This chapter will describe the different classifications and types of loans, and the types of mortgages.

Transcription

1 Principles of Real Estate Chapter 11-Loan Classifications This chapter will describe the different classifications and types of loans, and the types of mortgages. Overview Objectives At the end of this chapter, the student will be able to: Describe the VA, FHA, RHS, and conventional loans and compare the specific differences, as well as list the advantages of each Name the programs affiliated with a third-party backer List the different types of loans classified by special provisions Describe the structure of each loan classified by special provisions Discuss the advantages of each loan classified by special provisions Describe a "subject to" purchase 11.1 P a g e

2 Describe an "assumption" Cite the differences between an "assumption" and a "subject to" purchase Name the advantages and disadvantages of "subject to" and assuming a loan Loans Classified by Lender's Security-VA Loans Under the Servicemen's Readjustment Act of 1944 and subsequent federal legislation, the Veterans Administration is authorized to guarantee loans to purchase or construct homes for eligible veterans - those who have served a minimum of 181 days of active service since September 16, 1940 (some specifically designated wartime periods require as few as 90 days. Two full years are required for those enlisting for the first time after September 7, 1980). GI loans assist veterans in financing the purchase of homes with no down payments, at comparatively low interest rates. Rules and regulations are issued from time to time by the VA, setting forth the qualifications, limitations, and conditions under which a loan may be guaranteed. VA loan is something of a misnomer. The VA does not normally lend money itself; it guarantees loans made by lending institutions approved by the agency. The term VA loan refers to a loan that is not made by the agency but guaranteed by it. There is no VA limit on the amount of the loan a veteran can obtain; this is determined by the lender. The VA does, however, set a limit on the amount of the loan that it will guarantee. To determine what portion of a mortgage loan the VA will guarantee, the veteran must apply for a certificate of eligibility. This certificate does not mean that the veteran will automatically receive a mortgage. It merely sets forth the maximum guarantee to which the veteran is entitled P a g e

3 VA Loans: Value The VA will also issue a certificate of reasonable value for the property being purchased, stating its current market value based on a VAapproved appraisal. The appraiser uses a form called a URAR (Uniform Residential Appraisal Report) to present the appraisal results to the lender. The CRV places a ceiling on the amount the VA loan allows for the property; if the purchase price is greater than the amount cited in the CRV, the veteran must pay the difference in cash from his/her personal assets in order to purchase the property. Also, it sets forth in the contract that the veteran does not have to buy the property if the property does not appraise for the purchase price. Only in certain situations (such as in isolated rural areas) where financing is not reasonably available does the VA lend money itself; otherwise, a veteran obtains a loan from a VA-approved lending institution. The VA does not require a down payment, although a funding fee is charged to the borrower. It may be paid at closing or financed for the term of the loan. Also, all or part of the funding fee can be paid by the seller. The funding fee is waived for disabled veterans. Maximum loan terms are 30 years for one-to four-family dwellings and 40 years for farm loans. Residential property purchased with a VA loan must be owner-occupied. If a VA loan is assumed, the original veteran borrower receives a release of the liability on loans made after VA loans made prior to March 1, 1988 may be assumed without qualifying, but the seller retains secondary liability. Under most circumstances, a veteran may only have one VA loan in force at any given time. If the loan is assumed, the veteran's guarantee remains with that loan until it is completely eliminated, at which time the veteran's eligibility can be restored. The borrower under a VA loan can prepay the debt at any time without penalty. Also, the veteran may not be required to pay more than a one percent origination fee. VA loans are made by approved lending institutions, such as mortgage companies, and then sold to investors. Discounts, or discount points, are usually charged by a lending institution when the VA interest rate is less than the market rate. In VA, FHA and conventional loans, points are usually negotiated 11.3 P a g e

4 between the seller and the buyer. Points are charged for the purpose of increasing the effective yield. Loans Classified by Lender's Security-FHA Loans The Federal Housing Administration (FHA) was created in 1934 under the National Housing Act to encourage improvement in housing standards and conditions, provide an adequate home-financing system through insurance of housing credit, and exert a stabilizing influence on the mortgage market. The FHA was the government's response to the lack of housing, excessive foreclosures, and collapsed building industry that occurred during the Depression. The FHA, which operates under the Department of Housing and Urban Development (HUD), neither builds homes nor lends money itself. Rather, it insures loans on real property made by approved lending institutions. It does not insure the property, but it does insure the lender against loss. The term FHA loan refers to a loan that is not made by the agency but insured by it. FHA Loan: Title II, Section 203(b) The most popular FHA program is Title II, Section 203(b), which applies to loans on one-to four-family residences. While interest rates on these loans are no longer fixed by the FHA, such rates are generally 1/2 percent less than those charged under conventional loans. These rates are generally lower because the protection of the FHA mortgage insurance makes them a lesser risk to the lender. As mentioned previously, discount points are negotiable. Technical requirements established under Congressional authority must be met before the FHA will issue the insurance. These requirements include: In addition to paying interest, the borrower is charged a fee for the FHA insurance which is called a mortgage insurance premium. The mortgaged real estate must be appraised by an approved FHA appraiser, and the ratio of possible mortgage debt to the 11.4 P a g e

5 appraised value of the property decreases as the appraised value of the property increases. The formula for calculating the required down payment will vary from state to state depending upon maximum mortgage limit which FHA has set for various regions of the country. The FHA regulations set standards for type and construction of buildings and credit requirements for borrowers. FHA loans originated prior to December 1986, generally have no restrictions on assumption. For loans originated since December 1, 1986, a credit worthiness review is required. The review is required for the first 12 months for a residential property and 24 months for an investment property. When a mortgage or trust deed loan is insured by the FHA and the real estate given as security is a single-family dwelling or a building with no more than four units, the borrower retains the privilege of prepaying the debt without penalty. For loans originated since December 15, 1989, there are no assumptions without complete buyer qualification and there are no longer any investor loans. Loans Classified by Lender's Security-Other FHA Programs In addition to loans made under Title II, Section 203(b), FHA loans are also granted under the following programs: Title I: Home improvement loans are covered under this title; such loans are for relatively low amounts with a repayment term of no longer than seven years and 32 days. Title II, Section 234: Loans made to purchase condominiums are covered under this program, which in most respects is similar to the basic 203(b) program. Title II, Section 245: Graduated payment mortgages are allowed under this program; depending on interest rates, the loan-to-value ratio of such loans might range from 87 to 93 percent P a g e

6 Loans Classified by Lender's Security- RHS/FmHA The Rural Housing Service (RHS), formerly FmHA, is a federal agency under the U.S. Department of Agriculture, originally designed to handle emergency farm financing that channels credit to farmers and rural residents and communities. Loans can be made for housing located in open country and in all rural communities with populations under 10,000, and in most towns with populations between 10,000 and 20,000 that are outside of Standard Metropolitan Statistical Areas and have a serious lack of mortgage credit. Loans can be direct loans for low-income borrowers for whom the RHS originates the loan, sets the interest rate, and services the loan. The service can also guarantee loans originated by standard lending institutions. The RHS also sets the interest rates for these loans. Conventional Loans Any loan not government guaranteed or government insured is a conventional loan. As lenders began utilizing the fully amortized loan after the Depression, conventional loans were originated with loan-to-value ratios up to 80%. For instance, on a home valued at $10,000 a lender would have to make a loan of $8,000 ($8,000/$10,000 = 80%). During the 1950s, conventional lenders began to have a difficult time competing with government-backed loans. Homeowners simply could not afford the large down payment. They were attracted by the governmentbacked loans which required little or no down payment P a g e

7 Conventional Loans and Private Mortgage Insurance The solution to the conventional lender's problems was private mortgage insurance (PMI). The Mortgage Guaranty Insurance Corporation (MGIC) was the first private insurance company to insure conventional loans. PMI allows lenders to increase their loan-to-value ratios considerably, resulting in lower down payments for the borrowers. Today, conventional loans may be made at loan-to-value ratios as high as 95%, without the lender incurring any additional risk. In other words, PMI insures the top 20% to 25% of the loan amount. For example, on a $50,000 property, a lender would make a $40,000 loan and not require any private mortgage insurance. With an 80% loan, lenders feel reasonably protected because the purchaser has made a 20% down payment. If a lender makes a $45,000 loan on the same $50,000 property, he will want the additional $5,000 insured. Loans Classified by Special Provision- Adjustable Rate Mortgage An adjustable rate mortgage (ARM) is generally originated at one rate of interest, with the rate fluctuating up or down during the loan term based on a certain economic indicator called an index. Most indexes are tied to U.S. Treasury securities. The interest rate is determined by adding a premium, called the margin, to the index. Generally, interest rate adjustments are limited to one each year, and there are limits (called CAPs) to the amount of increase in any one year and over the life of the loan. The borrower is usually given the right to prepay the loan in full without penalty whenever the interest rate is changed P a g e

8 Loans Classified by Special Provision- Graduated Payment Mortgage The objective of a graduated payment mortgage (GPM) is to help borrowers qualify for loans by basing repayment schedules on salary expectations. With this type of mortgage, the interest rate and maturity are fixed but the monthly payment gradually rises. The first such program, FHA-245, came into being in The FHA-245 program is especially attractive to those just starting their careers and anticipating increases in their incomes. They are able to obtain a home with an initial lower monthly installment obligation than would be available under a level payment plan. This plan helps borrowers qualify for loans by basing repayment schedules on salary expectations and anticipated home price appreciation. Since FHA underwriting guidelines are based on the first year's monthly requirement for principal and interest amortization, those using FHA-245 can qualify for larger loan amounts than would ordinarily be available under other forms of financing. COMPARISON OF PAYMENT SCHEDULES OF LEVEL PAYMENT MORTGAGE AND FHA GRADUATED PAYMENT MORTGAGE (PLAN III) $100,000 loan, 11 1/2% interest, 30-year term (rounded to nearest dollar) Year Level Graduated Payment Difference 1 $991 $760 -$231 2 $991 $817 -$174 3 $991 $878 -$113 4 $991 $944 -$47 5 $991 $1,014 +$ $991 $1, P a g e

9 Loans Classified by Special Provision- Buydown Mortgage In a buydown mortgage, some of the interest is paid in advance for the purpose of temporarily lowering the interest rate. Builders wishing to sell their newly constructed homes often offer this form of financing as an incentive to buyers. Loans Classified by Special Provision-Budget Mortgage Loans To avoid the potential problem of a borrower not paying property taxes and hazard insurance when they become due, many lenders offer budget mortgage loans. At the time the loan is made, the borrower is required to establish a reserve fund for the payment of these items. The funds are placed in an escrow account, and each month, along with the regular principal and interest payment, the borrower pays 1/12 of the annual tax and insurance premium, called impounds, which are added to the account. When the taxes and insurance become due, the lender is assured of having collected enough to pay them. This procedure protects the mortgage lien from becoming subordinate to a tax lien and guarantees the lender that he has adequate protection in case the property is destroyed. Budget repayment plans are required on FHA and VA loans and may be used on any type of conventional loan. Loans Classified by Special Provision- Package Mortgage A package mortgage not only includes the real estate, but also expressly includes all fixtures and appliances installed on the premises. Such loans usually include the kitchen range, refrigerator, dishwasher, garbage disposal unit, washer and dryer, food freezer, and other 11.9 P a g e

10 appliances, as part of the real estate in the sales price of the home. Not all state courts agree that personal property (such as a washer and dryer) becomes real estate under these circumstances and is subject to the package mortgage. You must determine whether the package mortgage is used in your state. Loans Classified by Special Provision-Blanket Mortgage A blanket mortgage covers more than one parcel or lot, and is usually used to finance subdivision developments (though it can be used to finance the purchase of improved properties as well). These loans usually include a provision, known as a partial release clause that the borrower may obtain the release of any one lot or parcel from the lien by repaying a definite amount of the loan. The lender issues a partial release for each parcel released from the mortgage lien. This release form includes a provision that the lien will continue to cover all other, unreleased lots. Loans Classified by Special Provision- Wraparound Mortgage A wraparound mortgage, also known as an all-inclusive mortgage, enables a borrower who is paying off an existing mortgage to obtain additional financing from a second lender. The new lender assumes payment of the existing loan and gives the borrower a new, increased loan as well as the additional funds needed by the borrower. The borrower makes payments to the new lender on the larger loan, and the new lender makes the payments on the original loan P a g e

11 A wraparound mortgage is frequently used as a method of refinancing real property or financing the purchase of real property when an existing mortgage cannot be prepaid. It is also used to finance the sale of real estate when the buyer wishes to put up a minimum amount of cash for the sale initially. The buyer executes a wraparound document to the seller, who will collect payments on the new loan and continue to make payments on the old loan. The buyer should require a protective clause in the document granting him or her the right to make payments directly to the original lender in the event of a potential default on the old loan by the seller. Loans Classified by Special Provision-Reverse Annuity Mortgage A reverse annuity mortgage is one in which regular monthly payments are made to the borrower, based on the equity the homeowner has invested in the property given as security for the loan. To be eligible, the participant must be at least 62 years old and the reverse mortgage must be the only loan allowed on the property. A reverse loan allows senior citizens on fixed incomes to realize the equity build-up in their homes without having to sell. The money received by the senior can be monthly payments, a line of credit, or another agreed upon means. The borrower is charged a fixed rate of interest, which will be periodically added to the principal. The loan is eventually paid from the sale of the property or from the borrower's estate upon his or her death P a g e

12 Loans Classified by Special Provision-Open End Mortgage An open-end mortgage, which is being used with increasing frequency, secures a note executed by the borrower to the lender, as well as any future advances of funds made by the lender to the borrower or his or her successors in title. The mortgage or trust deed usually includes a statement of the maximum amount to be secured. Any sums the lender may have to pay to protect his or her security due to the borrower's neglect for such items as taxes, assessments, or insurance premiums are added to this maximum amount. An open-end mortgage is frequently used by borrowers to obtain additional funds in order to improve their property. The borrower "opens" the mortgage or trust deed to increase the debt to its original amount after the debt has been reduced by payments over a period of time. The terms of an open-end mortgage usually restrict the increase in debt to a limit of either the original amount of the debt or a stipulated amount set forth in the mortgage or trust deed. The lender is not obligated to advance the additional funds. Loans Classified by Special Provision-Shared- Appreciation Mortgage A shared-appreciation mortgage is one in which the lender originates a mortgage or trust deed loan at a favorable interest rate (several points below the going rate) in return for a guaranteed share of the gain (if any) the borrower will realize when the property is eventually sold. This type of loan was originally made to developers of large real estate projects, but in times of expensive mortgage money it has appeared in the residential financing market. The specific details of the shared-appreciation agreement are set forth in the mortgage or trust deed and note documents P a g e

13 The SAM can also be called a participation loan. Loans Classified by Special Provision- Purchase-Money Mortgage A purchase-money mortgage is a note and mortgage or trust deed created at the time of purchase to facilitate the sale. It is often given by the purchaser to the seller to finance the property. A purchase-money mortgage is usually given to cover a portion of the purchase price, such as the down payment; it may even be given to finance the entire purchase price. It is a form of owner financing in which the seller acts as the mortgage company. Loans Classified by Special Provision- Construction Loan A construction loan is made to finance the construction of improvements on real estate (homes, apartments, office buildings, and so forth). Under a construction loan, the lender disburses the loan proceeds in installments while the building is being constructed. This loan is generally a term loan and bears a higher interest rate because of the risks assumed by the lender. This type of financing is generally short-term, or interim. An end loan or take-out loan will "take out" the original construction financing lender when the work is completed. This "take out" loan is usually obtained from another lender. Purchasing 'Subject To' A person who purchases real estate that has an outstanding mortgage or trust deed on it may take the property subject to the mortgage or P a g e

14 may assume it and agree to pay the debt. This technical distinction becomes important if the buyer defaults and the mortgage or trust deed is foreclosed. Subject to: When the property is sold subject to the existing mortgage, the courts frequently hold that the purchaser is not personally obligated to pay the debt in full. The purchaser has bought the real estate knowing that he or she must make the loan payments and that, upon default, the lender will foreclose and the property will be sold by court order to pay the debt. If the sale does not pay off the entire debt, the purchaser is not liable for the difference. Assuming a Debt In contrast to "subject to," when the grantee assumes and agrees to pay the debt, the grantee becomes personally obligated for the payment of the entire debt. If the mortgage is foreclosed in such a case and the court sale does not bring enough money to pay the debt in full, a deficiency judgment against both the assumer and the original borrower may be obtained for the unpaid balance of the note. The assumer has primary liability while the original borrower is secondarily liable. In Review The Veterans Administration is authorized to guarantee loans to purchase or construct homes for eligible veterans. Loans with that guarantee are commonly called VA loans. The FHA neither builds homes nor lends money itself. Rather, it insures loans on real property made by approved lending institutions. It does not insure the P a g e

15 11.15 P a g e property, but it does insure the lender against loss. Any loan not government-guaranteed or government-insured is a conventional loan. An adjustable rate mortgage is generally originated at one rate of interest, with the rate fluctuating up or down during the loan term based on a certain economic indicator called an index. With a graduated payment mortgage, the interest rate and maturity are fixed but the monthly payment gradually rises. In a buydown mortgage, some of the interest is paid in advance for the purpose of temporarily lowering the interest rate. A package mortgage not only includes the real estate, but also includes all fixtures and appliances installed on the premises. A blanket mortgage covers more than one parcel or lot, and is usually used to finance subdivision developments An open-end mortgage secures a note executed by the borrower to the lender, as well as any future advances of funds made by the lender to the borrower or his or her successors in title Under a construction loan, the lender disburses the loan proceeds in installments while the building is being constructed.