FORECLOSURES, FHA, VA AND PURCHASE MONEY MORTGAGES

Transcription

1 Chapter 2 we will take a quick look at foreclosures before moving on to various forms of financing. CHAPTER 2 FORECLOSURES, FHA, VA AND PURCHASE MONEY MORTGAGES CHAPTER LEARNING OBJECTIVES Upon completion of this chapter, the student should be able to: Discuss foreclosure action Describe conventional, FHA and VA Financing Objectives Describe forms of financing 15

2 CHAPTER 2 - SECTION 1 FORECLOSURES, FHA, VA AND PURCHASE Foreclosure Actions Deed of Trust Foreclosures Deeds of trust have a provision that allows the trustee to sell the property should the borrower default. This is known as a power of sale clause. The process to foreclose is a non-judicial process. The power given to the lender to sell the property may be executed by the lender or their representative, typically referred to as the trustee. The trustee has the power to sell the property at auction known as a trustee s sale without court proceedings. If the auction results in more funds received than the amount of the loan, then the additional funds are allocated to the foreclosed borrower. A non-judicial foreclosure must adhere to strict guidelines: The trustee must give a notice of default (NOD) to the borrower A month after the NOD, the trustee gives the borrower a notice of sale (NOS) and records the NOS in the county where the property is located. The NOS must also be given to any junior lienholders or to anyone who has recorded a request to receive the NOS Between the time of the NOS and the trustee s sale, the borrower may pay the lender the late payments, charges and fees and may rectify the default. If the borrower does this, then the foreclosure is terminated and the loan is said to be reinstated and the borrower is known to have cured the default If the borrower has not cured the default, the property will be auctioned off at a trustee s sale. The trustee s sale is final and the borrower cannot redeem the property after the sale. The successful bidder at a trustee s sale receives a trustee s deed and can take immediate title. Mortgage Foreclosures The judicial process of foreclosure, which involves filing a lawsuit to obtain a court order to foreclose, is used when no power of sale is present in the mortgage or deed of trust. Generally, after the court declares a foreclosure, the property will be auctioned off to the highest bidder. Deed in Lieu of Foreclosure A deed in lieu of foreclosure is a deed instrument in which a mortgagor (i.e. the borrower) conveys all interest in a real property to the mortgagee (i.e. the lender) to satisfy a loan that is in default and avoid foreclosure. 16

3 The deed in lieu of foreclosure offers several advantages to both the borrower and the lender. The most important advantage to the borrower is that it immediately releases them from most of the personal indebtedness associated with the loan that was in default. The borrower also avoids the public notoriety of a foreclosure proceeding and may receive more generous terms than he/she would in a formal foreclosure. Another benefit to the borrower is that it may not be as damaging to their credit as a foreclosure. Advantages to a lender are a reduction in the time and cost of a repossession, and additional advantages if the borrower later files for bankruptcy. In order to be considered a deed in lieu of foreclosure, the indebtedness must be secured by the real estate being transferred. Both sides must enter into the transaction voluntarily and in good faith. Sometimes, the lender will agree to a deed in lieu of foreclosure if the outstanding indebtedness of the borrower exceeds the current value of the property. Other times, lenders will agree since they will end up with the property anyway and the foreclosure process is costly to the lender. Because of the requirement that the instrument be voluntary, lenders will often not act upon a deed in lieu of foreclosure unless they receive a written offer of such a conveyance from the borrower that specifically states that the offer to enter into negotiations is being made voluntarily. This will enact the parol evidence rule* and protect the lender from a possible subsequent claim that the lender acted in bad faith or pressured the borrower into the settlement. Both sides may then proceed with settlement negotiations. Neither the borrower nor the lender is obliged to proceed with the deed in lieu of foreclosure until a final agreement is reached. *Parol refers to verbal expressions or words. Verbal evidence, such as the testimony of a witness at trial is considered parol evidence *The parol evidence rule is a principle that preserves the integrity of a written documents or contract by prohibiting the parties from attempting to alter the meaning of the written document through the use of prior and contemporaneous oral or written declarations that are not referenced within the document. Forfeiture Forfeiture occurs in a land contract situation (also known as a real estate contract or installment contract). Forfeiture is only available in a land contract situation. The seller is known as the vendor and the buyer is known as the vendee. Conventional, FHA and VA Financing and Their Qualifying Requirements Conventional Loans Conventional Loans are any loans which are not government loans. This includes seller financing. typically sold in the secondary market to one of two primary investors Fannie Mae, 17

4 and Freddie Mac. These investors establish the qualifying guidelines that lenders must use when underwriting a mortgage. Currently the minimum down payment requirement for a conventional loan is 3%. Loans are run through the agency s automated underwriting system (Desktop Underwriter for Fannie Mae, and Loan Prospector for Freddie Mac) to determine approvability of the loan. Private mortgage insurance must be obtained for all LTV s over 80%, and PMI companies have separate qualifying guidelines. It is not uncommon for a loan to be approved through DU or LP, but be ineligible for private mortgage insurance. Conventional loans do allow for non-occupant co-borrowers, but the borrower must be able to demonstrate that they can manage the payments on their own. Conventional loans are not assumable. FHA Loans FHA Loans are insured through the Federal Housing Authority, which is a section of HUD. FHA loans traditionally offer more flexible guidelines when it comes to approving borrowers with somewhat lower credit scores. FHA currently requires a minimum down payment is 3.5%. FHA loans require a portion of the mortgage insurance premium to be paid at the time of closing this amount is added to the loan amount and amortized over the term of the loan. The balance of the mortgage insurance is paid monthly. This structure generally results in lower payments overall than a conventional loan with private mortgage insurance. Until recently FHA loan limits were often too low to make the program feasible in high cost areas, but recent changes enacted by congress have raised the loan limits, making FHA loans an attractive option for many buyers especially those with limited funds for down payment or lower credit scores. FHA loans do allow for non-occupant co-borrowers. FHA loans are assumable by a qualified buyer. VA Loans VA Loans are guaranteed by the Veterans Administration, and are made available to veterans who can provide a DD214 showing that they have met the service requirements necessary to be eligible for the program. VA guaranteed loans are made by private lenders, such as banks, savings & loans, or mortgage companies to veterans for the purchase of a home which must be for their own personal occupancy. To get a loan, a veteran must apply to a lender. If the loan is approved, VA will guarantee a portion of it to the lender. Using the VA program, a veteran can finance 100% of the purchase price of a home. If the seller of the home is willing to pay the veteran s closing costs, a veteran is often able to purchase with no cash out of pocket. Underwriting guidelines are established by the VA, and generally require the total debt to income ratio (including all reoccurring debts plus housing expense) to not exceed 41% of the borrowers gross income. Only the veteran and his or her spouse may be on the loan. VA loans are assumable by another qualified veteran, or if the buyer is not a veteran, the VA eligibility would remain with the house, and the original veteran would not be able to buy again using a VA loan until the original loan was paid off. USDA Programs The mission of the USDA is To increase economic opportunity and improve the quality of life for all rural Americans. Their housing program addresses the need for single-family homes, 18

5 multi -family homes as well as health and other community facilities. The USDA offers the following loan programs: Section 52 Loans Section 52 loans are primarily used to help low-income individuals to purchase homes in rural areas. Funds can be used to build, repair, renovate or relocate a home, or to purchase and prepare sites, including providing water and sewage facilities. Applicants for loans may have an income of up to 115% of the median income for the area. There are income limits for this program. Families must be without adequate housing, but be able to afford the mortgage payments, including taxes and insurance. In addition, applicants must have reasonable credit histories. The loan term is 30 years Section 52 Direct Loans Rural Housing Direct Loans are loans that are directly funded by the Government. These loans are available for low- and very low-income households. Applicants may obtain 100% financing to purchase an existing dwelling, purchase a site and construct a dwelling, or purchase newly constructed dwellings located in rural areas. Mortgage payments are based on the household's adjusted income. Applicants for direct loans from HCFP must have very low or low incomes. Very low income is defined as below 50 percent of the area median income (AMI); low income is between 50 and 80 percent of AMI; moderate income is 80 to 100 percent of AMI. Families must be without adequate housing, but be able to afford the mortgage payments, including taxes and insurance, which are typically within 22 to 26 percent of an applicant's income. However, payment subsidy is available to applicants to enhance repayment ability. Applicants must be unable to obtain credit elsewhere, yet have reasonable credit histories. Forms of Financing Purchase Money Mortgages A Purchase Money Mortgage is a home financing technique in which the buyer borrows from the seller instead of, or in addition to, a bank. This is sometimes done when a buyer cannot qualify for a bank loan for the full amount. It may also be called seller financing or owner financing. A purchase-money mortgage might be offered by the seller as an incentive to purchase a property. This can be used in situations where the buyer is assuming the seller s mortgage, and the difference between the balance on the assumed mortgage and the sales price of the property is made up with seller financing. A purchase-money mortgage is a note secured by a mortgage or deed of trust given by a buyer, as borrower, to a seller, as lender, as part of the purchase price of the real estate. In any event the seller should always see that he receives enough cash to more than pay the cost of foreclosing the mortgage and to more than cover any depreciation in the property, accrued interest and unpaid taxes. 19

6 The Consumer Financial Protection Bureau ("CFPB") recently issued several final rules concerning mortgage markets pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). One of these rules clarifies the definition of "loan originator" and outlines conditions under which "seller-financers" are exempt from the definition. The CFPB rules are federal. There are also Washington state requirements. You should advise your client to seek legal counsel regarding seller financing issues. Blanket Mortgages A blanket mortgage is a single mortgage that covers more than one parcel of real estate. A mortgage which is secured by several structures or numerous parcels. A blanket mortgage is often used to finance proposed subdivisions, cooperatives or development projects. This is an alternative to a developer having to take out numerous individual properties within a large property purchase that they intend to sell in individual parts. The blanket mortgages are typically taken out to cover the costs of purchasing and developing land that developers plan to subdivide into individual lots. Wrap-Around Mortgages Wrap-Around mortgages are a creative, though rare, way to allow buyers to purchase a home without having to qualify for a loan or to pay closing costs. The contract is made between the buyer and seller with the lender s approval. Here s how it works: (1) the seller holds onto the existing mortgage (2) the seller names the property s selling price (3) the seller offers the buyer a loan at a higher interest rate than the existing mortgage (4) the buyer pays the seller a fixed monthly amount and (5) the seller uses part of this money towards the existing loan and then pockets the difference. Unlike an installment sales contract, the buyer gets title (ownership) of the property at closing. This type of financing isn t used much since most mortgages have a due-on-sale clause. Allinclusive trust deeds (AITD) are another name for a Wrap-Around Mortgage. Open-End Mortgages An Open-End Mortgage is a provision in mortgage contracts in some states, that declares the mortgaged real estate may be used as security for future additional advances from the original lender, if the lender and borrower agree. All subsequent advances under this clause represent a claim on the property dating back to the time of recording the original mortgage. Construction Loans A construction loan is an interim loan covering construction and development costs, secured by a Mortgage on the property financed. Funds are advanced at specific stages of construction, in so-called progress payments, with a portion held until completion of the 20

7 project. For example, a certain percentage of a building has been leased, or other criteria have been met. Construction financing is paid off from the proceeds of a permanent mortgage by an Institutional Lender. For example a life insurance company or pension fund or bank. However, some lenders have made construction loans on speculation. Many of these construction loans financing speculative real estate developments have, as a result, become long-term permanent mortgages on the books of the original lender. Construction loans can have stories. That means that the lender has to know the story behind the planned construction before they're willing to loan you money. Because it's a story loan, it's not going to be standardized like mortgage loans underwritten to Freddie Mac or Fannie Mae guidelines. That said, there are some common features to a construction loan. Construction loans typically require interest-only payments during construction and become due upon completion. Completion for homeowners means that the house has its certificate of occupancy. Construction loans are usually variable-rate loans priced at a spread to the prime rate or some other short-term interest rate. You, the contractor and the lender establish a draw schedule based on stages of construction, and interest is charged on the amount of money disbursed to date. Another variable in construction loans is how much of the project cost the lender is willing to lend. If you already own the land, then that can be considered as equity on the construction loan. Many homeowners use construction-to-permanent financing programs where the construction loan is converted to a mortgage loan after the certificate of occupancy is issued. The advantage is that you only have to have one application and one closing. Sale and Leaseback In a Sale and Leaseback situation, an owner sells a property, then immediately leases it back from the new owner. This arrangement allows the original owner to have full use of the property, while their capital is not being tied up. This capital may used for other activities which may be more advantages. CASE STUDY The Dhenrider Company wants to expand its research and development in the area of heating and HVAC energy efficiency for green building. Their hopes are to have the first truly efficient product on the market and be a leader in this technology. The company is short on capital and without additional funds cannot continue their R and D development. They sell their building and land to an investor who leases the building back to the company. The company is now a tenant and has freed up a great deal of capital for research. The company also has had the advantage of not disrupting business activities since they did not need to move their facility. Installment Contracts 21

8 An agreement between a buyer and seller of property in which the buyer makes payments toward full ownership (as with a mortgage) However, in a land contract, the title or deed is held by the owner until the full payment is made. As in a standard mortgage, there is an agreed upon price and payment schedule, but the payments are often not amortized evenly, so that a large balloon payment may be required to complete the purchase. They are also known as an installment purchase contract or an installment sale agreement or land contract. Land contracts were very popular in the late 1970s and early 1980s. Back then, installment sale contracts, sometimes called contracts for deed, offered more attractive financing terms over the higher rates and rigid qualification standards of institutional lenders. Land contracts began to disappear when loan requirements softened and rates dropped below 8%. But they have not vanished all together and, in fact, have begun making a comeback in the market starting in Graduated Payment Mortgages (GPM) A type of fixed-rate mortgage in which the payment increases gradually from an initial low base level to a desired, final level. Payments increase in steps each year until the installments are sufficient to amortize the loan. In a graduated payment mortgage, only the low initial rate is used to qualify the buyer, which allows many people who might not otherwise qualify for a mortgage to own a home. This type of mortgage payment system may be optimal for young homeowners as their income levels gradually rise to meet higher mortgage payments. Reverse Annuity Mortgages A Reverse Annuity mortgage is one in which a homeowner's equity is gradually depleted by a series of payments from the mortgage holder to the homeowner. Thus, a reverse annuity mortgage increases in size as the annuity payments continue. A reverse annuity mortgage is used primarily by elderly homeowners who wish to convert the equity in their homes into a stream of retirement income payments. They are also called reverse mortgage or home equity conversion mortgage. Personal Lines-of-Credit Personal lines of credit allow a borrower to access funds using a checkbook or ATM. A Credit limit is established and usually there are no additional fees associated with accessing the account. Often times, these lines of credit bear a lower interest rate than credit cards and some banks base the monthly payments on the actual amount that you use. Elements of an Adjustable Rate Mortgage (ARM) What is an ARM? 22

9 With a fixed rate mortgage, the interest rate stays the same during the life of the loan. With an Adjustable Rate Mortgage (ARM), the interest rate changes periodically over the life of a loan. This change is usually in relation to an index. Payments can go up or down. Lenders usually charge a lower interest rate for ARM s than fixed rate mortgages when originating a loan. For a given amount, this makes payments on an ARM easier at first. The loan could be more or less expensive over a long period, depending on the movement of the interest rates. There are risks for the borrower in that interest rates could sharply increase leading to higher monthly mortgage payments. Questions to think about when considering an ARM: Is my income likely to increase enough to cover the payments if the rates go up? How long am I planning on owning the home? If it is for a short period of time, rising interest rates may not be an issue as they would if you are planning to own the home for a long time. Basic Features of ARM s Adjustment Period With most arms, the interest rate and payment change every year, three years or five years. The time period between one rate change and the next is called the adjustment period. So an ARM with an adjustment period of three years is called a three year ARM. Index Most ARM s are tied to an index rate. If the index rate goes up, so does the mortgage interest rate. Conversely, if the index goes down, the mortgage interest rate goes down. There are many different indexes, but the most commonly used are the rates on one, three, or five year Treasury securities. Another common index is the cost of funds to saving and loan associations. It is important for a borrower to know what index is being used and to have an idea of the index s past fluctuations. The Margin To calculate the interest rate, lenders take the index rate and add a few percentage points. These percentage points are called a margin. Index Rate + The Margin = ARM Interest Rate Interest Rate Caps An interest rate cap places a limit on how much your interest rate can increase. There are two types of interest rate caps: 23

10 Periodic Caps which limit the interest rate increase from one adjustment period to the next Lifetime or Overall Caps which limit the interest rate increase over the life of the loan. Let s look at an example of an ARM with a periodic cap rate of 3% with 1% margin First year interest rate 5% If the index rises 1% Second year interest rate" 7% A decrease in the interest rate does not always mean that there will be a decrease in an ARM s monthly payment. The payment could even increase if the index has stayed the same. This could happen when an interest rate cap has been holding your interest rate down below the sum of the index and the margin. If a cap rate holds down your interest rate, increases to the index that did not happen due to the cap may carry over to future rate adjustments. Let s look at an example of a carryover using a periodic rate cap of 2%. First year interest rate 6% If index + margin rise 3% Second year interest rate 8% (because there was a 2% cap rate) If the index now stays the same, the third year interest rate 9%. Even though the index between the second and third year stayed the same, the interest rate increased due to the carry over. Payment Caps Some ARM s have payment caps which limit the monthly payment increase at the time of each adjustment. Some ARM s with payment caps don t have periodic interest rate caps. Negative Amortization If an ARM contains a payment cap, there is the possibility of negative amortization. Negative amortization happens when the mortgage balance increases. This occurs when the monthly mortgage payments are not large enough to pay all of the interest due on the loan. Because payment caps limit the amount of the payment increases only, and not the interest rate increases, payments sometimes do not cover the interest due on the loan. When this happens, the interest shortage is automatically added to the debt, and interest is charged on that amount. Convertible ARM s Some ARM s contain a convertible clause which allows you to convert to a fixed rate mortgage at designated times. When the conversion takes place, the new rate is generally set at the current rate for fixed rate mortgages. There may be an extra fee to get an ARM with a convertible feature. 24

11 So there s a high level look at various forms of financing options available to your customers. Let s take a quick assessment and then move on to chapter 3. Check your understanding Use this link to open a short quiz: Copyright 2015 Simplify CE, LLC 25