Cost of Credit
Yield-return or income that can be generated. Risk is the likelihood that the investment will lose money
- In addition to creditworthiness, the interest rate the lender charges depends on four factors:
- Term of the loan
- Type of mortgage loan
- Loan amount
- Lender's cost of money
- Regulation Z--requires credit institutions inform borrowers of the true cost of obtaining credit. Regulation Z generally applies when a credit transaction is secured by a residence or is less than $25K. Does not apply to business, commercial or agricultural loans of any amount.
- Truth in Lending Act--a consumer must be fully informed of all finance charges and true interest rate before a transaction is completed. Disclosure must include any loan fees, finder's fees, service charges and points and interest. The lender must also disclose the APR
- Creditor-for the purposes of Reg Z, the creditor is the person who extends consumer credit more than 25 times per year or more than five times a year if the transactions involve dwellings as security. Credit must be subject to a finance charge or payable in more than four installments by written agreement.
- Three-day right of rescission--the borrower has three days in which to (cancel) the transaction by notifying the lender. The right of rescission does not apply to owner occupied residential purchase-money or first mortgage. REFINANCING ONLY
- Advertising--Reg Z provides strict regulation of real estate advertisements, in all media including newspapers, flyers, signs, billboards. Websites, radio or television ads and direct mailings that refer to mortgage financing terms. General phrases like flexible terms available may be used, but if details are given, they must comply with the act. The APR, calculated based on all charges than the interest rate alone, must be stated. Advertisements for buydowns or reduced rate mortgages must show both the limited term to which the interst rate applies and the APR. If a variable rate mortgage is advertised, the advertisement must include--the number and timing of payments, the amount of the largest and smallest payments and a statement of the fact that the actual payments will vary between these two extremes. Trigger Terms--down payment, monthly payment, dollar amount of the finance charge or term of the loan. IF these terms are used, the advertisement must include the following information: Cash price, required down payment, number, amount and due dates of all payments, APR, total payments to be made over the term of the loan, unless advertised credit refers to a first mortgage to finance the acquisition of a dwelling. Penalties--Reg Z provides penalties for non compliance. The penalty for violation of and administrative order enforcing Reg Z is $10K for each day the violation continues. A fine of $10K may be imposed for engaging in an unfair or deceptive practice. Willful violation os a misdemeanor, punishable by a fine of up to $5000, one year's imprisonment or both.
Equal Credit Opportunity Act (ECOA)
prohibits lenders and others who grant or arrange credit to consumers from discriminating aganist credit applicants based on race, color, religion, national origin, sex, marital status, age or dependence of public assistance. All rejected credit applications of the principal reasons must be informed fir the denial or termination of credit. Must be provided in writing within 30 days. Also provides that a borrower is entitled to a copy of the appraisal report if the borrower paid for the appraisal.
Community Reinvestment Act (CRA)
- Refers to the responsibility of the financial institutions to help meet their communities needs for low and moderate income.
- Passed by congress in 1977
- Financial institutions are periodically reviewed by one of four financial supervisory agencies
- Emphasis on low to moderate housing
- Taxes and Insurance are put in impound, reserve or escrow accounts.
Real Estate Settlement Act RESPA
- Applies to any residential real estate transaction involving a new first mortgage loan
- Designed to ensure that the buyer and the seller are fully informed all of the settlement costs.
Amortized Principal and Interest Rates
- Loan: $70,000 x 7.5% = $5,250 (annual interstes)
- $5250/12=$437.50 (month's interest)
- $489.30 Monthly payment
- $437.50 Month's interest
- $51.80 Month's principal
- $69,948.20 New Principal Balance
Payment does not change, but the amount of interest and princpal changes. Interest goes down monthly and pricnipal goes up monthly.
- 20% Down and the Loan would be 80%
- Offers the least risk to the mortgagee
- Morgagor, borrower , is using a down payment
Loan to Value Ratio
- If a property has an appraised value of $200,000, secured by an $180,000 loan, the LTV is 90%
- $180,000÷200,000 = 90%
- PITI Payments: Principle, Interest, Tax, Insurance
- Principle and Interest change, tax and Insurance stay the same
- Loans the are NOT government insured or guaranteed.
- Most secure because the loan to value ration is lowest.
- Ration is 80% of the value of the property or less; and the borrower makes a down payment of 20% or more. (80-20)
- Security is provided solely by the mortgage; payment of debts on the ability of the borrower to pay
- Lender relies primarily on the appraisal of the property
- With 20% down, no insurance is necessary
Conventional Loan Example
- Combined Monthly Gross Income $8000
- Monthly Housing Expenses:
- Principle and Interest $1200
- Property Taxes $ 400
- Hazard Insurance 50
- PMI Insurance 90
- Homeowners' Association Dues 30
- Total Housing Expense $1770
- $1770÷8000 = 22%
- Debt Expense:
- Installment Payments $200
- Revolving Charges $ 80
- Auto Loan 250
- Child Care 300
- Other 200
- Total Debt Expense $1030
- Plus Housing $1770
- Grand Total $2800
- $2800÷8000 = 35%
The borrower will qualify for this loan under conventional loan guidelines of 28% and 36%
Private Mortgage Insurance PMI
- Conventional Loan with a lower down payment
- Buyer purchases an insurance policy that provides the lender with funds in the event the borrower defaults on the loan
- Once the loan is repaid to a certain level, the lender may choose to terminate the insurance. 22% equity
FHA Insured Loans Federal Housing Authority
- Loan Down Payments
- Operates under HUD
- Neither builds or lends money
- FHA means that the loan is insured by the agency.
- Loan must be made by the FHA approved lending institutions.
- FHA provides security to the lender and the real estate
Title II FHA Loan
- Fixed interest rate for 10-30 years on one to four family residences.
- Rates are competitive with other types of loans, even though they are high LTV loans. Borrower is eligible for approximately 96.5% financing fee for one to four unit structures.
- Requirements for the FHA to secure the loan:
- Borrower must pay a down payment of at least 3.5% of the purchase price, but most of the closing costs and fees can be included in the loan.
- Borrower is charged a mortgage insurance premium (MIP) for all FHA Loans. Up-Front Premium is charged at closing and can be financed into the loan.
- Borrower is responsible for paying an annual premium that is usually charged monthly.
- The up-front premium is charged on all FHA loans, except those for the purchase of a condo, which only require the MIP
- Mortgaged real estate must be appraised by an approved FHA appraiser
- FHA sets maximum mortgage limits for various regions all over the country
- Borrower must meet standard FHA credit qualifications
- Financing for manufactured and factory built housing is available, both for those who own the land that the home is on and also for manufactured homes that are, or will be, located on another plot of land.
If purchase price exceeds the FHA-appraised value, the buyer may pay the difference in cash as part of the down payment
- A qualified buyer may assume an existing FHA-insured loan. The application consists of a credit check to demonstrate that the person assuming the loan is financially qualified.
- Sometimes, the older loan has a lower interest rate and no appraisal is required
- FHA loans originating before 12/86 have no restrictions on their assumptions.
- 12/86 and 12/89, a creditworthiness review of the prospective assumer is required.
- Loans originating 12/15/89 or later , no assumption is permitted with out a complete buyer qualification
- Lender of FHA-insured loan may charge discount of points in addition to a loan origination fee.
- Payment is a matter of negotiation between the seller and the owner
- Each discount point = 1%
- No Downpayment required
- US Dept of Veterans Affairs (VA) is authorized to guarantee loans to purchase or construct homes for eligible veterans and their spouses
- Include unremarried spouses of veterans whose deaths were service related
- Also guarantees loans for ,manufactured homes and the lots to place them.
- VA does not lend money, it guarantees the loan by VA approved lenders.
- No dollar amount--limit is determined by the lender and the qualifications of the buyer
- VA limits the amount of the loan it will guarantee.
- Certificate of Reasonable Value--states the property's current market value based on a VA approved appraisal. Places a ceiling on the amount of a VA loan allowed for the property. If the purchase price is greater than the amount cited on the CRV, the veteran may pay the difference in cash
- Only one active VA loan at a time and my only own two properties that were acquired using VA benefits will never expire as long as the precious benefits have been paid in full.
- VA borrower pays a loan origination fee to the lender and a funding fee 2-3%, depending on the down payment amount to the VA
- Can be prepaid with out penalty
Assumption Rules of a VA Loan
- VA must approve the buyer and assumption agreement
- Original veteran-borrower remains personally liable for the repayment of the loan unless the VA approves a release of liability.
- Release will be issued by the VA only if:
- The buyer assumes all of the veteran's liabilities on the loan and
- The VA and the lender approve both the buyer and the assumption agreement
- Releases are also possible if the veterans use their own entitlement in assuming another veteran's loan.
Agricultural Loan Programs Farm Service Agency FSA
- Farm Service Agency FSA is a federal agency of the UDA
- Help families purchase or operate family farms.
- Through the Rural Housing and Community Development Service, it also provides loans to help families purchase or improve single-family homes in rural areas, with populations of fewer than 10,000
- Two categories: guaranteed loans, made and serviced by private lenders and guaranteed for a specific percentage by the FSA and loans made directly by the FSA.
- Farm Credit System (Farm Credit) provides loans to farmers, ranchers and rural homeowner, agricultural cooperatives, rural ultilty systems and agribusinesses.
- Farmer Mac (formerly the Federal Agricultural Mortgage Corporation, or FMAC is another government-sponsored enterprise (GSE) that operated similarly to Fannie Mae and Freddie Mac but in the context of agricultural loan. It is a secondary loan
- Most are amortized--equal payment for the life of the loan
- Straight Loans---equal payments and at the end of the loan, one large payment.
- All payments are interest payments until the last payment which is the principle plus final interest payment
Adjustable Rate Mortgage ARM
- Generally originate at one rate of interest the fluctuate up or down during the term of the loan based on an objective economic indicator.
- Common components of the ARM are:
- The Index--undeterminable economic indicator that is used to adjust the interest rate in the loan. Most are tied to US Treasury securities.
- Margin--interest rate is the index, plus a premium The margin represents the lender's cost of doing business.
- Rate Caps limit the amount the interest rate may change. Most ARMS have two types of rate caps--periodic and life-of-the-loan, or aggregate. Periodic rate cap limits the amount the rate may increase, usually over a year. A life of the loan cap limits the amount the rate may increase over the entire life of the loan
- The mortgagor is protected from unaffordable payments by the permanent cap.
- The adjustment establishes how often the rate may be changed, whether it is monthly, quarterly or annually.
- Lenders may offer a conversion option that permits the mortgagor to convert from an adjustable-rate to a fixed-rate at certain intervals during the life of the mortgage.
- Partially amortized loan because pricipal is still owed at the end of the term.
- It is assumed that if if payments are made promptly, the lender will extend the balloon payment for another limited term.
- The lender is not legally obligated to grant this extension and can require payment in full when the note is due
- FInal paymenr is less than the straight loan.
- Loan with the following terms:
- $130,000 at 6% interst, with interest only payable monthly and the loan fully repayable in 15 years. Following illustrates how to calculate the amount of the final balloon payment:
- $130,00 x .06=$7800 annual interst
- $7800 annual interest, divided by 12 months = $650 monthly interest payment
- $130,00 principal payment + $650 final month;s interest =$130,650 final baloon payment
Growing Equity Mortgage GEM
- Also know as a rapide-payoff morgage, uses a fixed interest rate, but payments of principal increase according to an index or a schedule.
- The total payment increased and the loan is paid off more quickly.
- GEM is most frequently used when the borrower's income is expected to keep pace with the increasing loan payments
- Borrower is charged a fixed rate of interest and no payments are due until the property is sold or the borrower defaults, moves or dies.
Purchase-Money Mortgages PMM
- created when the seller agrees to finance all or part of the purchase price and consists of a first or junior lien depneding on whether prior mortgage liens exit
- Often called seller financing or owner financing, a PMMis often used when the buyer does not qualify for a typical lender loan.
- PAyments are made to the seller, according to the terms of the note
- If the buyer stops making payments, the seller, according to the terms of the note; if the buyer stops making payments, the seller has recourse to forclose on the property
- Seller extends credit to the buyer, the seller becomes the mortgagee
- Not permitted in PA
- Includes real and person property
- Usually include furniture, drapes, the kitchen range, refridgerator, diswasher, washer, dryer, food freezer and other appliances as part of the sales price of the home.
- Covers more than one parcel or lot.
- Used to finance subdivision developments
- Can also be used to finance rhw purchase of improved properties or consolidate loans as well.
- Partial release clause--permits the borrower to obtain the release of any one lot or parcel from the lien by repaying CERTAIN PART OF THE LOAN.
- As parcels of subdivision are paid off, they are released from the loan
- Enables a borrower with an exisiting loan to obtain additional financing from a second lender without paying off the first loan
- Second lender gives the borrower a new, larger loan at a higher interest rate ans assumes payment of the existing loan
- Total amount of the new loan includes the exiting loan, as well as the additional funds needed by the borrower
- Borrower makes payments to the new lender on the larger loan.
- The new lender makes the payments on the origional loan out of the borrower's payments.
- Can be used to refiance real property or to finance the purchase of property when an existing mortgage can be repaid.
- Only possible if the origional loan permits it.
Open End Loans
- Equity line of Credit
- Secure a note executed by the borrower to the lender.
- Secures any future advances of funds made by the lender to the borrower
- Interest rate on the first loan is fixed, but interest on future advances may be charged at the market rate, rahther than in effect.
- Lest costly than a home improvement loan
- Allows the borrowe to open the mortgage to increase the debt to it's origional amount or the amount stated in the note, after the debt has been reduced by payments over a period of time
- made to fiance th econstruction of improvements on real estate such as homes, apartments and office buildings.
- Lender commits to the full amount of the loan, but disburses the funds periodically during construction
- Draws are made to the general contractor or the owner for tht part of the construction work that has been completed since the previous payment
- Lender inspects the work before each payment is made
- General contractoe mus provide the lender with adequate waivers that release all mechanic's lien righd for the work covered by the payment
- Generally ARE SHORT TERM OR INTERIM FINANCING
- Borrower pays interest only on the monies that have actually been disbursed
- Borrower is expected to arrange for a permanent loan, also known as the end loan or take out loan, which will repay the take out the construction financing lender when the work is completed
Sale and Leaseback
- arrangements that are used to finace a large commercial or industral property
- Existing business that wants to stay open but will sell the building to an investor
- Investor leases the building to the seller
- The buyer becomes the lessor (landlord) and the origional owner becomes the lessor, renter
- Temporarily or permantly lower the interest rate on the mortgage loan
- Reduce the interest rate by 1 to 3% over the first one to three years of the loan term. After that the rate rises
- A lerger upfront payment reduces the effective interest rate for the lofe of the loan
Home Equity Loans
- source of funds using the home's equity
- Orgional mrtgage loan remains in place; the home equity loan is junior to the orgional lien
- An alternitive to refinancing and can be used for a variety of fiancial needs, such as
- FInance the purchase of expensive items
- Comsolidate existing installment loans or credit card debt and
- pay medical, education, home improvement or other expenses
- Can be take out asa fixed loan amount or an equity line of credit HELOC, the lender extends a line of credit that the borrower can use at will