Chapter 5: Closing and Funding

Periodic Interest

• A periodic interest rate is the interest rate charged on a loan over a specific period of time. Lenders quote interest rates on an annual basis, but in most cases, the interest compounds more frequently than annually. As a result, the periodic interest rate is the annual interest rate divided by the number of compounding periods. • The interest on a mortgage is compounded or applied monthly. If the annual interest rate on a mortgage is 8 percent, the periodic interest rate used to calculate the interest assessed in any single month is 0.08/12 = 0.0067 or 0.67 percent. This means that every month, the remaining principal balance of the mortgage loan has a 0.67 percent interest rate applied to it. • For test purposes, it is important to know about calculating interest-only payments (an interest-only loan requires that the borrower only pay the amount of interest accrued on the loan for a specific period). It is more difficult than the formula above to determine the payment on a regular amortizing loan that pays principal and interest so students are not tested on those calculations. Below is an example of calculating the payment on an interest-only loan: • Regan has finally decided to purchase a new home. Regan works closely with a financial planner. After speaking with her financial planner, she decides that the best product for Regan would be a 5/1 I/O ARM. If Regan's new loan amount will be $445,000 and her interest rate is 3.75 percent: • What will her Interest only payment is without taxes and insurance? o Answer: $1,390.63 o How did we get this answer? o For Interest only, the formula is Loan amount x Rate = Payment/12 months. o So, we take $445,000 x 3.75 percent =$16,687.50 o We then divide $16,687.50 / 12 months = $1,390.63

What is Consummation?

• Consummation occurs when the consumer becomes contractually obligated to the creditor on the loan, not for example, when the consumer becomes contractually obligated to a seller on a real estate transaction.

The Closing Disclosure

• Creditors are required to provide a Closing Disclosure at least 3 business days prior to consummation. The term business day in the case of the Closing Disclosure is defined as all calendar days except Sundays and legal public holidays. The Closing Disclosure must disclose all the final terms and costs of the loan.

Corrections to Closing Disclosures

• Creditors must re-disclose terms or costs on the CD if certain changes occur to the transaction after the CD was provided that caused disclosures to become inaccurate. There are three categories of changes that require a corrected CD containing all changed terms: o Changes that occur before consummation that require new 3-business-day waiting period, o Changes that occur before consummation and do not require a new 3-business-day waiting period, and o Changes that occur after consummation. 1. The disclosed APR becomes inaccurate, 2. The loan product changes, 3. A prepayment penalty is added. • The occurrence of any of the above will require the creditor to re-disclose the CD with the changes and then they must wait 3 business days before consummating the loan. • If something else changes that does not trigger one of the above items the creditor is still required to provide a corrected CD with any terms or costs that have changed and ensure that the consumer receives it, but the creditor is not required to wait another 3 business days to consummate the loan. • Sometimes things change after consummation. If that happens, the creditor is required to provide a corrected CD no later than 30 calendar days after receiving the information that establishes that an event occurred to change the CD after consummation • Further, creditors are required to provide a corrected CD to correct non-numerical clerical errors and document refunds for tolerance violations no later than 60 calendar days after consummation.

Foreclosure: Judicial vs. Non-Judicial Foreclosure

• Foreclosure o is what happens when a borrower falls behind on their mortgage and the lender uses legal procedures to sell their home. Foreclosure procedures vary by state. In some states, the lender must file a lawsuit to foreclose (judicial foreclosure), while in others, it can foreclose without going to court (non-judicial foreclosure). • In judicial foreclosure, o the lender is required to go to court to get the foreclosure started. A judicial foreclosure typically takes several months or more, giving the borrower time to look for another place to live and to save money for the future. Another advantage is that the borrower can raise in court any legal defenses they may have to the foreclosure. • The states the use judicial foreclosure o at closing, the borrowers will sign a mortgage as their security instrument. • The following is the typical process of a judicial foreclosure: o The borrower gets behind on their payments. The mortgage holder begins the foreclosure procedures. Lenders can start after one missed payments, but usually wait much longer before starting the foreclosure process. o The lender sends a notice of intent to begin the foreclosure process. Most states require this be sent before they even start proceedings. The notice informs the borrower that proceedings can be avoided if they make up the missed payments, plus the cost and interest. The lender will file a lawsuit, if they don't make up the payments the lender will go to the court and file the lawsuit. o The lender gives the borrower notice of the lawsuit by delivering a summons and complaint to the borrower. o The borrower has between 15-30 days to respond. The lender bears the burden of proving that the foreclosure is justified under the terms of the mortgage. o If the borrower fails to respond, it is almost certain the foreclosure will go through. In this situation, the court issues a default judgment that authorizes the lender to sell the borrower's home. If the borrower responds, the borrower can explain why they think they have a legal right to keep their house and that foreclosure is not warranted. The better the defenses, the longer the process. Even if the borrower wins, it may be temporary victory if the lender can fix whatever problem caused it to lose. o After the court rules in favor of the lender, the lender sends the borrower and occupants a notice of intent to sell. At this point in many states, the borrower can avoid the foreclosure sale if they can "redeem" the mortgage (pay it off in full, as well as the foreclosure costs and attorney's fees). o The auction is held. If no one buys the home at the auction, ownership goes to the lender. Up to this point, the entire process, from the first notice to the auction, typically takes three and a half months -- more, if the borrower file a response to the summons and complaint. o The borrower can stay or get evicted. Even when they lose ownership of their home, most state laws don't require them to move out right away. Typically, the Lender will then have to go through the eviction process. The lender may just let the house sit, waiting for the market to improve. The borrower can remain in the home payment-free until they receive an official, written eviction notice. • If a borrower's property is in a non-judicial foreclosure state, then the borrower signed two core documents at the time of closing, a promissory note and a deed of trust. The deed of trust turns the promissory note into a debt secured by a lien on their home. The deed of trust authorizes the lender to foreclosure on the property if the borrower defaults. The deed of trust typically allows the foreclosure to proceed outside of court, under state law. Non-judicial foreclosure typically is much faster than judicial foreclosure because the lender does not have to prove that the foreclosure is warranted to a judge. • Each state has a specific process for a nonjudicial foreclosure. The process should dictate how much notice the borrower is given, how the property will be sold (typically at public auction), and what rights the borrower has to reinstate the loan or rights to recover title to the property after it is sold. • With nonjudicial foreclosures, there may be very little notice to the borrower and once it happens the borrower can permanently be out of luck. In some states the borrower's first notice will be the notice of sale. Some states also require the provision that the borrower receives two notices, a formal written notice that they are in default and another formal notice that their house will be sold at auction (usually within about a month). • Between the notice of default and the notice of sale, the borrower typically can reinstate the mortgage by paying off whatever they owe, plus fees and costs (which can be very high). With a couple exceptions, hovered, once the sale occurs, the borrower's house is gone. • If the borrower doesn't reinstate their mortgage, the home will be sold at auction. As with judicial foreclosures, if no one meets the minimum bid, the property goes to the lender. • A few states allow the borrower the right to redeem their property after the foreclosure action (to recover ownership of the property by paying off the successful bidder).

Funding

• Funding is o the process at closing by which the funds are dispersed to their proper owners. In the situation of a purchase transaction, funds are transferred to the seller from the buyer and the buyer also transfers funds to the lender. At closing the buyer will bring their down payment and closing cost funds with them and transfer them to the lender at that time. The lender will then transfer the funds to the seller on behalf of that buyer. This happens immediately at the time of closing. • For a refinance transaction on an owner-occupied property, o funding is a slower process because of the borrower's right to rescind. The lender will not fund an owner-occupied refinance transaction until the borrower's period of rescission has ended. This happens because the lender does not want to provide the funds to the borrower, whether it is in the form of paying off their current mortgage, providing the borrower cash funds, or paying off any other creditors of the borrower until the borrower has fully accepted the terms of the loan. • For refinance transactions on non-owner occupied properties, o funding occurs same day just like on a purchase transaction. Funding occurs this way because there is no right of rescission, just like there isn't a right of rescission on a purchase transaction

Page 3 of the CD

• Page three of the CD includes how the amount of cash to close was calculated by the lender. It lists the total closing costs, the closing costs paid before closing, the closing costs that will be financed into the loan the down payment/funds from the borrower, the deposit already being held by the lender, the funds for the borrower, seller credits, and any other adjustments and other credits. Please note, not all sections are applicable to every loan. If an amount does not apply, it is left blank. This also indicates if any of these amounts changed from what was disclosed on the LE. • Page three of the CD also includes the summaries of the transaction; including more detail on how the cash to close was calculated. It is separated into two columns, the borrower's transaction and the seller's transaction. The borrower's transaction column includes what the borrower needs to bring to closing, any adjustments made, and any adjustments made specifically because of items paid by the seller in advance. It also shows what has already been paid by or on behalf of the borrower at closing, and any other credits or adjustments unpaid by the seller for a total. It also includes the cash to close from or to the borrower. • The seller's transaction is similar; it will show what is due to the seller at closing, and what adjustments were made from items paid by the seller before closing. It also includes amounts due from the seller at closing and the adjustments for items unpaid by the seller. There is a total calculation for a total due to seller at closing and total due from seller to closing. It totals the amount of cash from or to seller.

The Bank Secrecy Act / Anti-Money Laundering

• The Bank Secrecy Act/Anti-Money Laundering or BSA/AML specifically requires financial institutions institute a compliance program to detect money laundering and suspicious activity. A large part of BSA/AML is the requirement of suspicious activity reports or SARs. These are required when: o Insider abuse involving any amount is suspected o A transaction aggregating $5,000 or more where the suspect can be identified o A transaction aggregating $25,000 or more regardless of potential suspects o A transaction aggregating $5,000 or more that involve potential money laundering or violations of the Bank Secrecy Act • Monetary transactions like the purchase of a home have been used for money laundering and so during this process if the borrower is bringing a large amount of cash to closing there might be a concern where that money came from unless it can be verified.

The USA Patriot Act

• The USA Patriot Act was created in response to the attacks of September 11, 2001. The Treasury Department through its Financial Crimes Enforcement Network (FinCEN) became responsible for implementing the USA Patriot Act. As part of the USA Patriot Act, financial institutions are required to require proper identification of borrowers to verify that the borrower is who they claim to be. Regulation requires that all Customer Identification Programs developed by financial institutions are reasonable in obtaining the information to: o Verify the information of the individual(s) applying for a loan program, o Maintain records to show what methods were used in identifying the individual, and o Determine if the individual(s) applying for a loan appears on any list of known or suspected terrorist or terrorist organization. • This happens during the underwriting process and again at closing the borrower is required to provide identification to verify their identity before they sign the documents.

Explanation of Documents

• The borrower may receive the following at closing: o A promissory note indicates the borrower accepts the mortgage loan from the lender and agrees to repay the amount borrowed plus any interest. They will sign a security instrument that pledges that their home is collateral for the loan. In some states this document is a mortgage and in other states this document is a deed of trust. o After the lender transfers the money to the seller on the borrower's behalf (in a purchase transaction), the seller will then sign the deed, and transfer ownership to the borrower. • The mortgage note o is a legal document that provides evidence of the borrower's indebtedness and their formal promise to repay the mortgage loan, according to the terms agreed upon. These terms can include the amount owed, the interest rate on the mortgage, the dates when payments are to be made, the length of time for repayment and the place where the payments should be sent. The note also explains any consequences for failing to make a monthly payment. • The mortgage or deed of trust o is the security instrument that the borrower gives to the lender that protects the lender's interest in the property. When the borrower signs the mortgage or deed of trust, they are giving the lender the right to take the property by foreclosure if they fail to properly pay their mortgage. The mortgage or deed of trust will provide the same information that appears in the note and states that it is the borrower's responsibility to keep the house in good repair, insure it, pay property taxes and make payments on time • A deed o is a document that transfers ownership of the property from one party to another. It contains the names of the previous and new owners and a legal description of the property. The person transferring the property signs it. The deed gives the borrower title to the property, but the title is conveyed to a neutral third party (called a trustee) until the borrower pays their mortgage in full. (This is like purchasing a car, when you have a car loan the lender holds that title until you pay it off, once you pay it off they mails you the title to your car and then you can do whatever you wish to do with the car). • The closing agent or settlement agent will record these documents in the county's public records. The borrower will receive a copy at closing and another copy of these documents once they have been recorded. • The borrower may be asked to sign affidavits and declarations at closing, these statements declare something to be true. For example, they may affirm that the house will be their principal place of residence, or that all the repairs needed on the property were completed prior to closing. In most cases, the borrower signs more than one of these affidavits or declarations at closing.

Settlement and Closing Agents

• The closing is the final step in the mortgage process, it is also referred to as settlement. A representative of the closing company oversees and coordinates the closing, records the closing documents, and disperses money to the appropriate individuals and organizations. At closing, borrowers sign a lot of different documents, including the mortgage note and mortgage or deed of trust. • The settlement agent and closing agent are responsible for going over all documents before the borrower signs them. The settlement agent will guide your borrowers through the last part of the origination process. They are employees of the closing agency, in some states the closing agent is an attorney or performed at an attorney's office under their supervision. • These individuals are responsible for preparing all the documents and making sure all of them are properly signed. • As an MLO, depending on your individual situation, you can be present at the closing but you are not required to be present at the closing. It is good business practice to be available to your borrower at the time of closing in case they have questions or need additional clarification that the settlement agent cannot answer. The MLO typically knows the details of the loan better than the settlement agent and may be more qualified to answer borrower questions. It is good business practice to encourage your borrower to reach out to you at closing if they have specific questions about the loan.

Page 5 of the CD

• The final page of the CD includes the total of payments, the total finance charge, the APR and the TIP from the loan. It should look similar to what was disclosed on the LE but can change based on any changes to the closing costs. • There is also contact information for all parties involved in the transaction including the lender, the real estate broker for the borrower and the seller, and the settlement agent's contact information. • This page also lets the borrower know that the lender is required to give the borrower a copy at no additional cost at least 3 days before closing and that the borrower should contact the lender if they have not received that appraisal at the time they receive the CD. There is also a disclosure for contract details encouraging the borrower to review their note and security instrument. It also outlines the borrower's liability after foreclosure. • There also lets the borrower know that their ability to refinance this loan depends on their future financial situation and is not guaranteed. The final disclosure regarding tax deductions indicates that if the borrower is borrowing more than this property is worth, the interest on the loan amount above this property's fair market value is not deductible from their federal tax returns and encourages the borrower to consult a tax professional. • The final piece of the CD for the borrower's signature(s), indicating that they have received the loan. If the borrower signs the CD they are only confirming they have received the document, their signature does not mean that they accept the loan.

Page 4 of the CD

• The fourth page of the CD includes loan disclosures, similar to the last page of the LE but with more detail. The first disclosure is whether the loan will be assumable. Most loans are not, but some, like VA, are assumable, which means someone else can take the loan over without refinancing. The second disclosure indicates whether the loan has a demand feature. o A demand feature allows the lender to require early repayment of the loan (at any time, for any reason). • The third disclosure relates to late payments including when a payment is considered late and the amount of the late fee. The fourth disclosure addresses negative amortization and whether there is a possibility of negative amortization on this loan (which would make the loan get bigger over time). The fifth disclosure covers whether the lender will accept partial payments and how those partial payments may be handled. • The sixth disclosure defines the security interest including the fact that the lender is being granted security interest in the property. The seventh disclosure identifies whether the loan will have an escrow account and a breakdown of the amount that will be collected over the first year for the escrow account. If the borrower is not receiving an escrow account it will indicate whether it is because the borrower chose not to have one or if the lender does not offer escrow accounts. o The last part of the escrow disclosure indicates that the escrow amount can change based upon a change in taxes or a change in the insurance premium charged by the homeowner's insurer. o It also warns that if the borrower fails to pay property taxes it may result in fines, penalties, and tax liens. It also states that the lender has the right to add the amounts of those things to the loan balance and add an escrow account to their loan. o Also, the lender can require the borrower to pay for property insurance the lender buys on their behalf if they fail to keep property insurance on their home. This is known as forced placed insurance and is always more expensive than what the borrower can obtain on their own.

Page 1 of the CD

• The next few sections will go page by page through the CD. Please refer to the copy of the CD provided in the index of this manual. • Page one of the CD is almost a mirror image to its earlier counterpart the Loan Estimate. The top header of the CD includes additional information including the date the CD was issued, the date the loan will close (to show that the CD was provided 3 days before consummation), the disbursement date (when the loan funds will be disbursed), the settlement agent, the file number, the property address, the sales price (or appraised value depending on the type of transaction), the borrower's information, the seller's information when applicable, the lender's name and the loan term, purpose, product, loan type, loan ID and MIC. • The first box on the page of the CD is Loan Terms. This section lists: o The final loan amount, including whether this amount can increase after closing; o The interest rate, including whether this can increase after closing or not; o Monthly principal and interest payment, including whether this amount can go up after closing; o Prepayment penalty, if one exists, the highest it can be and when can the prepayment penalty be enacted; o Balloon payment, if one exists, how high it can go and under what circumstances it will be required). • The second box on the first page is Projected Payments. This section includes the payment calculations over the period of the loan. For fixed rate mortgages, this section is typically two columns. These columns are determined by an event, in most situations that is going to be a change in the payment because of the loss of mortgage insurance on the loan. If the CD is for an ARM, there will be several columns based upon the structure of the adjustments and the maximum amount the interest rate can adjust (and therefore the payment adjusts) over the period of the loans amortization. The projected payments section includes whether the borrower has any mortgage insurance and their estimated escrow payment. This box also includes a detailed breakdown of the borrower's escrow payment, including what's included in the escrow, and the monthly amount that will be paid to the escrow account. • The final box on the first page is Costs at Closing. This box will give the amount of closing costs the borrower will be paying. Please note the amount on page one is a quick breakdown of the costs but page two shows closing costs in detail. The second line is the cash to close box, it will indicate how much the borrower will need to bring to closing. In some situations, cash to close will be a negative number indicating that the borrower is receiving money from the proceeds of the closing as opposed to bringing money to closing.

The Right of Rescission

• The right of rescission is a special protection provided by TILA on owner-occupied refinance transactions (this does not apply to purchases, or refinance transactions on second or investment properties). The right of rescission allows anyone with ownership interest to rescind (cancel) the loan. The borrower must notify the creditor of their wish to rescind the loan before midnight on the third business day after one of the following whichever comes last: o The signing of the loan documents, o The delivery of the right to rescind notice, or o The delivery of all disclosure. • The two copies of the right to rescind notice must be provided to the borrower along with one copy of the disclosure statement. The notice must be on a separate document, identify the rescission period on that specific loan, clearly disclose the retention of a security interest in the principal dwelling, outline the borrower's right to rescind, and instruct the borrower how to exercise their right to rescind. The form must also include the creditor's place of business as well as any fax number where the borrower can send the right to rescind notice if they choose to rescind the loan. • For rescission, it only takes one person on the title of the property to rescind the loan regardless of whether that person is on the loan or not. If a person rescinds the loan, the transaction is void for everyone. The creditor is required to return any money or property, or take any action that shows the transaction was cancelled within 20 calendar days after the borrower remits a rescission notice. • If the required rescission notice is not provided to the borrower, or if there are errors on the disclosures, the borrower's right to rescind expires 3 years after the closing, transfer of the interest in the property, or sale of the property, whichever occurs first. • A borrower can waive the right of rescission only in the event of a bona fide personal financial emergency. The borrower must provide the creditor with a dated handwritten statement that describes the emergency, request the right to rescind be waived or shortened and contains the signatures of all individuals listed on the title. • Test Tip o With the right of rescission, it is extremely important to remember that it only applies to owner-occupied refinance transactions. It is easy to get tripped up in a question that asks about the right of rescission and you don't notice that they are asking about the right of rescission on a purchase transaction. There is no such thing as a right of rescission on purchase transaction!

Page 2 of the CD

• The second page of the CD delves deeper into the costs associated with the loan. It begins with the Loan Costs: The Origination Charges, the Services the Borrower Did Not Shop For and the Services the Borrower Did Shop For. • The first section on origination charges includes charges like discount points, application fees, underwriting fees, and other types of compensation that the lender will receive. These lines should look identical to what was disclosed on the LE because these fees have zero tolerance, meaning they cannot change from the LE to the final disclosure on the CD. • The second section "services the borrower did not shop for" includes services rendered by third parties required by the lender. These fees cannot change cumulatively by more than 10 percent from the original disclosure on the LE and their final disclosure on the CD. This generally includes appraisal fees, credit report fees, flood determination fees, and tax monitoring fees. • The third section "services the borrower did shop for" includes services provided by a third party that were selected by the borrower. These fees can change by any amount from the original disclosure on the LE and their final disclosure on the CD as they were chosen by the borrower not the lender. This typically includes pest inspection fees, survey fees, in some situations even title fees. • The sum of the fees is listed at the end. Included in this section of CD is whether these fees are to be paid at closing or were paid before closing. It also indicates whether the borrower, seller or another individual or institution (like the lender) is paying these fees • The other costs, are similar to the CD as it shows the same taxes and other government fees, the prepaids, the initial escrow payment at closing, and other fees for a total of other costs. It again denotes who is paying and if the fees have already been paid or will it be paid at closing. • The final box on the second page is the total closings costs (borrower-paid) which shows the total amount the borrower needs to pay at closing and the fees they have already paid. It also shows how much will be paid by the borrower at closing and how much they have already paid and lastly how much was paid by another party.

Temporary and Fixed Interest Rate Buy-Down

• There are two types of Discount Points. A Temporary 2-1 Buydown means the first year of the loan, the borrower will be making payments based on an amortization schedule computed using a rate which is 2 percent less than the rate stated in the Note. o The second year of the loan, the borrower will be making payments, based on an amortization schedule computed using a rate which is 1 percent less than the rate stated in the Note, then the third year the borrower makes the payments on the full Note Rate. o During these two years, the enticing party (normally a builder) will contribute the 2-1 buy down fee that funds an escrow account with the lender at the time of closing that will supplement the lower payment the borrower is making. o Each month the borrower pays 2 percent less than the note rate, that difference is taken from the escrow account, and applied to the loan (so full payment is made every month on the loan). o Then when the borrower is making his payment based on a rate that is 1 percent less than the note rate, the difference is taken from the escrow account, and applied to the loan. At the end of the two years, the escrow account is depleted and borrower makes the full payment. • A Permanent Discount buy-down is also referred to as Discount Points. The borrower pays discount points based on a percentage of the loan amount to "prepay" interest to obtain a lower Note Rate for the duration of the loan. o For example, a $100,000.00 loan with 1 discount point is equivalent to a $1,000 fee, which will reduce the actual interest rate from the quoted 6 percent to approximately 5.75 percent for the life of the loan. Not all lenders will offer a 0.25 percent reduction for 1 discount point, check with your lender to determine the actual reduction amount given. A discount point generally costs 1 percent of the loan amount as you saw in the example. • Example of a 2-1 buy down: o Benjamin has an FHA 2/1 buy-down. His note rate is 3.5 percent. What will Benjamin's rate be in year 3? o Answer: 3.5 percent o After year three, the rate is in fact the note rate as the buy-down period is over. • Example of a discount point: o Lila is purchasing a home for $150,000. She is purchasing 2 discount points, how much will Lila be paying for those discount points? o Answer: $3,000 o 1 percent of $150,000 is $1,500 per discount point, for two $1,500 + $1,500 = $3,000 total for both discount points.