Financing

A mortgage is a pledge of property to the lender as security of payment of the debt.  The mortgagor is the borrower giving the pledge to the lender.


The basic steps for securing a mortgage are:

- Qualifying the buyer

- Which includes securing a credit report and employment history

- A debt income ratio is a loan qualifying tool, simply said if you had a million dollars and owed ten dollars, that would be a good debt income ration, however if you had ten dollars and owed a million dollars that would be terrible.

Do not forget the property

- It must be appraised because that property is the collateral for the loan.


The mortgagee is the lender receiving the pledge.  The mortgagor is the one who borrows the money to purchase property.


The borrower will sign a note, a note is an evidence of debt, it states the amount borrowed, the interest rate and the loan terms


In a note the borrower is making the promise to repay so the borrower is the promissor and the lender is the promisee.   When recorded the mortgage becomes a voluntary lien on the property.  The rights the borrow gives the lender in a mortgage document is determined by state law.


States are classified as Lien theory, title theory and intermediate theory states. 


Remember a lien is a legal interest that a creditor has in a person’s property.


Most states are lien theory states that give the lender a lien interest in the property.  This means that if the borrower defaults the lender would foreclose through a judicial sale


A judicial sale is a sale made under court order rather than a voluntary sale by the owner or one appointed by the owner.


In title theory states the lender holds title to the property.


Because the lender holds the title the law interprets the lender as owning the property until the final payment is made.


A trust deed is the security document used in most title theory states.


This is how it works.


A trust involves three parties, a trustor, trustee and a beneficiary.


At the closing the borrower who is the trustor signs the deed of trust and gives legal title to the trustee.  Remember OR is always the giver and EE always Receives.


The trustee is usually a title insurance company or an attorney.  They hold the title for the beneficiary which is the lender.  The borrower has equitable title.  Equitable title is the present right to possession with the right to acquire legal title once a preceding condition has been met.


Once the loan has closed there are two possible scenarios


First one is where the borrower, the trustor makes all the appropriate payments to the lender and pays off the loan.  When the final payment is made the lender will sign a request of reconveyace to the trustee and the trustee will issue a reconveyance deed to the trustor.


A Reconveyance deed is used in conjunction with a trust deed and its purpose is to clear the title of any liens pertaining to the Note and trust deed.


The second scenario is when the borrower defaults on the loan.  In this case the beneficiary would notify the trustee, the trustee would notify the trustor and give them a time period to get the payments up to date, if the payments are not made the trustee would conduct a non-judicial foreclosure, also known as a trustees sale.


Lenders


The lenders make there money from finance charges and reoccurring income

Finance charges include origination fees and discount points.


The reoccurring income is the interest collected on the loan.


An origination fee is a fee paid to a lender for processing a loan application. The origination fee is stated in the form of points.  Discount points increase the lenders yield, a point is equal to one percent of the loan amount.


Interest is the amount paid for the use of money, usually expressed as an annual percentage. Think of it as rent on money, you pay rent to use somebody’s property to live, that is their resource, now you are paying to use somebody’s money. Thus interest is just rent on money.


Simple interest is the common type of interest paid on home loans.  Simple interest is calculated as a percentage of the original principal amount


Usury is the illegal act of charging extremely high interest rates on a loan.  Usury is commonly referred to as loan sharking.  State usury laws determine the highest interest lenders can charge on loans.  The state laws vary with each type of loan


Conventional loans are loans that are not part of any government housing program such as FHA or VA.


In a conventional loan typically if you are putting less than 20% down. The lender may require PMI due to the risk of the borrower defaulting and the property, value dropping and thus not being able to cover the debt of amount the borrower owes to the lender


The Private mortgage Insurance (PMI), would act as the FHA or VA would for a non-conventional loan, it insures the lender in case of default.


The loan to value ration is the ratio of the amount of money you borrow compared to the value of the property.  For example, if you put 5% down you will have a loan of 95% of the value of the property or an LTV of 95%.


A higher loan to value ratio represents more risk for the lender.


Amortization is a gradual reduction of a loan debt through periodic installment payments of principal and interest calculated to pay off the debt at the end of a fixed period.


A fully amortized loan will be completely paid off at the end of the loan term


A balloon loan would be an example of a partially amortized loan.  It is considered a partially amortized because at the end of the loan term the entire debt is not fully paid.  Thus one huge payment would be due at the end of the term that would be the balloon payment.


Once the loan has been originated the lender is required to service the loan.


Servicing the loan includes collecting the mortgage payment and sending it to the secondary mortgage market, sending a monthly statement to the borrower.  Providing a contact number for borrower questions, escrow instructions for taxes and insurance.  Accepting additional payments applied to the principle and computing the payoff should the borrower request it.


Promissory note is a written contract between a borrower and a lender that is signed by the borrower and provides evidence of the borrower's indebtedness to the lender.  Notes are negotiable instruments meaning they can be freely transferred from one person to another.


A mortgage is not a negotiable instrument.  If you look closely at a dollar bill, you will see the word note; this should tell you that notes are freely transferable from one party to another


Primary mortgage


The primary mortgage market is where Lenders make mortgage loans directly to borrowers such as savings and loan associations, commercial banks, insurance companies and mortgage companies.   These lenders sometimes sell their mortgages into the secondary market to institutions such as FNMA or GNMA.


Fannie Mae, The Federal National Mortgage Association, also known as “fannie Mae" is a federally sponsored private corporation which provides a secondary market for housing mortgages.


The Government National Mortgage Association, known as "Ginny Mae," is a governmental part of the secondary market that deals primarily in recycling VA and FHA mortgages, particularly those that are highly leveraged.


The savings and loan association is a state or federally-chartered financial intermediary that accepts deposits from the public and invests those funds primarily in residential mortgage loans


Commercial banks offer a full range of retail banking products and services, such as checking and savings accounts, loans, and investments to individuals and businesses.


Insurance companies prefer income producing properties and long term industrial projects. They frequently demand to be able to do a participation loan which is a loan that requires interest plus a portion of the profits as payment.


Mortgage brokers are real estate financing professionals acting as the intermediary between consumers and lenders during mortgage transactions. A mortgage broker originates loans while the mortgage lender actually funds the loans.


A mortgage banker is a direct mortgage lender. No middlemen here. A mortgage banker or lender funds loans in his or her own name and is usually more competitive than a broker in terms of "points" and "fees".


Secondary Market 


Once a loan is originated on the primary market it may be sold on the secondary market.  The secondary market is where lenders and investors buy and sell existing mortgages or mortgage backed securities, thereby providing greater availability of funds for additional mortgage lending.  The secondary market is the resale market place of loans.


Prior to the stock crash of 1929 most lenders required a borrower to have down payment of 20 to 40 percent.  If that was the case today, not many people would be able to afford a home.


Not only did the lenders require a large nonpayment, but the loan was a straight mortgage, which meant they would only pay the interest, the term was typically 1 to 7 years, at the end of the 7 years, if the borrower could not pay the entire balance, a new loan would be negotiated.


After the stock crash the government needed to stabilize the economy and stimulate the stock market.  In 1934 the government introduced FHA insured loans.  The FHA’s Primary purpose is to insure lenders from loss.


The FHA made it possible for people to purchase a home with a smaller down payment; a smaller monthly payment would be made to the lender over the course of 30 years.  A portion of the payment would be applied to the principal and the remaining would be interest.


A 30 year fixed rate mortgage with monthly payments was a new concept at the time.  To reduce the risk to the lender the FHA required the lender to verify the borrower’s employment, have the property appraised by a neutral third party and have a title search.  If the government guidelines were met then the lender would negotiate the loan.


The lenders and the government knew that within 30 years the borrower might default on the loan, so the government insured the loan.  The borrower was a charged a one time up front insurance premium based on the loan amount and one half percent annually on the loan balance


If the borrower defaulted on the loan and the loan amount exceeds the price of the property the FHA will pay the difference.  By 1938 the lenders who offered the FHA insured loan had a problem.  Banks can negotiate loans on a percentage of there deposits.  Due to the popularity of the 30 year fixed rate loan that percentage had been reached.


Banks did not want to have to turn anybody away because all the money was loaned out for the next 30 or so years.  So in 1938 the government created the Federal national mortgage association or Fannie Mae.  This was to buy FHA insured mortgages from lenders.  This would provide lenders with a roll over of funds.


So they would not have to turn any borrowers away who wanted to negotiate a loan.  When the veterans returned to the war in 1935, Fannie Mae agreed to buy VA guaranteed loans that lenders negotiated.


Eventually Fannie Mae started purchasing loans from lenders.  But the loan had to meet Fannie Mae guidelines.  Today Fannie Mae is a Quasi Government agency that is privately owned and Fannie mea stock may be purchased on the New York stock exchange.  Fannie Mae buys mortgages on the secondary market, pools them together, and then sells them back as mortgage securities to investors on the open market.  Monthly principle and interest payments are guaranteed by Fannie Mae, but not by the US government.


In 1968 Fannie Mae was split and the Government National mortgage Association or Ginnie Mae was created.  Ginie Mae is a federally owned corporation in the Department of Housing and Urban Development.  Ginnie Mae administers special assistance programs.


The main focus of Ginie Mae is to insure liquidity for us government insured mortgages.  Included those insured by the FHA and VA.


FHA


FHA and VA loans are classified as unconventional loan because they are backed by the government.


The Federal Housing Administration, generally known as "FHA", provides mortgage insurance on loans made by FHA-approved lenders throughout the United States and its territories. It is the largest insurer of mortgages in the world, insuring over 34 million properties since its inception in 1934. The FHA became a part of the Department of Housing and Urban Development's (HUD) Office of Housing in 1965.


FHA mortgage insurance provides lenders with protection against losses as the result of homeowners defaulting on their mortgage loans. The lenders bear less risk because FHA will pay a claim to the lender in the event of a homeowner's default. Loans must meet certain requirements established by FHA to qualify for insurance.


In summary, FHA was created because the housing market was flat on its back in the 30’s.

- FHA Does not make loans

- Lenders must be approved to negotiate FHA Loans

- FHA loans have a low down payment

- Less Stringent qualifying standards

- Closing costs may be financed

- There can be no pre-payment penalty as long as the lender receives a minimum - - of 30 days notice of pay off

- The borrower must have a cash down payment but the cash may be a gift

- FHA loans are not assumable without complete buyer qualification

- Eligible properties for the FHA loan would be single family homes, one to four units owner occupied and qualified condominium communities.

- FHA loans are fully amortized, thus balloon mortgages are not allowed

- If discount points are charged they may be paid by the buyer or the seller


VA


The VA home loan guaranty program was established in 1944 to aid veterans returning from war. The goal of VA home loan benefits was to help Veterans toward purchasing or refinancing a home in gratitude for the sacrifices they made by serving our country.


A VA loan can be used to purchase a house, condominium, or townhouse. You can also build a home, make energy-efficient home improvements, or refinance your mortgage.


There are several reasons why a VA loan may be preferable to a standard loan. Most important, if you qualify, you may obtain a VA loan even if you did not qualify for other loans.

The VA does not require a down payment, however the lender can require one.

VA loans rates are often lower interest rates than conventional loans, and many times you can negotiate the interest rate with the lender.

There are no mortgage insurance premiums on VA loans, and assumable mortgages are permitted.

Closing costs can be lower than other forms of financing, and there is no penalty for prepaying your mortgage, as in some other forms of loans.

In addition, VA assistance is available to those who qualify if temporary financial difficulty occurs.


Types of Loans


In this sections we will discuss different types of loans, let’s review some basic loan terminology


Amortization is a gradual reduction of a loan debt through periodic installment payments of principal and interest.


A Buy Down is obtaining a lower interest rate by paying additional points to the lender.  The lower rate may apply for the full duration of the loan or for just the first few years.  A buy down may be used to qualify a borrower who would otherwise not qualify.   This is because a buy down results in lower payments which are easier to qualify for.


Equity is that interest or value remaining in property after payment of all liens or other charges on the property. An owner's equity is normally the monetary interest over and above the mortgage indebtedness.


For example if your home is worth of 300 thousand dollars and you have 200 thousand dollars in debt.  You would have 100 thousand dollars in equity.  Simply said, it’s the money left over after you sell a house that you can go by a cookie with.


Owners can negotiate a home equity line of credit, also known as a HELOC, against the equity.  The home equity usually has a set limit.  And can be used by an owner much like a check book account or a credit card.


Typically the payments are interest only and the principle amount is due at the end of the loan term


An adjustable rate mortgage, more commonly known as an arm, is a mortgage with an interest rate that changes over time in line with movements in the Index


The interest rate is determined by the index plus the mortgage.  A margin witch represents the lenders profit and the cost of doing business will remain constant over the life of the loan.


An adjustable rate mortgage will contain a rate cap.  The rate cap will limit the adjustments that can change over the life loan.


A payment cap is the maximum adjustment amount for a payment.  While an adjustment period indicates how often a rate can be changed.


A balloon mortgage is a partially amortized loan.  At the end of the loan term a large payment is made to pay off the loan


A blanket mortgage covers more than once parcel in a lot and may be negotiated by a developer.


A release clause is a provision found in many blanket mortgages enabling the mortgagor to obtain partial releases of specific parcels from the mortgage upon payment


A growing equity mortgage is also known as a rapid payoff mortgage.  When borrowers negotiate a growing equity mortgage they know the monthly payments will increase.


However the payment increase will apply directly to the principle, thus reducing the term of the loan.


A graduated payment mortgage is also known as a flexible payment plan.  Payments start out a low and increase, or graduate a certain percentage each year for a specific number of years.  The payments then level off for the remaining term of the loan.


A graduated payment mortgage can cause of negative amortization.  Negative amortization is an increase in the outstanding amount because a monthly payment does not cover the monthly interest due.  This is dangerous because the debt increases as payments are made.


An open mortgage allows a borrower to pay off the loan before the end of the term.  Thus the borrower who negotiated a 30 year fixed rate mortgage can make additional payments and pay the loan off before the 30 year term.


An open end mortgage allows the borrower to secure additional funds under the original loan without redoing the original paperwork.


Let’s review this


An open end loan is like a credit card, a credit card has a credit limit and we can use the credit card up to that limit, if we had to complete the paperwork every time we used a credit card, we probably wouldn’t use it as often


A construction loan is an example of an open end loan, if a borrower negotiates a construction loan the borrow will receive the money in a series of draws as each stage is being developed.


The borrower does not have do redo the paperwork at each stage of construction.

A construction loan is also called a short term loan or an interim loan because the loan is only for the period of construction and is not the end loan.


A borrow must negotiate a long term mortgage upon completion of the home.  This is also called a take out loan.


A package mortgage includes both real and personal property.  If a furnished condo is purchased in a resort community, the borrower may negotiate a package mortgage covering the condo and the furnishing.


The term participation loan can have different meanings.

1) A loan that requires interest plus a portion of the profits as payment.

2) A loan made or owned by more than one lender; the joint investors share profits and losses in proportion to how much of the loan each owns.


In a shared appreciation mortgage loan the lender originates the loan at a below market rate.  In return for a guaranteed share of the appreciation the borrower will realize when the property is sold.


A purchase money mortgage can refer to any type of financing for the purchase of real estate but usually refers to a transaction in witch there is an extension of credit by the seller to the buyer.


In purchase money mortgage witch is also known as a take back mortgage, title passes at closing and the seller takes back a note for part or the entire purchase price of the property.


A reverse mortgage is a loan for home owners 62 years of age and older, there are no income or credit ration qualifications in order to qualify for a reverse mortgage, and there are no monthly payments made to the lender.  The loan is repaid when the borrower no longer resides in the property.


If the owner does not have an existing loan on the property they can negotiate a loan and receives a monthly payment guaranteed to them for the rest of there lives as long as they live in the house.


They may take there money in a lump sum, open a line of credit or a combination of both.  If there is an existing lien on the property it could be paid off by the reverse mortgage and relieves the senior from making the monthly payments. 


A straight note is a mortgage where the borrower is required to pay the interest due on the principle mortgage amount during the specified term. The principle loan must be repaid at the end of the term.


A Wraparound loan is a method of refinancing in which the new mortgage is placed in a secondary, or subordinate, position; the new mortgage includes both the unpaid principal balance of the first mortgage and whatever additional sums are advanced by the lender. In essence it is an additional mortgage in which another lender refinances a borrower by lending an amount over the existing first mortgage amount without disturbing the existence of the first mortgage.


In a sale lease back there is a simultaneous selling and leasing back of the property.  The seller will become the tenant of the new owner.  Hence Sale-Lease Back.  The advantage of a sale lease back to the seller is that the capital gained from the sale and all future rents paid are 100% deductible. 


The main advantage to the buyer is they have a quality tenant at the inception of the ownership of the building.


Loans clauses

A clause is the term used to identify a certain section of the contract or policy.  There are many different clauses that can come up in regards to a loan


The acceleration clause is the clause in a mortgage or trust deed that stipulates the entire debt is due immediately if the mortgagee defaults under the terms of the contract.


An alienation clause is the clause in a mortgage or trust deed which asserts the lender's option to require that the balance of the loan becomes immediately due and payable if the property is sold or transferred by the borrower, preventing the borrower from assigning the debt without the lender's approval.  It is also known as a due-on-sales clause.


A prepayment clause allows the borrower to pay the debt before the due-date.


A prepayment penalty is a charge imposed on a borrower who pays off the loan early. This clause states that the borrower cannot repay a loan prior to a specified date without paying a fee.


This fee goes towards compensating the lender for interest and other charges that would otherwise be lost.


The prepayment penalty is based on percentage of the loan balance.


A lock-in clause in a loan agreement states that the borrower cannot repay a loan prior to a specified date.


A subordination clause in a mortgage states that rights of the holder shall be secondary or subordinate to a future lien.  That future lien would take priority.


It is important to understand the difference between assuming a mortgage and subject to the mortgage.

When a buyer buys a property and assumes a mortgage the buyer becomes primarily liable for the debt and the seller becomes secondarily liable for the debt.


Remember

“Subject to” seller liable, buyer not liable

“Assume” relieves seller, buyer is liable


For example if I have an FHA insured loan and you want to purchase my property and assume the mortgage, you are primarily liable to the lender for the debt and I am secondarily liable.


When the property is sold subject to the loan the buyer is not liable to pay the lender.

The original borrower remains primarily liable to the lender.


For example I am a qualified veteran and two years ago I negotiated a VA guaranteed loan to purchase my home, my company is transferring me to another state, and you are purchasing my property subject to my mortgage.  Because you are not a qualified veteran if you default on the loan I am still primarily liable to the lender.  Upon default you would lose the property and all equity in it.


Introduction

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Financing   

Lenders   

Primary mortgage   

FHA   

VA   

Types of Loans   

Loans clauses   

Investing   

Construction Terms   

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