically, it is 3.5% of the appraised value of the property or of the sales price, whichever is less. Competitive interest rates. = FHA does not set the interest rate. Easy qualifying requirements. = Even with less-than-perfect credit, it is easier to qualify for an FHA loan than a conventional loan. Reasonable loan fees = HUD regulates that the closing costs associated with FHA-insured loans must be reasonable and customary.
List 3 of the 5 words used to describe the terms of a loan.
Most home loans show the loan amount (principal), interest, interest rate, loan term, and a repayment schedule.
Differentiate between packing and junk fees.
Packing is the practice of adding credit insurance or other extras to increase the lender's profit on a loan. A junk fee is a questionable fee charged in closing costs that may not bear any significant relationship to the actual loan transaction.
Describe private mortgage insurance (PMI
Private mortgage insurance (PMI) is a type of mortgage insurance from private insurance companies.
FHA Property Appraisal
The FHA uses a current appraisal of the property to determine the market value and acceptability of the property for FHA mortgage insurance purposes. For example, the loan amount for an FHA 203(b) loan is based on the appraised value of the property or the sales price, whichever is lowest.
Why do lenders want to know the purpose of the loan?
The lender uses the purpose of the loan to determine the risk and make decisions on the type of loan and terms that the lender will offer.
Freddie Mac Loan Products
The majority of Freddie Mac's home loans are fixed-rate, with 15, 20, and 30-year -year terms. These products enable borrowers to have the security of stable monthly payments throughout the life of the loan. The 15- and 20-year term loans allow borrowers to build equity faster and carry a lower interest rate. These fixed-rate loans can be combined with other Freddie Mac loan options to accommodate a wide variety of borrowers. In recent years, Freddie Mac has been more aggressive in serving the subprime market and has developed loan products to serve that market.
conventional loan
The majority of loans originated by lenders for 1- to 4-unit residential properties any loan without government insurance or guarantees. The main sources of conventional loans are commercial banks, thrifts, and mortgage companies. either are conforming or non-conforming
adjustment period
The period between rate changes For most ARMs, the interest rate and monthly payment change every month, quarter, year, 3 years, or 5 years. For example, a loan with a 1-year adjustment period is a 1-year ARM. This means the interest rate and payment can change once every year. A loan with a 3-year adjustment period is a 3-year ARM.
Lenders must know:
The purpose for the load so they know the risk
What is the commonality of interest rate, index, margin, caps, initial payment, and adjustment period?
These are the basic features of every ARM
initial payment
These payments are usually lower than if the loan were a fixed-rate loan. In some ARMs, the initial rate and payment adjust after the first month. Other ARMs keep the initial rate and payment for several years before making an adjustment.
Name three common home loans.
Typical residential loans include conventional loans, government loans (FHA, VA, and USDA), and other loans, such as seller carryback loans.
fully indexed rate
When the margin is added to the index For example, the current index value is 5.5%, and the loan has a margin of 2.5%. Therefore, the fully indexed rate is 8.0%. Many adjustable-rate loans (ARMs) have a low introductory rate or start rate, sometimes as much as 5.0% below the current market rate of a fixed-rate loan.
prepayment penalty
a clause in a mortgage or deed of trust stating that a penalty will be charged if the loan is paid down or paid off within a certain period. The penalty is based on a percentage of the remaining loan balance or a certain number of months' worth of interest. Depending upon the amount, this penalty can effectively wipe out any equity gains the borrower might have realized in the first years of ownership.
Mutual Mortgage Insurance Fund
a federal fund that insures home loans guaranteed by the Federal Housing Administration (FHA). The MMI insures loans to protect the lenders who make the loans.
interest rate
a figure calculated as a percentage that is used to indicate the rate charged for the use of money in a loan. Interest rates may be fixed or variable.
graduated payment mortgage (GPM)
a fixed-rate loan with initial payments that are lower than the later payments. The difference between the lower initial payment and the required amortizing payment is added to the unpaid principal balance. This loan is for the buyer who expects to be earning more after a few years and can make a higher payment at that time.
non-conforming loan
a loan that does not conform to Fannie Mae/Freddie Mac underwriting guidelines. Since these loans do not conform to Fannie Mae/Freddie Mac credit standards, they cannot be sold into the secondary market.
adjustable-rate loan or adjustable-rate mortgage (ARM)
a loan with an interest rate that adjusts according to a movable economic index. The interest rate on the loan varies upward or downward over the term of the loan depending on money market conditions and the agreed upon index. interest rate on the ARM only changes if the chosen index changes. The borrower's payment stays the same for a specified time (for example, one year or two years) depending on the borrower's agreement with the lender. At the agreed upon time, the rate adjusts according to the current index rate. A lender may offer a variety of ARMs, all of which share similar features—interest rate, index, margin, caps, initial payment, and adjustment period. These basic features are part of every ARM loan.
teaser rate
a low, short-term introductory interest rate designed to tempt a borrower to choose a loan. When these rates adjust, typically in as little as 2 years, the new fully indexed rate on this subprime home loan can increase debt-to-income ratios 20% or more. This dramatic rate increase causes the payments to jump to a level that a majority of homeowners cannot pay.
index
a measure of interest rates a publicly published number that is used as the basis for adjusting the interest rates of adjustable-rate mortgages. The most common indices, or indexes, are the Constant Maturity Treasury (CMT), the 11th District Cost of Funds Index (COFI), Certificate of Deposit Index (CODI), and the Bank Prime Loan (Prime Rate). Then, the lender adds a few percentage points, or margin, to the index
fixed-rate loan is:
a nontraditional mortgage product.
exploding ARM
a notorious home loan product offered in the subprime industry. This adjustable-rate mortgage product features a teaser rate for which the borrower qualifies even with high debt-to-income ratios.
junk fee
a questionable fee charged in closing costs that may not bear any significant relationship to the actual loan transaction.
debt-to-income ratio (DTI)
a ratio derived by dividing the borrower's total monthly obligations (including housing expense) by his or her gross monthly income.
Payment shock
a significant increase in the monthly payment on an ARM that may surprise the borrower.
Automated underwriting (AU)
a technology-based tool that combines historical loan performance, statistical models, and mortgage lending factors to determine whether a loan can be sold into the secondary market can evaluate a loan application and deliver a credit risk assessment to the lender in a matter of minutes. It reduces costs and makes lending decisions more accurate and consistent. Automated underwriting systems promote fair and consistent mortgage lending decisions because they are blind to an applicant's race and ethnicity. The most widely used automated underwriting systems are Fannie Mae's Desktop Underwriter® and Freddie Mac's Loan Prospector®. FHA-insured loan processing uses the FHA Total Scorecard AUS. Contrary to popular belief, Desktop Underwriter® and Loan Prospector® do not approve loans. They provide quick feedback as to the eligibility of the borrower and property for a particular Fannie Mae or Freddie Mac loan. As useful as an AUS is, it is only as good as its inputs. If a lender inputs incorrect data (accidentally or intentionally), then the AUS results are invalid.
Private mortgage insurance (PMI)
a type of mortgage insurance from private insurance companies. If a borrower does not make a 20% down payment, conventional lenders make the borrower purchase PMI to protect the lender if the borrower is unable to pay the mortgage. In other words, PMI protects the lender if the borrower stops making payments on the home loan. If the borrower makes a high down payment (20% or more), a lender has less risk and may offer a lower interest rate. Conversely, a low down payment means greater risk for the lender, who typically will charge the borrower a higher interest rate.
convertible ARM
an ARM that can be converted to a fixed rate by the borrower at some point during the loan term. As an example, a lender may have a 1-year ARM with a feature that allows conversion from the ARM to a fixed-rate loan during the first 60 months of the loan.
margin
an extra amount that the lender adds.
Negative amortization
an increase in the principal balance of a loan caused by a failure to make payments that cover the interest due. Later as the payments increase, the payments cover all the interest as well as the larger principal amount.
Types of Loans
conventional loans, government-backed loans, alternative financing for specific borrowing needs. and carryback loans
FHA Loan Limits
determined by the type of property—one-unit, two-unit, three-unit, and four-unit properties. The FHA maximum loan amounts vary from region to region and change annually. Typically, loan limits for FHA-insured loans are less than the loan limits for conventional financing in most parts of the country. Borrowers who need a loan that exceeds the FHA loan limits for the area will have to put additional money down on the property or get conventional financing.
Subprime loans
do not meet the borrower credit requirements of Fannie Mae and Freddie Mac. Subprime loans are called "B" paper and "C" paper loans as opposed to "A" paper conforming loans. The purpose of "B" and "C" paper loans is to offer financing to applicants who do not currently qualify for conforming "A" paper financing. Subprime loans are offered to borrowers who may have recently filed for bankruptcy or foreclosure, or have late payments on their credit reports. Borrowers in the subprime category include those who have low credit scores or no credit score, income that is difficult or impossible to verify, an excessively high debt-to-income ratio, or a combination of these factors. Other factors, such as the purpose of the loan and the property type, may require the borrower to secure a subprime loan. For example, a borrower who is qualified to purchase a single-family home under standard Fannie Mae or Freddie Mac guidelines may have to use a subprime loan to finance the purchase of a non-owner occupied fourplex.
Federal Housing Administration (FHA)
does NOT actually make loans. A borrower does NOT apply to the FHA for a home loan. Instead, the borrower applies for an FHA-insured loan through an approved lender, who processes the application and submits it for FHA approval.
Portfolio loans
either retained in the lender's portfolio or privately securitized for sale on Wall Street. Lenders who originate non-conforming loans set their own lending policies and underwriting standards
jumbo loan
exceeds the maximum conforming loan limit set by Fannie Mae and Freddie Mac. Because jumbo loans are bought and sold on a much smaller scale, these loans usually carry a higher interest rate and have additional underwriting requirements.
fixed-rate loan (2 distinct features)
fixed interest for the life of the loan and level payments. level payments of principal and interest = structured to repay the debt completely by the end of the loan term The major advantage of fixed-rate loans is the predictability of housing costs for the life of the loan. Fixed-rate loans are suitable for the majority of homebuyers. If the borrower plans to stay in his or her home for a long time and can afford the payments associated with a fully amortizing, fixed-rate loan, this type of loan offers level, predictable payments.
Lenders classify loans by the type of amortization
fixed-rate, ARM, or GPM
repayments
generally cover a portion of the principal and the interest charge (P & I). Some payments include the property taxes and insurance as well.
partially amortizing loan
has a repayment schedule that is not sufficient to pay off the loan over its term. This type of loan calls for regular, periodic payments of principal and interest for a specified period of time. At maturity, the remaining unpaid principal balance is due as a balloon payment
Conforming loans Limits
have maximum loan amounts that are set by the Federal Housing Finance Agency (FHFA) and follow the underwriting guidelines set by Fannie Mae and Freddie Mac. Different loan limits apply according to the number of units. The limit is less for a single-family property and more for a fourplex. Fannie Mae and Freddie Mac announce new loan limits every year or as market conditions change.
Conforming loans
have terms and conditions that follow the Fannie Mae or Freddie Mac underwriting guidelines.
caps.
help avoid payment shock with built-in protections Caps regulate how much the interest rate or payment can increase in a given period.
most common types of amortization
include fixed-rate loans, adjustable-rate mortgages (ARM), and graduated payment mortgages (GPM).
Home loans have the
interest, interest rate, loan term, and a repayment schedule.
Cash-out refinancing
involves refinancing the loan for a larger amount than the current loan.
Two common types of conventional non-conforming loans
jumbo loans and subprime loans.
periodic adjustment cap
limits the amount the interest rate can adjust up or down from one adjustment period to the next after the first adjustment.
interest-only ARM (IO)
loan allows payment of interest only for a specified number of years (typically between 3 and 10 years). This allows the borrower to have smaller monthly payments for a period of time.
Full documentation
means that the lender requires 2 years of tax returns, verification of income, deposits, employment, a high credit score, and a clean credit history.
straight loan (interest only loans)
not amortized. The borrower only makes periodic interest payments during the term of the loan. The entire principal balance is due in one lump sum upon maturity. These loans are also called interest-only loans. Institutional lenders usually do not offer straight loans, but a seller or a private lender may offer a straight loan to a buyer
Fannie Mae Loan Products
offers traditional fixed-rate, conforming loans with 10, 15, 20, and 30-year terms. These fixed-rate loans lock in an interest rate and a stable, predictable monthly payment. They continue to be the home loan of choice for the majority of borrowers. Fannie Mae's short-term fixed-rate loans allow borrowers to build equity faster and carry a lower interest rate. In addition to the conforming loans that Fannie Mae purchases, it also offers ARMs and other loan programs to ensure that working families have access to mortgage credit to buy homes they can afford over the long term.
closed-end loan
one in which the borrower receives all loan proceeds in one lump sum at the time of closing. The borrower may not draw additional funds against the loan later.
two interest rate caps
periodic adjustment caps and lifetime caps.
"A" paper loans
prime loans, or full documentation (full doc) loans
Underwriting guidelines
principles lenders use to evaluate the risk of making real estate loans. Lenders who expect to sell their loans to Fannie Mae or Freddie Mac use underwriting guidelines that adhere to the Fannie Mae/Freddie Mac standards. Fannie Mae and Freddie Mac underwriting guidelines determine which properties are suitable, set maximum loan limits, and set debt-to-income ratios for conforming loans.
Loan Purpose
purchase, refinance, or cash out
fully amortizing loan
repaid in full at maturity by a periodic reduction of the principal. A fully amortizing loan has equal payments over the duration of the loan. Any home loan other than a 30-year, fully amortizing,
Refinancing
replaces the old loan with a new one. A person may refinance to reduce the interest rate, lower monthly payments, or change from an adjustable-rate to a fixed-rate loan. The loan amount remains the same, but the terms change. Refinancing usually makes sense only when there has been a drop in interest rates. Refinancing may also benefit those who want to refinance for a longer term to lower monthly payments.
second loan
secured by either a mortgage or deed of trust and has a lien position that is subordinate to the first mortgage or deed of trust.
repayment schedule
shows the loan payments laid out over the life of the loan. Over the term of the loan, the borrower makes repayments on a regular basis—typically monthly.
balloon payment
substantially larger than any other payment and repays the debt in full.
"B" paper loans
the 2/28 ARM and 3/27 ARM. These ARMs have a fixed interest rate for the first 2 or 3 years of the loan. After that, the interest rate can change yearly according to the applicable index plus the margin (subject to any caps). "B" paper loans allow borrowers with less-than-perfect credit to rebuild their credit and refinance the loan at a better rate. Usually, 2/28 ARMs and 3/27 ARMs have a higher initial interest rate and a prepayment penalty during the first 3 years.
loan term
the agreed period the borrower has to repay the loan. For some loans, this could be a year or less; however, for most home loans it is 25-30 years.
Loan products differ based on:
the amount borrowed, interest rate, length of the loan, and type of amortization.
Principal
the amount of money a person borrows from the lender.
type of amortization
the basis for how a loan is repaid. An amortization schedule details each payment, displays the specific amount applied to interest and principal, and shows the remaining principal balance after each payment.
Interest
the fee the lender charges for the use of their money. People pay for the privilege to borrow money. The interest charge on the loan depends on the amount of money that is borrowed, the interest rate, and the term of the loan. Interest is merely another name for the rent paid to use someone else's money.
interest rate is made up of two parts:
the index and the margin.
Compound interest
the interest paid on original principal and on the accrued and unpaid interest that accumulates as the debt matures. It is the interest that interest earns. For example, if Kris invests $100 at 5% interest for 2 years, then she will have $105 at the end of the first year. Assuming she does not spend the interest, she will have $110.25 at the end of 2 years. Because she invests only $100 but gets back $110.25, her money is working for her.
Amortization
the liquidation of a financial obligation on an installment basis.
life time cap
the maximum interest rate that may be charged over the life of the loan.
down payment
the portion of the purchase price that is not financed.
Packing
the practice of adding credit insurance or other extras to increase the lender's profit on a loan. Lenders can require the purchase of credit insurance with a loan as long as they include the price of the premium in the finance charge and annual percentage rate.
loan-to-value ratio (LTV)
the ratio of the loan amount to the property's appraised value or selling price, whichever is less. A common LTV ratio is 80%, but lenders often originate loans with LTVs of 90% or higher. For example, if a lender makes an 80/20 LTV loan for a property appraised at $100,000, the buyer would have a $20,000 down payment (20%), and the loan amount would be for $80,000 (80%). If the LTV were 90%, the down payment would be $10,000, and the loan amount would be $90,000. Lenders may require low LTV ratios for certain property types or for borrowers with low credit scores. LTV loans in excess of 100% are risky and are seldom used.
