tx marketing i: building a real estate practice · pdf file... the basics of real estate...

TX Marketing I:

Building a Real Estate Practice

MODULE SEVEN: REAL ESTATE FINANCE ..................................................................... 2

MODULE DESCRIPTION ........................................................................................................ 2

MODULE LEARNING OBJECTIVES ........................................................................................... 3

KEY TERMS ......................................................................................................................... 4

LESSON 1: INTRODUCTION TO REAL ESTATE FINANCE .............................................. 7

LESSON 2: CONVENTIONAL LOANS ........................................................................... 28

LESSON 3: FHA LOANS ................................................................................................ 40

LESSON 4: VA LOANS ................................................................................................... 59

LESSON 5: THE BASICS OF REAL ESTATE FINANCING & REAL ESTATE PRACTICE .. 73

2 TX Marketing I: Building a Real Estate Practice

Module Seven: Real Estate Finance

Module Description

This course provides an introduction to residential real estate finance, including

information on how to underwrite FHA, VA, FNMA, and FHLMC loans.

In this course, you will learn the basics of the different types of loans available, loan

applications, appraisals, escrow, titles and credit reports, including qualifying for

loan amounts and verifying income and assets.

You will also learn how to calculate loan amounts, estimate monthly payments,

property taxes, hazard and mortgage insurance (for Conventional, FHA and VA), and

qualifying ratios and income.


Module Learning Objectives

Upon completion of this module, you should be able to:

Understand the basic concepts and key terms of real estate financing.

Explain how to qualify a buyer for the most common types of loans.

Demonstrate the use and function of escrow accounts.

Define what a mortgage insurance premium is.

Detail the process of underwriting its guidelines.

Recall the three most common types of loans: conventional, FHA, and VA.

Distinguish the advantages and disadvantages of conventional loans.

Show how to use conventional qualifying ratios.

Distinguish the advantages and disadvantages of FHA loans.

List the differing FHA qualification ratios.

Distinguish the advantages and disadvantages of VA loans.

Identify VA eligibility and qualification periods.

Calculate the amount of VA entitlement used.

Calculate VA loan amounts and required down payments.

Follow the process and qualifications for assuming VA and FHA loans.

Name the other types of loans available.

Apply this knowledge to underwrite and close loans.


Key Terms

Acceleration Clause: (Also called an “alienation clause”) A clause in the mortgage

document that, if enforced, makes the entire balance of the mortgage due to the

lender immediately upon default.

Amortization: The paying down of the principal of a loan over time; a loan that is

so paid down is said to be amortized; the period of time it takes for such a loan to

be paid off is called the amortization period.

Appraisal: The process by which the value of a piece of real estate is determined;

any value so determined is called the appraisal value.

Assumption: Taking over the obligation or commitment of another, as in a loan,

insurance policy, etc.

Closing: The finalizing steps of a real estate transaction, when the real property is

turned over to the purchaser on the closing date.

Escrow Account: An account held by the lending institution into which the

borrower pays taxes, insurance, and special assessments and from which the

lender pays these sums as they become due.

Expense-to-Income ratio: The ratio of the housing expense of a borrower, or PITI

(Principal + Interest + Taxes + Insurance), to the net income of the borrower.

FHA: Federal Housing Authority; the Federal Housing Administration, which

operates under the Department of Housing and Urban Development, administers

the government home loan insurance program. This program allows prospective

homebuyers to get a loan in order to finance their home by removing the risk from

the lender.


FHLMC: Federal Home Loan Mortgage Corporation, also known as Freddie Mac,

purchases first mortgages on residences.

FNMA: Federal National Mortgage Association, also known as Fannie Mae, supplies

home mortgage funds through a congressionally chartered, shareholder company.

Loan Discount: An amount paid to the lender to lower the lending rate; loan

discounts are expressed in points, where one point equals one percent of the loan;

eight points is equivalent to a one percent interest rate reduction.

Loan-to-Value (LTV) ratio: The ratio of the amount of a loan to the value of the

property to be purchased; used in determining such things as buyer payment

restrictions and veteran eligibility.

Mortgage: A document wherein a borrower gives a lien against or title to his or her

property to a lender as collateral for the loan amount.

Mortgage Insurance Premium (MIP): The amount paid by the borrower for private

mortgage insurance, which insures the lender against loss in the event of borrower

default.

PITI: Principal, Interest, Taxes, and Insurance.

Principal: The unpaid amount of a loan, not counting interest.

Private Mortgage Insurance (PMI): Insures the lender against loss in the event of

borrower default; the insurance is paid for by the borrower through the mortgage

insurance provider.


Promissory Note: A note wherein the borrower acknowledges his or her debt and

agrees to pay the lender according to the terms of the loan.

Secured Loan: A loan that places a lien or title against a property as security for the

loan amount; opposite of an unsecured loan.

Underwriting Process: The process by which an applicant is qualified for and then

receives a loan.

Unsecured Loan: A loan where there is no collateral pledged for the loan, and it is

backed only by the borrower’s signature.

VA: The Veterans Administration is responsible for providing federal benefits for

veterans and their dependents.

Veterans Entitlement: The amount of money a veteran is entitled to under the VA

loan program, based on the veteran’s record and the amount of entitlement

currently being used.


Lesson 1: Introduction to Real Estate Finance

Lesson Topics

This lesson focuses on the following topics:

Introduction

Promissory Notes

Secured vs. Unsecured Notes

Default

Amortization

Assumption

Escrow Accounts


Private Mortgage Insurance

Self-Acceleration

Loan Payments

Types of Loan

Qualifying a Buyer

Loan Application Checklist

Underwriting Guidelines and Process

Lesson Learning Objectives

By the end of this lesson, you should be able to:

Identify the basic concepts and key terms of real estate financing.

Explain how to qualify a buyer for the most common types of loans.

Demonstrate the use and function of escrow accounts.

Recall the three most common types of loans: conventional, FHA, and VA.

Explain loan applications and basic underwriting guidelines.

Introduction

As you read through this lesson, and the module, keep in mind that real estate

financing focuses on these basic questions:

How do we pay for real property?

Should we pay cash or borrow?

Should we pay now or pay later?

Most residential real estate financial transactions involve a loan; real estate is one

of the few assets that can be purchased without full payment in advance. The group

of investors that consumers borrow money from are known as primary lenders.

These lenders accept and process loan applications, underwrite loans and make

loans upon approval. Every loan made by a primary lender requires the borrower

to sign a promissory note.


It should be noted that the information contained within this lesson may become

dated and the student may need to update his or her knowledge on the issues

presented here. Information on lending programs does change frequently and it

will be important that the licensee stays informed on any changes and updates in

loan programs.

Promissory Notes

The promissory note is the common document for all loans, not just the ones

commonly referred to as a “mortgage.” It is an agreement between the obligor,

maker or payor (borrower), and the obligee, or payee (lender), and is the written

agreement of the borrower’s personal promise to repay the lender. In the note, the

borrower acknowledges the debt, and the agreement provides for all of the terms

of repayment.

The promissory note, commonly referred to simply as a “note,” begins with an

acknowledgment of the borrower's debt to the lender and the borrower’s promise

to repay the debt, either to the lender named in the note or to anyone who later

holds the note.

The note is a negotiable instrument that can be sold to another investor or lender.

It specifies the amount of the debt, the rate of interest and date on which interest

charges are to begin, and the amount and terms of repayment. It is the complete

contract or agreement of the loan terms between the borrower and the lender.


Secured vs. Unsecured Notes

Promissory notes can be secured or unsecured. A secured note refers to a mortgage

that pledges rights (a lien or title, depending on state law) against a property as

security for the debt. An unsecured note has no collateral pledged for the loan and is

a promise backed only by the signature of the borrower. This is often referred to as

a signature loan. The note will, when applicable, refer to the mortgage or deed of

trust that is security for it.

A mortgage is a document that creates a lien, a claim that the mortgage holder has

on the property. A deed of trust is a document that actually conveys title to the

property to a trustee, who holds the title until the debt has been cleared. If it is

secured by a mortgage or deed of trust in favor of the lender, that document will

also refer to the note for which it is security. Without mention of security, the note

is an unsecured loan. Either type of note will provide for the signature(s) of the

borrower(s), who are required to sign the note to agree she, he, or they owe the

money. It is not required for the lender to sign the note, as notes are transferable.

What most people commonly refer to as a mortgage loan actually includes two

documents: a mortgage and a promissory note. The mortgage is a document in

which the borrower, known as the mortgagor, gives a lien against or title to his or

her real estate as collateral for the loan to the lender, also known as the mortgagee.

Whether it gives a lien against the property or actually transfers the title until the

loan is repaid depends on state law. The mortgage document makes reference to

the promissory note that it secures.


Default

Usually included in a promissory note is an acceleration clause. It gives the lender

the right upon any default by the borrower(s) to make the entire balance plus

accrued interest immediately due and payable. This clause is important because it

gives the lender the right to foreclose on the property if the entire loan balance is

not then paid. Without this clause, the lender would have to sue for each individual

late payment. The acceleration clause allows him or her to make the remaining

balance due and payable immediately after the borrower is declared in default and

given required notice. The lender can then sue to foreclose on the whole amount.

Although non-payment is the most common form of default, there are other

reasons that could cause default and the execution of the acceleration clause. The

borrower's failure to comply with any terms of the loan agreement, such as the

requirement to pay taxes or insurance or failure to maintain the condition of the

property could also be considered a default.

Amortization

A loan will usually be paid off in portions over time or amortized. The word

amortization is a Latin term that means “killing off slowly over time.” If the note is to

be amortized, there will be equal monthly payments that contribute to both

principal and interest until the entire loan is paid. The payments will be credited

first to interest when due, then any remainder credited to principal. In addition,

there will usually be a statement providing a grace period for each payment and a

penalty to be added to any payments made after the expiration of the grace period.

If the payment being made is not sufficient to cover the interest due for any

payment period, then the unpaid interest is added to the principal balance. This is

known as negative amortization or deferred interest.


Payments on amortized loans are calculated by using mortgage constant factors.

Mortgage constant factors can be obtained from amortization tables, financial

calculators or financial programs on personal computers.

Assumption

Sometimes it is an advantage to a buyer to take over an existing loan when

purchasing a property. The interest rate may be less than prevailing rates or other

terms may be more favorable.

In an assumption of a mortgage, the purchaser signs an agreement to assume the

obligation of the original mortgage. This makes the buyer equally responsible to the

lender. If the buyer defaults, then both the buyer and the seller may be responsible

for any deficiency.

Most modern mortgages have clauses prohibiting an assumption without the prior

written permission of the lender. If the buyer must qualify and the seller is given a

release of liability and is no longer part of the loan agreement, then the correct

term for this would be novation (terminating one agreement by replacing it with

another, usually including a new party or parties).

A buyer can also purchase the property subject to any encumbrances, as an

alternative to assuming the loan. Here, the buyer would not be personally

responsible for the repayment of the loan, and the lender could not sue her or him

in the event of default. The drawback to purchasing a property with a lien on it and

not at the same time assuming the responsibility of repaying the debt is that the

property could be foreclosed through no fault of the owner.


Escrow Accounts

Escrow accounts are accounts held by the lending institution to which the borrower

pays monthly installments for property taxes, insurance, and special assessments.

Lenders also disburse these sums as they become due from these accounts. When

a LTV loan that is greater than 80 percent is made, these accounts are required on

all loans, regardless of whether conventional, FHA, or VA.

Escrow accounts generally contain the following payments:

Taxes

Hazard insurance

Private mortgage insurance

Taxes

All property owners will be taxed by a variety of taxing authorities such as state,

county, city, school, junior college, MUD (municipal utility district–set up for a

subdivision to retire the bonds issued to pay for installation of the water and sewer

facilities), fire district, and/or FM road. Lenders will generally estimate taxes on new

home construction at 2.5 percent of the sale price (unless the home is in a MUD

district, then the lender uses 2.75 percent). For resale homes, lenders will obtain a

tax certificate showing actual taxes paid on the property.

Hazard Insurance

Insurance premiums may be calculated in the field using a rate sheet provided by

an insurance company. Annual premiums are given based on the replacement

value for frame or brick construction, factoring in depreciation, proximity of

property to nearest fire station and/or fire hydrant, and the physical location of the

property (i.e., within the city limits or on the fringe).


Note

The insurance covers the improvements and contents

only if a person chooses to add them, but does not

cover land value.

Private Mortgage Insurance

The purpose of PMI is to insure lenders against losses due to non-repayment of low

down payment conventional mortgages. Loan limits above a loan-to-value (LTV)

ratio of 80 percent require PMI, but the full amount of PMI payments is tax

deductible. Not all lenders require the same PMI coverage. One of the determining

factors is the type of loan being sought. The other is the loan-to-value ratio (LTV).

When a loan is paid off so that the remaining balance is less than 80 percent LTV,

the insurance may be cancelled. Now let us cover how PMI is computed.

Monthly PMI

The monthly PMI is figured on the loan amount. There is no up-front PMI premium

paid. The PMI is as follows for various loan percentages.

Loan % PMI

95% (Loan amount x 0.0078) / 12

90% (Loan amount x 0.0052) / 12

85% (Loan amount x 0.0033) / 12

This monthly premium amount is then added into the PITI payment (principal,

interest, taxes, and insurance).


One-Time PMI Premium–(Optional Arrangement)

Some private mortgage companies have introduced a program called ZOMP (Zero

Option Mortgage Premium), which allows the buyer to incorporate the PMI into the

monthly payment. This has been an alternative to the traditional practice of

charging an initial premium plus renewal premiums. Under this program, the initial

premium and renewal premiums are combined into a single, one-time premium

that is financed over the loan term rather than paid as a lump sum. The amount of

the one-time premium is simply added to the mortgage amount before calculating

the monthly payment. This program has advantages and disadvantages for

borrowers:

Advantages of the one-time premium:

There is no cash requirement at closing.

The mortgage payments including the monthly portion of the amortized one-

time premium are usually smaller than the mortgage payments including a

share of the traditional renewal premium.

The policy is self-canceling when the home is sold.

Disadvantages:

It cannot be cancelled after LTV drops below 80 percent.

It has an amortizing MIP (Mortgage Insurance Premium) over 30 years.

Self-Acceleration

Self-acceleration happens when a borrower pre-pays principal amounts of the loan

before they are due, thus shortening the life of the loan. Some notes include a pre-

payment penalty that charges a borrower who makes pre-payments. This is to

make up lost profit from interest when the loan is amortized quicker than normal.


Loan Payments

Here is an example of a partial loan payment schedule, including the amount of

monthly payments, monthly interest, paid principal, and the balance remaining on

a $100,000 fixed-rate loan amortized over 30 years.

Loan Amount =$100,000 Annual Interest =10% TERM=30 YEARS

Monthly Payment Chart

No. Pmt Amt Interest Principal Balance

1 877.57 833.33 44.24 99,955.76

2 877.57 832.96 44.61 99,911.15

3 877.57 832.59 44.98 99,866.17

4 877.57 832.22 45.35 99,820.82

5 877.57 831.84 45.73 99,775.09

6 877.57 831.46 46.11 99,728.98

61 877.57 804.79 72.78 96,501.63

62 877.57 804.18 73.39 96,428.24

63 877.57 803.57 74.00 96,354.24

121 877.57 757.82 119.75 90,818.60

122 877.57 756.82 120.75 90,697.85

123 877.57 755.82 121.75 90,576.10

This schedule shows how, as time goes by, payments on interest decrease and

payments on the principal increase. Thus, at the 123rd payment, the loan principal is

decreased by almost three times that of the 1st payment.


Interest Rates

Interest is the rent paid on money. Interest rates are determined by the market—

the individual lenders—but are influenced by the Federal Reserve System’s open

market activities and its primary lending discount rate (the interest rate the Fed

charges to other banks). They are also limited by usury laws, which prohibit lenders

from charging excessive interest on a loan.

Interest rates are inversely correlated with property values. That is, rising interest

rates cause falling property values, and falling rates cause property values to

increase.

Types of Loan

The three most common types of loans are conventional loans, FHA loans, and VA

loans. Conventional loans meet the Fannie Mae and Freddie Mac requirements for

sale on the secondary loan market. FHA (Federal Housing Authority) loans are loans

partially guaranteed by the federal government. VA loans are loans for veterans

and are fully guaranteed by the government. We will treat these three types of

loans, as well as the less-common varieties of loans, in detail in later lessons.

Qualifying a Buyer

Before deciding whether a buyer can obtain a real estate loan or not, a loan

underwriter analyzes two things:

The borrower's overall financial condition.

The value of the property that the loan is being sought for (often referred to

as collateral for the loan).

The primary concern of the lender is determining the degree of risk. Most lenders

use FNMA/FHLMC underwriting standards (discussed later) for conventional loans

and FHA and VA standards for FHA/VA loans. With this in mind, we will first turn to

qualifying the buyer.


There are five major areas of concern when qualifying the buyer, all of which must

be verified by the lender:

Income

Credit

Net worth

Source of funds

Debts

Income

The three tests of the borrower’s income are quantity, quality, and durability: how

much, how well, and how long income can be expected to last.

Quantity

The applicant's income must be sufficient to repay both the mortgage loan and all

other recurring installment debts. Part-time income, overtime income, pensions,

retirement benefits, and income from second jobs can be considered. Military

allowances are counted provided they can be verified. Income from rental property

is also considered.

The lender usually requires copies of signed leases, and only a percentage of any

net income counts towards qualifying because of possible future vacancies.

Alimony and/or child support is counted provided it is court-ordered and a history

of payments can be verified. Only a percentage of this income is counted

depending on the length of time it is expected to continue.

Any negative cash flow, such as car payments or losses on rental property, is

counted as long-term debt and subtracted from net income.


Quality

All income reported by the applicant is verified by the lender. If the borrower is an

employee, then the lender sends a Verification of Employment Form to the

employer requesting information regarding the length of employment, gross salary,

and other income and the likelihood of continued employment.

If the applicant's sole income is in the form of commissions, then it must be verified

by the past two-year's tax returns. If only part of the total income is commissions,

W-2 forms and a verification of employment are also considered as proof of such

income. A two-year history is usually required if the income is to be counted.

If the borrower applicant is self-employed, the lender usually wants to review:

federal income tax returns for the previous two or three years, profit and loss

statements, business credit reports, business plans and the borrower’s current

financial statement.

Durability

Income is considered sufficient if consistent working patterns are established and

there is a reasonable expectation the income will continue. As a general rule, a two-

year job history must be verified.

Credit

The credit history of the applicant is provided through a credit report from a

reputable credit reporting service, which indicates a 10-year record of past and

current credit accounts, the amount of credit involved, and the pattern of

repayment. Letters of explanation may be submitted with regard to credit

problems. These should be submitted to the lender at the time of application to

avoid any misunderstandings further into the underwriting process.


Net Worth

The applicant's current assets, including the source of funds being used for any

down payment and settlement costs, will be verified. Also, a borrower's net worth

oftentimes has an important effect on the lender's final loan decision. A lender

counts only demonstrable net worth on other real estate owned by the borrower.

Source of Funds

Verification of the source of the borrower's down payment and settlement costs is

made through the Request for Verification of Deposit Form. The two primary

figures on this form that the underwriter looks at are:

Current balance on deposit.

Average balance for the previous two months, although this varies by lender.

Debts

All debts, regardless of the number of payments remaining, must be included on

the loan application. For conventional loans, installment debts that cannot be paid

off by paying the minimum payments in 12 months or less will be included in the

applicant's total long-term debt ratio. For FHA and VA loans, debts with six or more

payments remaining will be included in the applicant's total long-term debt ratio.

These are simply guidelines; lenders may impose their own standards, which may

actually be more stringent. This could include counting all debts without regard to

the number of payments remaining or even factoring in the maximum possible

payments on credit cards or other lines of credit that do not currently have

balances.


Loan Application Checklist

Quick turnaround time begins with a complete loan application. Although this topic

will be dealt with later with more detail, a brief overview is essential for all real

estate licensees. Essential loan application information that borrowers should have

ready includes:

Name and phone number of all landlords for the past two years.

Copies of 30 days’ worth of most recent pay stubs (or original pay stubs on

VA loans).

Previous two years of W-2s (or 1099s if self-employed).

All Bond Programs require three years of tax returns, W-2s and residency

information.

Most recent two months’ bank and investment statements for all accounts.

These will need updating through approval.

Copy of recorded divorce decree (all pages) (if applicable).

Settlement statements from all real estate sold in the past two years.

Copies of lease agreements on any rental property owned and proof of

rental income for the past two years.

Copy of DD214, Statement of Service or Certificate of Eligibility (VA loans

only).

Copies of car titles to any vehicle(s) owned free and clear and less than four

years old.

Warranty deeds on any free and clear real property.

Next, we turn to a brief overview of underwriting guidelines and the underwriting

process so that you will understand further what is involved in obtaining real estate

financing.


Underwriting Guidelines and Process

What Factors do Underwriters Consider?

Underwriters approve or deny a mortgage loan application based on an evaluation

of the following:

Income and assets, which help determine the borrower's ability to pay a

loan.

Credit, which shows the borrower's current credit use, shows how the

borrower treated obligations in the past, and helps determine the borrower's

credit worthiness and willingness to repay a loan.

Property, which determines whether or not the property is adequate

collateral for the loan.

Underwriters base their decision on a combination or layering of these three

factors.

How do Layers of Risk Affect Homeownership?

The presence of individual risk factors does not necessarily threaten a borrower’s

ability to maintain homeownership. However, when layers of risk—a number of

interrelated high-risk characteristics—are present without sufficient offset, their

cumulative effect dramatically increases the likelihood of default and foreclosure.

To help borrowers maintain long-term homeownership, underwriters work to

understand borrowers’ needs and to manage the present risks in their loans.

Income Analysis

Once a lender determines how much stable income the loan applicant has, he or

she must decide whether or not the amount of stable income is adequate to cover

the proposed monthly mortgage payment. The lender must also consider at this

time the income ratios included in the purchaser’s debt. In addition to lender ratios,

a purchaser’s credit score affects the ability to obtain a loan.


Real estate professionals should be able to qualify prospective buyers before

showing them homes. Qualifying prospects up front gives them an idea of the

maximum monthly mortgage payment their income will support and helps to

determine which properties to show them.

Once the maximum monthly payment is established, the real estate licensee can

determine the maximum sale price the buyer can afford. And in a similar manner, if

a licensee knows what the monthly payment on a particular property is, she or he

can determine the monthly income necessary to qualify for the loan.

Housing Expense-to-Income Ratio

The housing expense-to-income ratio is the percent of net income that goes toward

paying for the property. High percentages are a risk factor, and lenders usually set

limits on the ratio. For example, for conventional loans, the proposed housing

expense (principal, interest, taxes, and insurance) should not exceed 28 percent of

the borrower’s stable monthly income. Lenders on conventional loans will consider

compensating factors in the qualifying process.

Some of these factors include:

A large down payment

Cash reserve

Upward mobility

Military benefits

Company benefits

Temporary income

Nominal increase in housing expenses


Total Debt Service Ratio

Conventional lenders consider a borrower’s income adequate for a loan if the total

debt service—i.e., the proposed total housing expense (including principal, interest,

taxes, hazard insurance, and mortgage insurance, if applicable) plus any other

recurring liabilities—does not exceed 36 percent of the borrower’s stable monthly

income.

A borrower’s recurring liabilities can be broken down into three categories:

installment, revolving, and other.

Installment debts have a fixed beginning and ending date. An example would

be a car loan. An installment debt will be included in the total debt ratio if

there are more than six months remaining.

Revolving debts involve an open-end line of credit with minimum monthly

payments. Examples would be credit cards and department charge cards.

The lender uses the most recent required minimum monthly payment in

their debt calculation.

The “other” category includes alimony, child support, and other similar

ongoing obligations. At the current time, neither FNMA nor FHLMC take into

account childcare expenses as a recurring liability.

The following example illustrates the process of loan qualification. Create a

Conventional Loan Analysis and calculate an estimated monthly payment using the

following information.

A house sells for $100,000. The borrower receives a 90 percent LTV loan at 8

percent interest for 30 years. The monthly payment required to amortize a $1,000

loan over 30 years at 8 percent is $7.34.


Sale price: $100,000 Gross Monthly Income: $4,500

LTV Ratio: 90% Long Term Debts: $325/mo.

Interest Rate: 8% Taxes: $200/mo.

Term: 30 year fixed rate Insurance: $48/mo.

Qualifying ratios: 28% / 36% Homeowners Fee: $35/mo.

PMI: 0.0052 annually

Estimated Monthly Payment

(Conventional Loan)

Mortgage Payment

Principal and Interest $ ______

Taxes $ ______

Insurance $ ______

PMI $ ______

Homeowner's Fee $ ______

Total Mortgage Payment

$ ______

Conventional Loan Analysis

1st Ratio = $ ________PITI / $________GMI = ________%

Should Not Exceed ______%

2nd Ratio = $________PITI + $________LTD / $________GMI = _____%

Should Not Exceed_______%

To fill in the estimated monthly payment chart, we must first calculate the amount

of the loan. A 90 percent LTV on a house whose value is $100,000 will be 0.90 x

$100,000 = $90,000.


Then we must calculate the principal and interest payment. If a $1,000 loan takes a

$7.34 monthly payment to fully amortize in 30 years, then a $90,000 loan will take a

90 x $7.34 = $660.60 monthly payment over the same term.

For the rows labeled “Taxes,” “Insurance,” and “Homeowner’s Fee,” we simply

record the monthly figures given to us in the question at their respective places.

To calculate the monthly PMI charge, we must divide the annual percentage by 12

(the number of months) and multiply the figure by the amount of the loan. So

(0.0052 x $90,000)/ 12 = $39.00.

The total monthly payment is the sum of all the figures in the right column.

Mortgage payment

Principal and Interest $ 660.60

Taxes $ 200

Insurance $ 48

PMI $ 39

Homeowner's fee $ 35

Total Mortgage Payment

$ 982.60

To fill out our conventional loan analysis, we take our previously calculated PITI =

$982.60, and divide it by the borrower’s stable monthly income of $4,500 to find the

housing expense ratio. Since 21.84 percent is less than the maximum ratio of 28

percent, this is a housing expense the borrower can be expected to handle.


To calculate the total debt service ratio, we add the monthly long term debt

payment to the PITI payment: $982.60 + $325 = $1307.60 and divide this number by

the borrower’s stable monthly income. This ratio, too, is below the maximum

amount, and the borrower should qualify for a conventional loan.

Conventional Loan Analysis

1st Ratio = $982.60 / $4500 = 21.84%

Should Not Exceed 28%

2nd Ratio = ($982.60 + $325) / $4500 = 29.06%

Should Not Exceed 36%

Lesson Summary

To purchase residential real estate, individuals usually take out loans. Most loans

are fully amortized, meaning they are paid off in equal monthly installments

reducing the principal over time. The process by which borrowers are considered

for loans and, if qualified, receive them is called underwriting.

Underwriters consider the quality, quantity, and durability of a borrower’s income,

and his or her credit, net worth, source of funds, and debt. Borrowers qualify for

loans on the basis of two ratios: the housing expense-to-income ratio and the total

debt service ratio.


Lesson 2: Conventional Loans

Lesson Topics


Introduction

Conventional Financing

Conforming and Non-Conforming Loans

Conventional Loan Guidelines

FNMA/FHLMC Underwriting Guidelines




Distinguish the advantages and disadvantages of conventional loans.

Show how to use conventional qualifying ratios.

Explain how the secondary mortgage market works.

Explain Fannie Mae/Freddie Mac underwriting guidelines.

Explain conforming loans to consumer.

Introduction

Now that the student has a basic understanding of real estate finance, the next

three lessons detail each of the different kinds of loans: conventional, FHA, and VA.

This lesson covers conventional loans. This lesson also discusses the meaning and

use of conventional financing and then states the differences between the types of

lenders, including: commercial banks and credit unions, savings and loans

associations, and mortgage banks. It will then go over the details of qualifying

buyers and the underwriting process, as well as the sale of conventional home

loans on the secondary market.





loan programs.

Conventional Financing

A conventional loan is defined as a loan that is neither federally insured (such as an

FHA loan) nor federally guaranteed (like a VA loan).


They are offered by primary lenders such as commercial banks and credit unions,

savings and loans associations, and mortgage banks. In general, they are divided

into two categories: conforming and non-conforming.

Conforming and Non-Conforming Loans

The Federal National Mortgage Association, or Fannie Mae, and the Federal Home

Loan Mortgage Corporation, or Freddie Mac, have developed a set of loan

guidelines to regulate and homogenize the conventional loans offered on the

primary market that they subsequently purchase on the secondary market.

Conventional loans that adhere to these guidelines are referred to as conforming,

while those that do not are referred to as non-conforming, or jumbo loans.

Most conventional primary lenders follow these set limits on the amount of money

they will lend for two main reasons: first, because the limits are meant to decrease

the risk of default, and, second, because primary lenders look to sell conventional

loans on the secondary market to secondary lenders, such as Freddie Mac or

Fannie Mae. Freddie Mac and Fannie Mae are two of the largest purchasers of

home loans on the secondary market. Consequently, one could see why primary

lenders would be interested in adhering to the guidelines by which Freddie Mac

and Fannie Mae purchase.

Conventional Loan Requirements

Each lender has its own requirements as to the type of property she or he will

finance, as well as different procedures for qualifying potential borrowers. These

loans may be assumed with the permission of the lender. In general, most

conventional lenders use the same basic underwriting guidelines covered in this

modules. Nevertheless, real estate practitioners should always check with each

lender for their specific underwriting guidelines to be sure.


Primary Lenders for Home Loans

Commercial Banks and Credit Unions

Commercial banks are called commercial because they originally specialized in

short-term capital loans for business and construction. Today, these banks have

expanded into the home-loan market. Most of the mortgages created by

commercial banks are sold to buyers on the secondary market.

Credit unions are more recent and less common than commercial banks, though

they offer most of the same services. They are financial institutions that are

controlled by their members, usually all of a certain group (for example, teachers,

union members, or the employees of a certain military base). Many credit unions

focus on home equity loans, short-term loans based on the portion of a home the

borrower has already paid off (her or his equity).

Savings and Loan Associations

Savings and Loan Associations (S&Ls), otherwise known as thrift lenders, were

originally established by the government for the purpose of offering long-term,

single-family home loans. For a long time S&Ls dominated the home loan market,

but in the 1980’s, deregulation led to a savings and loan crisis. Today, S&Ls are

much like commercial banks, and offer a wide variety of financial services. However,

S&Ls are chartered by the government and must meet the qualified thrift lender

(QTL) test to retain that charter and receive benefits from the Federal Home Loan

Bank System. At least 70 percent of an S&Ls assets must be housing-related (for

example, home mortgages, home equity, and mortgage-backed securities) for it to

meet the QTL test.


Mortgage Bankers

Mortgage banks control the greatest share of the primary lending market. They

manage capital, not from personal deposits, but from large investors like insurance

companies and retirement funds. Mortgage companies also borrow money from

commercial banks to finance loans. All of these loans are then sold on the

secondary market, as mortgage companies do not hold loans in portfolio. Some

mortgage companies operate entirely from the proceeds of secondary-market

sales, selling their loans to insurance companies and retirement funds, and to

buyers like Fannie Mae and Freddie Mac.

The Secondary Market

The secondary market is where real estate loans are bought and sold. A lender is

willing to advance funds to a borrower in exchange for periodic interest payments

for the use of those funds; for the same reason, an investor is willing to purchase a

promissory note from a lender. These notes sell at present values determined by

using discounted cash flow analyses, as will be discussed later. The idea is to give

the note a relative worth, based on alternative investment opportunities open to

the purchaser. If the investor could earn seven percent annual returns in the stock

market, the net present value of the note is the value of the future cash flows from

interest, discounted at a rate of seven percent.

Levels of risk are important as well. Investments with high risk and low returns are

of little interest to investors. To ensure the level of risk associated with loans in the

secondary market does not run too high, the largest buyers in the secondary

market have established guidelines to which loans must conform, if they are to be

traded in the secondary market.

These conforming guidelines have a further benefit to the secondary market, in

making loans easy to value and compare.


These guidelines are established by three government-sponsored agencies which

are the chief operators in the secondary market: the Federal National Mortgage

Association (FNMA or Fannie Mae), the Federal Home Loan Mortgage Company

(FHLMC or Freddie Mac), and the Government National Mortgage Association

(GNMA or Ginnie Mae).

Fannie Mae

Originally created by the government to provide a secondary market for FHA-

insured loans (discussed in a later lesson), Fannie Mae is now a privately owned

purchaser of FHA, VA, and conventional loans. Mortgages are purchased on an

administered price system. That is, the required yields (the money each loan

returns per unit of present value) are set daily. Lenders can check these

requirements and place an order to sell by phone.

In addition to the purchase and sale of loans, Fannie Mae issues what are known as

mortgaged-backed securities. These are investment instruments like stocks, which

pay returns to their holders. They differ from stocks in having as collateral a pool of

mortgages the issuing institution (in this case, Fannie Mae) owns. Fannie Mae does

not necessarily own or sell the securities; a lender brings a mortgage package to

Fannie Mae, and Fannie Mae exchanges the guaranteed securities with the lender

for the mortgages.

These securities are attractive to investors for two reasons: first, they cost less than

purchasing an entire loan and are more easily liquidated; and second, they are

guaranteed. That is, the holder of the security receives the full payment from it,

whether or not the borrowers of the mortgages held as collateral pay their loans in

full. For this guarantee, investors take slightly lower profits from the mortgages

than if they held them themselves, through the payment of a guarantee fee. For

more info, visit Fannie Mae online.

http://www.fanniemae.com/


Freddie Mac

Freddie Mac was created to provide a secondary market for conventional loans

during the Savings and Loan crisis of the 80’s. The success of the secondary market

in ameliorating the losses in the primary market illustrates an important dynamic.

Lenders are willing to lend large sums of money deposited in their institutions to

borrowers because they receive cash flows from interest. But until they receive this

interest, they are lacking in funds to lend out. By selling the loans on the secondary

market, lenders receive the present value of those interest cash flows, which they

can immediately lend out to other borrowers, continuing the process. In addition,

the primary market is stabilized by the mortgage-backed securities—liquid assets—

issued by secondary market purchasers.

Freddie Mac’s secondary market activities are, in part, what bailed out the S&Ls.

Securities sold by Freddie Mac are known as participation certificates (or PCs), but

they work in the same way as Fannie Mae’s mortgage-backed securities (MBSs).

Freddie Mac buys VA, FHA, conventional and adjustable rate loans that meet its

underwriting criteria. For more info, visit Freddie Mac online.

Ginnie Mae

Unlike Fannie Mae and Freddie Mac, Ginnie Mae is wholly owned by the

government. Its activities are under the direct supervision of the Department of

Housing and Urban Development, otherwise known as HUD. Ginnie Mae plays an

important role in the primary market, by offering loans to housing projects of

interest to HUD’s purposes, but not easily financed through private loans. However,

Ginnie Mae’s role in the secondary market, as the largest issuer of mortgage-

backed securities, and the only issuer of government guaranteed mortgage-backed

securities, is of greater importance. The government guarantee allows the type of

special assistance and residential mortgage loans that Ginnie Mae deals with to

rival other securities in the secondary market. For more info, visit Ginnie Mae

online.

http://www.freddiemac.com/

http://www.ginniemae.gov./


Conventional Loan Guidelines

A Conventional Loan Qualifying Worksheet is available here.


The amount limits set forth by Fannie Mae for conforming loans are listed in the

chart below.

Conforming Loan Limits

Single-Family $417,000

Two-Family $533,850

Three-Family $645,300

Four-Family $801,950


These new limits are effective for loans closed on or after January 1, 2011.

A fully amortized loan is repaid within a certain period of time (usually 15 or 30

years) by means of regular payments (usually monthly) including a portion for

principal and a portion for interest, often referred to as P/I. As each payment is

made, the appropriate amount of principal is deducted from the debt and the

remainder of the payment, which represents the interest, is retained by the lender

as earnings or profit.

With each payment, the amount of the debt is reduced and the interest due with

the next payment is recalculated based on the lower balance. The total monthly

payment remains the same throughout the term of the loan. However, every

month, the interest portion of the payment is reduced, and the principal portion is

increased.

The final payment pays off the loan completely, including any remaining interest

owed through that time. The principal balance is zero and no further interest is

due. Not all conventional loans are fully amortized—some are paid off through a

balloon payment, where the remaining amount due on the loan is paid after a

specified period of time in a single lump sum payment.

FNMA/FHLMC Underwriting Guidelines

The Federal National Mortgage Association, commonly called Fannie Mae, and the

Federal Home Loan Mortgage Corporation, commonly called Freddie Mac, are the

largest buyers of conventional mortgages in the secondary market. All mortgage

loans purchased by FNMA and FHLMC must meet their guidelines, and applications

must be submitted using documents which are developed and approved by each

organization.


Another entity in the mortgage loan process is private mortgage guaranty insurers.

Along with having to meet FNMA and FHLMC guidelines, mortgage loans with an 80

percent or greater loan-to-value (LTV) ratio must be insured by additional

guidelines established by each mortgage guaranty insurer.

General FNMA Underwriting Guidelines

The FNMA underwriting guidelines divide loans by Loan-to-Value ratio. Consider the

following guidelines for 98 percent and 90 percent LTV loans.

98 percent loans

Three percent limit on seller contribution toward buyer closing costs

Three months mortgage payments in reserve escrow account

Flawless credit

No buydowns of the interest rate allowed

Gifts allowed to help buyer with down payment

Qualifying ratios are 33 percent and 40 percent (more on this later)

Co-borrowers must also take title to collateral property

90 percent loans

Three percent limit on seller contribution (up to 6 percent below 90 percent)

Two months mortgage payments in reserve escrow account

Gift letters for five percent of the down payment must be matched with five

percent cash from borrower

Co-borrower must be a member of the immediate family and take title to

collateral property

Because the borrower has less equity in the house and, thus, less to lose in the

event of default, 98 percent LTV loans are riskier.


For this reason a 98 percent loan requires a borrower to have flawless credit,

whereas a lender would be more likely to give a 90 percent loan to sub-prime

borrowers, i.e., those with less than perfect credit.

For similar reasons, a borrower who receives a 90 percent loan is only required to

keep two months’ mortgage payments in an escrow account, while a 98 percent

borrower must have three. For loans less than 80 percent LTV, no escrow account is

required. The qualifying ratios, as well, increase with the LTV—for the 98 percent

loans above, the ratios are 33 and 40 percent, well above the typical

nonconforming ratios of 28 and 36.

Lesson Summary

A conventional loan is not guaranteed or insured by the federal government.

Conventional loans either conform to the Federal National Mortgage Association

(Fannie Mae) guidelines or they do not. The latter is called non-conforming or

jumbo loans.

Conventional loans are typically fully amortized loans, which have the same

monthly payment each month and reduce the principal gradually over time. They

generally have a 28 percent/36 percent (housing expense to income/total debt

service ratio) ratio requirement, but these ratios can be higher for sub-prime

borrowers. The Fannie Mae underwriting guidelines are designed to decrease the

risk of default, by increasing restrictions on higher LTV loans.


Lesson 3: FHA Loans

Lesson Topics


Introduction

Qualifiers

Income Qualifications

Mortgage Insurance Premium

Underwriting Guidelines

Down Payment Requirements

Minimum Investment

FHA Appraisal

Direct Endorsement


Additional Facts about FHA Loans

Programs

Advantages and Disadvantages

Practice



Define what a mortgage insurance premium is.

Detail the process of underwriting guidelines.

Distinguish the advantages and disadvantages of FHA loans.

List the differing FHA qualification ratios.

Determine the monthly payment on an FHA loan.

Introduction

The Federal Housing Authority (FHA), was established in 1934 as a government

agency as part of the Department of Housing and Urban Development (HUD). The

FHA does not make loans directly, but insures lenders against loss in case of buyer

default with FHA mortgage insurance. Because of this, lenders are willing to lend

money with a very low down payment required from the borrower.

The FHA program was designed to encourage home ownership. If a borrower

defaults, then the lender forecloses as with any other loan. After the foreclosure

sale, if the lender suffers a loss, the FHA would make-up the loss to the lender up to

25 percent of the original value. FHA loans are insured loans and, therefore, viewed

by lenders as less risky. The underwriting guidelines on these loans are, therefore,

less stringent than on conventional loans.

The borrower pays FHA for insurance coverage on the loan. This insurance helps to

stabilize the mortgage market and creates an active national secondary market for

FHA insured mortgage loans.


An FHA Loan Qualifying Worksheet is included for you here.





loan programs.


Qualifiers

Being of legal age and having either proof of U.S. citizenship or possessing a green

card are the only two qualifications for an FHA-insured loan.

Income Qualifications

An FHA loan requires a housing expense-to-income ratio not in excess of 29

percent. Housing expenses include PITI (principal, interest, taxes, and insurance).

It also requires a total debt service ratio of 41 percent. Debts paid in full within nine

months are generally not included, but long-term debts, including installment debts

exceeding nine months to pay in full and all revolving debts are included. Alimony

and child support payments are deducted from monthly gross income before

calculating the qualifying ratio.

The FHA also considers compensating factors, if the ratios are exceeded.

Mortgage Insurance Premium

Current Up-Front Mortgage Insurance Premium

The UPMIP is currently at 1.75% of the base loan amount. This applies regardless of

the amortization term or LTV ratio. There will be no change in Annual Mortgage

Insurance Premiums for all case numbers assigned on or after January 26th, 2015

for the following:

1. On loans with a Loan to Value of less than or equal to 78% and with terms up

to 15 years. The annual MIP for these loans will remain at 45 basis points.

2. On terms <= 15 years and loan amounts <=$625,500 - If the loan to value is

<= 90%, the Annual Premium remains the same at 45 basis points (bps). If

the loan to value is >90%, the Annual Premium remains the same at 70 basis

points (bps).


3. On terms <= 15 years and loan amounts >$625,500 - If the loan to value is

78.01% - 90.00%, the Annual Premium remains the same at 70 basis points

(bps). If the loan to value is >90%, the Annual Premium remains the same at

95 basis points (bps).

There will be the following reduction in premiums in Annual Mortgage Insurance

Premiums for all case numbers assigned on or after January 26th, 2015 for the

following:

1. On terms > 15 years and loan amounts <=$625,500 - If the loan to value is <=

95%, the new Annual Premium is reduced from 130 basis points (bps) to 80

basis points (bps). If the loan to value is >95%, the new Annual Premium is

reduced from 135 basis points (bps) to 85 basis points (bps).

2. On terms > 15 years and loan amounts >$625,500 - If the loan to value is <=

95%, the new Annual Premium is reduced from 150 basis points (bps) to 100

basis points (bps). If the loan to value is >95%, the new Annual Premium is

reduced from 155 basis points (bps) to 105 basis points (bps).

With a $100,000 FHA-insured 30-year loan, the borrower would pay a $1,750 MIP at

closing or financed ($100,000 x 0.0175 = $1,750), plus $79.17 per month ($100,000 x

0.0095 = $950/12 = $79.17).

Underwriting Guidelines

The Housing Authority sets limits on the maximum amount of loans it insures.

Below is a table of the maximum loan amounts for 2015. Loan limits vary county by

county. The figures for the non-high cost area listed below are for Travis County,

Texas.


FHA Maximum Loan Limits

Type of

Property

High Cost

Area

Non-High Cost

Area

Single-family $625,500 $331,200

Duplex 800,775 424,000

Triplex 967,950 512,500

Four-unit dwelling 1,202,925 636,900

The FHA high-cost loan limits for Alaska, Guam, Hawaii, and the Virgin Islands may

be adjusted up to 150 percent of the new ceilings.

Note

FHA loan limits vary depending upon location

of properties.

Down Payment Requirements

One commonly asked FHA loan question involves down payment requirements.

Many people want to know what the FHA loan down payment rules are for a

particular state or zip code.

There's a mistaken impression among some FHA mortgage loan applicants that

FHA rules for down payments vary from state to state, but the truth is that FHA loan

rules require a minimum down payment of 3.5% for new purchase loans.

According to FHA.gov, "Your down payment can be as low as 3.5% of the purchase

price, and most of your closing costs and fees can be included in the loan. Available

on 1-4 unit properties."


One source of the confusion on the down payment issue? Many borrowers find

there are additional factors that affect the amount of the down payment. For

example, those who do not qualify for the most competitive loan terms may not be

able to get the lowest required down payment. Credit issues or other factors may

affect the lender's perception of your credit worthiness. That can affect the terms,

rates and down payment you're qualified for from that particular lender.

Also, participating FHA lenders may also have a higher down payment requirement

based on other issues—the FHA minimum isn't a guarantee that you'll be offered

that by a particular lender.

FHA rules for down payments don't vary from state to state, but the amount of your

down payment could vary depending on individual circumstances. Borrowers

should not expect to be given the same terms or conditions on an FHA loan as a

friend or fellow borrower, and the lender's requirements could vary from loan to

loan for a variety of reasons.

Minimum Investment

In addition to maximum loan limits and the down payment requirements, FHA has

established certain criteria of minimum investment for all insured loans.

Borrowers must have a minimum three percent cash investment in the

property.

That investment cannot consist of discount points (monies paid to buy down

the rate of a loan up front) or pre-paid expenses (items paid in advance at

closing).

The difference of the 2.25 percent down payment requirement and the three

percent investment may consist of some portion of the buyer's allowable

closing costs.


The seller can pay the balance of buyer's closing costs, all prepaids and

discount/origination points up to a maximum contribution of six percent

(three percent if the loan amount is 90 percent or above).

No origination fee (an amount of money, usually one percent of the loan

amount, collected up front to initiate the loan) is required as part of the

closing costs.

Existing credit policies remain intact for those transactions not previously

eligible for high LTV (loan-to-value ratio) financing.

FHA Appraisal

FHA has no requirement for the property to sell at or below the appraised value.

The sale price can be any price agreed upon by the buyer and seller. However,

maximum insurable loan amounts are computed on the FHA appraised value of the

property or sale price, whichever is less, and the difference between actual sale

price and maximum loan amount must be paid in cash by the borrower as a down

payment at closing or the borrower can choose not to buy the home.

An FHA appraisal is usually a little higher than a conventional appraisal, since the

appraiser must be FHA approved and is also given a checklist of items to inspect for

the lender. FHA appraisals are not regular property appraisals, which the purchaser

should still have conducted. FHA accepts VA appraisals with some restrictions,

provided the appraisal is less than 90 days old.

FHA requires a builder's plans meet both state and local building codes in addition

to 17 provisions not found in such codes. The property must also be adjacent to a

publicly maintained street.


Direct Endorsement

Some lenders have the authority to approve FHA loans in-house without submitting

the file to the FHA regional office for prior approval. This will save 10-14 days in

processing time.

Note

Check with each lender on this when applying for more

exact times before filling out final purchase contract so

that sufficient days are negotiated in it to close the

transaction without being in default.

Additional Facts about FHA Loans

An individual may hold more than one FHA loan. If the buyer has sold a

home on which the FHA loan was assumed within the past year, that loan

must be current. If the loan was assumed, it must be current and the buyer

must be an owner-occupant OR the loan must be reduced to 75 percent of

the maximum loan available to the owner-occupant under 203b, according to

a new appraisal.

Do not specify non-realty items on the contract; use a separate agreement. If

they are specified on the contract, FHA will assign a value to each item and

reduce the appraised value of the property accordingly. (Note to agent: if a

Non-Realty Items Addendum is part of the contract, do NOT submit it with

the loan application. This reduces any confusion by the lender and is a legally

binding document on its own.)

Qualifying assumption of FHA loans (non-qualifying before 1986) allow for a

release of liability of seller if:

The buyer assuming the loan is pre-approved by the lender.


The transaction has been consummated to the then applicable FHA

standards.

Escrow of taxes and insurance is required by FHA.

Discount points may be charged, payable by either the buyer or seller.

FHA requires a larger down payment than a VA loan, which requires none.

Anyone of legal age and otherwise legally capable of owning property, may

obtain a FHA loan. The borrower does not need to be a citizen of the U.S.

(green card sufficient).

Any gift does not have to come from an immediate family member, although

no direct business relationship with the borrower can exist.

Programs

There are 14 major FHA programs under the National Housing Act. These include:

Name of Program Area of coverage/Loan available for

Title I Home improvements

Title 11 (Section

202)

Rental or cooperative housing for the elderly

or handicapped

Section 203(b) Fixed interest rate loans for single-family

owner-occupied homes

Section 203(k) Rehabilitation loans for existing homes and

refinancing existing debt

Section 203(v) Eligible veterans

Section 221(d)(2) Low-income to moderate-income families

Section 221(d)(3) Commercial projects for multifamily rental

housing for moderate-income families

Section 221(d)(4) Commercial projects with 90 percent loans for

rental housing for moderate-income families

Section 223(e) Declining neighborhoods where normal

underwriting requirements cannot be met


Section 223(f) Purchase or refinancing of existing apartment

buildings, which are at least three years old

Section 231 Construction or rehabilitation of homes for

the elderly or handicapped

Section 234 Construction or rehabilitation of apartment

projects that are to be sold as individual

condominium units

Section 245 Graduated-payment loans

Section 251 Adjustable-rate loans

Advantages and Disadvantages

Advantages of FHA Loans

FHA loans have several advantages over conventional loans. They typically have a

lower down payment and there is never a pre-payment penalty charged for making

loan payments earlier than they are due. FHA loans can be assumed by other

borrowers; however, since 1986, the assumptor has had to go through the same

underwriting process—verifying debts and income, etc.—as the original borrower

to prove his or her creditworthiness. Sellers can be held liable for a FHA loan if the

person to whom they have sold the house assumes the loan without a test of

creditworthiness. Another important advantage of FHA loans is that mortgages can

be made on a graduated payment schedule, with low monthly payments that

increase over time.

Disadvantages of FHA Loans

FHA loans also have several disadvantages when compared to conventional loans.

First, processing an FHA loan takes between 15 and 30 days longer than processing

a conventional loan. Second, there is a maximum loan amount on FHA loans and

this can be limiting.


For example, in 2002, in certain areas, the maximum loan amount was $101,500

plus MIP. Third, the mortgage insurance premiums must either be paid up front at

closing or be financed. Finally, the FHA loan program does not insure loans to

investors, only to homeowners.

Practice

To determine principal and interest payments, it is best to use a mortgage loan

calculator like the one found here.

As an example let us calculate a mortgage loan of $1,000 at 10 percent interest over

15 years.

Using the calculator at the above link, we find that the monthly payment will be

$10.75 and a chart is also provided that shows the monthly breakdown of principal

vs. interest payments.

So, let us see if the applicant qualifies for the FHA loan using the following

information:

Sale Price $82,000

Interest Rate 6.00%

Terms 15-year loan

Gross Monthly Income $3,850 combined

Long Term Debts $75

Child Care $150

Taxes $155

Insurance $30

http://www.webmath.com/amort.html

http://www.webmath.com/cgi-bin/amort.cgi?amount=1000&years=15&period=12&rate=10&extra=0


FHA Qualifying Worksheet

The total loan amount is calculated by subtracting the down payment from the

sales price. Since the sales price is in excess of $50,000, the down payment must be

at least 3.5% of the sales price.

The qualifying loan amount is calculated by adding the MIP to the loan amount.

(Remember, with a $100,000 FHA-insured 15-year loan, the borrower would pay a

$1,750 MIP at closing ($100,000 x 0.0175 = $1,750), plus $58.33 per month

($100,000 x 0.0070 = $700/12 = $58.33). Bearing this in mind—and using the chart

—complete the following worksheet.

Part 1

Sale Price $______ – Down Payment $_______ = Loan Amount $ ________

Loan Amount $_______ + MIP (1.5%) $________ = Loan Amount for Qualifying

$__________

Gross Monthly Income = $__________ (A)

Sale Price $82,000.00 – Down Payment $2,870.00 = Loan Amount $79,130.00.00

Loan Amount $79,130.00 + MIP (1.75%) $1,384.78 =

Loan Amount for Qualifying $80,514.78


Part 2

Using what we know (remembering the mortgage calculator and that the annual

MIP renewal premium is .95 percent for any loan longer than 15 years, and .70

percent for 15 years or less with 10 percent or less down), and the first chart, fill in

the following information in the spaces provided.

Gross Monthly Income = $___________ (A)

Monthly Housing

Expenses:

Principal and Interest (PI) $

Taxes (T) +

Hazard Insurance (I) +

Monthly MIP +

Total Housing Expenses $_______(B)

Housing Expense to Income Ratio:

B / A = ____% (should not exceed 29%)

Gross Monthly Income = $3,850.00 (A)

Monthly Housing Expenses:

Principal and Interest (PI) $ 679.85 (15 years)

Taxes (T) +155.00

Hazard Insurance (I) + 30.00

Monthly MIP (.70% x

$79,130) +46.16

Total Housing Expenses $911.01_(B)



Housing Expense to Income Ratio:

B / A = 28% (should not exceed 29%)

Part 3

Using what we know (remembering the mortgage calculator and that the annual

MIP renewal premium is .5 percent for any loan longer than 15 years, and .25

percent for 15 years or less with 10 percent or less down), and the first chart, fill in

the following information in the spaces provided.

Total Housing Expenses $________ (B)

Child Care +

Long Term Debts +

Total Living Expense $_______(C)

Total Debt Service Ratio:

C / A = ____% (should not exceed 41%)

Total Housing Expenses $ 911.01 (B)

Child Care +150.00

Long Term Debts + 75.00

Total Living Expense $1,136.01_ (C)

Total Debt Service Ratio:

C / A = 34% (should not exceed 41%)



Solution

Here is the step-by-step solution to the problem:

The sale price of the property in question is in excess of $50,000. Therefore, the

down payment must be at least 3.50% of its amount:

$82,000 x 3.5% = $2,870

The loan amount can be calculated by subtracting the down payment from the

sales price:

$82,000 - $2,870 = $79,130

Now, the upfront mortgage premium can be calculated by multiplying the required

percentage of down payment, 1.5%, by the loan amount.

1.75% x $79,130.00 = $1,384.78 Mortgage Premium

The total loan amount for qualifying will then be:

$79,130 + $1,384.78 = $80,514.78

Using a mortgage calculator then, monthly principal and interest payments will be:

$679.85 / month

To fill out the required table, we just recopy the tax and insurance figures from the

applicant’s expense chart. The monthly MIP charge at .70% per year is ($79,130.00 x

0.0070) / 12 months = $46.16 / month.


The total housing expense then is the sum of all dollar amounts in the right column:

Monthly Housing

Expenses:

Principle and Interest (PI) $679.85

Taxes (T) +155

Hazard Insurance (I) +30

Monthly MIP +46.16

Total Housing Expenses $911.01 (B)

Remembering that gross monthly income is $3,850 (A), we find the housing

expense to income ratio by dividing (B) by (A).

Therefore, the housing expense to income ratio equals $911.01 / $3,850 = 0.23663,

or 23.66%.

Using the same equation, and adding in other expenses, we determine the total

debt service ratio similarly:

Total Housing Expenses $911.01 (B)

Child Care + 150

Long Term Debts + 75

Total Living Expense $1,136.01 (C)

The total debt service ratio is calculated by dividing the total living expense (C) by

gross monthly income (A): $911.01/ $3,850 = 0.29507, or 29.51%.


Recalling that the total housing expense to income ratio should not exceed 29%,

and that the total debt service ratio should not exceed 41%, our numbers of 27.95%

and 33.79% respectively indicate that this borrower would be eligible for an FHA

loan.

Lesson Summary

FHA loans are loans insured by the Federal Housing Authority, which Congress

created as part of the U.S. Department of Housing and Urban Development. The

FHA program was designed to encourage homeownership and anyone who is a U.S.

citizen or holds a valid green card can apply. The cost of the insured loan is the

Mortgage Insurance Premium: 1.5 percent of the loan amount up-front and an

additional 0.5 percent or 0.25 percent annual payment for 30- and 15-year terms

respectively. The FHA sets certain limits on the loans it insures, including stipulating

a maximum loan limit, down payment, and minimum investment requirements and

income qualifications for borrowers. Borrowers must have a three percent total

investment and may not have a housing expense to income ratio exceeding 29

percent or a total debt service ratio exceeding 41 percent.


Lesson 4: VA Loans

Lesson Topics


Introduction

VA Loan Entitlements

VA Eligibility Requirements

Use of Veterans Entitlement

Assuming VA Loans

Closing Costs

Certificate of Reasonable Value

Qualifying the Buyer

Practice




Distinguish the advantages and disadvantages of VA loans.

Explain the VA Funding Fee.

Identify VA eligibility and qualification periods.

Calculate the amount of VA entitlement used.

Calculate VA loan amounts and required down payments.

Introduction

VA loans constitute a federally regulated program administered by the Veterans

Administration to assist eligible military personnel in obtaining home loans with the

interest rate set by VA and no down payment required (in most cases). VA loans are

only available to eligible veterans and a select group of others. Unlike other loans,

VA loans are guaranteed loans and, therefore, viewed as less risky by lenders since

they have a risk partner: the federal government. These loans may be made for

owner-occupied purchases only, and at the time of closing, the buyer must sign a

statement attesting that he or she intends to live on the property.

VA loans vary greatly from both conventional and FHA insured loans. This lesson

will outline how VA loans differ, how guaranteed amounts are determined, and how

entitlement is established. In addition, this lesson will touch on the Veteran's

Benefits Improvement Act and explain how it affects VA entitlement.





loan programs.


VA Loan Entitlements

There is no VA limit on the amount of the loan a veteran can obtain; the lender

determines this. However, the VA does set a limit on the amount of the loan it will

guarantee. The VA also sets guidelines to be adhered to by the borrower to ensure

lenders are making prudent loans, and it may refuse to guarantee loans issued by

certain lenders who have previously failed to meet any VA requirements.

The VA guarantees the lender against loss, but the maximum amount of the

guarantee changes every few years to keep up with home prices. The basic

entitlement guarantees loans up to $417,000. In general, a lender will lend up to

four times the veteran’s eligibility. Therefore, if the veteran qualifies, she or he may

borrow up to four times $417,000 under the current VA guidelines.

The VA does not insure loans like FHA, and there is no mortgage insurance

premium charged to the veteran for a VA loan; however, the veteran does pay a

one-time up-front funding fee as the cost of receiving the guaranteed loan.

The concept of the VA program is to guarantee a portion of the loan against loss by

the veteran purchaser's default on payments in a similar fashion of the FHA

program. In the event of a loss on a transaction by the lender, after the loan has

been foreclosed and the property sold at auction, the Veteran's Administration will

make-up the loss suffered by the lender up to its applicable guarantee limit, which

is normally sufficient.

As another benefit of this program, the seller is allowed to pay all of the buyer-

veteran's settlement charges, including the prepaid items to establish the escrow

account. Since October 27, 1995, however, veterans have been able to pay their

own points, but these points may not be financed in the loan as with some other

types of loans.


When lending no more than four times a borrower’s eligibility, the lender is never

more than 75 percent LTV at risk on a VA loan. The underwriting guidelines on

these loans are, in turn, also less stringent than on conventional loans. There is only

one qualifying ratio for housing expense and total long term debt, which is 41

percent of gross income.

VA Eligibility Requirements

The eligibility requirements for VA loans are many and detailed. We will only be

concerned with an overview of these requirements. The full, detailed list is provided

here.

Overview

Veterans who served during World War II, the Korean War, Vietnam, Gulf War, or

peacetime efforts following these wars are eligible for VA loans, if they have either

of the following:

90 days of wartime service.

181 days of continuous peacetime service.

In both instances, the veteran must have been discharged under other than

“dishonorable” conditions. If a veteran’s service time was cut short by an injury or

for some other reason out of her or his control, such as an “involuntary reduction in

force,” then he or she may still be eligible.

Certain other persons who are not wartime veterans can also be eligible for VA

guaranteed loans. Selected Reservists or National Guard members who have

served at least six years are eligible, as well as the spouses of veterans killed or

missing in action or prisoners of war. In addition, U.S. citizens who served in the

armed forces of a government allied with the U.S. in World War II may also be

eligible.

http://www.military.com/Finance/Content?file=Home_Loans_Eligibility.htm&area=Content


VA stipulations allow several veterans to purchase one- to four-family unit homes

together, even if they are not married or related, provided they intend to occupy

the property. However, a veteran and a non-veteran or a veteran and a non-

veteran, unmarried partner cannot be co-borrowers on a loan. On the other hand,

an exceptionally well qualified non-veteran may be a co-signer for a veteran, but

the non-veteran would not hold any title to the property. Naturally, the non-veteran

co-signer would have liability for the repayment of the loan.

Certificates of Eligibility

The Veterans Administration issues and updates Certificates of Eligibility. These

certificates establish a veteran’s eligibility in writing and can be obtained with the

following forms:

DD-214 (discharge form)

VA Form 26-1880 (application form)

DD-13 (statement of service if veteran is still on active duty)

DD-1747 (unavailability of base housing)

Use of Veterans Entitlement

VA Guaranty History

Since its inception, the loan guaranty amount has been raised from time to time by

Congress from its original amount of $2,000 to its current amount of $417,000.00.

Calculating Amount of Entitlement

There are two methods for calculating the amount of eligibility used by the veteran

in a transaction. The reason this is important is because if the veteran has

remaining entitlement, she or he can obtain another VA loan while retaining

ownership of his or her present original property or with the original VA loan still in

effect.


The 60 Percent Rule

The amount of the eligibility used is 60 percent of the loan amount or the total

eligibility available, whichever is less. This method was utilized for all loans

originating before 01/31/88.

Sliding Scale

This method is used for all loans originating after 01/31/88.

Loan Amount Guarantee Used

$44,999 OR LESS 50% of the loan amount

$45,000 - $56,250 $22,500

$56,251 - $144,000 40% of the loan amount to a maximum of $36,000

$144,000 and above 25% of the loan amount to a maximum of $359,650

When calculating partial entitlement under either of these methods, use the

$36,000 entitlement figure instead of the $359,650 entitlement figure if the

resulting loan amount will be under $144,000.

Re-using Entitlement

Once a veteran uses his or her entitlement, it cannot be reused until:

The original loan is paid off in full.

The VA is notified of the fact that it has been paid off by the original lender.

The house is disposed of (no longer owned by the veteran).

There is an exception to this, however. The Veteran's Benefit Improvements Act of

1994, signed in November by President Clinton, changed a number of veteran

programs and benefits. In addition to recognizing and offering medical assistance

for the previously “un-diagnosable” Gulf War Syndrome, it also allows veterans a

one-time exception to the “disposal of original house” rule.


If a veteran pays off her or his original loan in full and the original lender of the

note acknowledges the full payment, then the veteran may gain VA entitlement

once again without disposing of his or her home. This is true for one time only.

In addition to re-gaining entitlement, veterans may substitute entitlement when

assuming an existing VA loan. To substitute entitlement, the purchaser must meet

the following qualifications:

Be a veteran

Have at least as much entitlement as the original mortgagor

Agree in writing to substitute her or his entitlement

Qualify for the assumption

Assuming VA Loans

Anyone, veteran or non-veteran, may assume a VA loan. There is no limit to the

number of VA loans an individual may assume. VA loans originated prior to

03/01/88 are fully assumable with no qualifying and no change in terms. VA loans

originated after 03/01/88 are assumable only with a full qualification process on the

borrower. There is still no change in the terms of the loan. This provision holds true

for the life of the loan. The borrower assuming these loans closed after this date

also assumes the obligation of the veteran to the VA.

A 0.5 percent funding fee will be charged on all assumptions of VA loans originated

after 03/01/88. Up to a $500 lender's processing fee will also be charged. The

person assuming the loan may be either an owner occupant or an investor.


Closing Costs

The VA sets limits on the allowable costs at closing. The “no prepayment penalty”

provision applies to all VA loans.

The seller may pay any or the entire veteran’s closing costs, including the loan

origination fee. However, VA now puts a four percent limit on any seller

contribution.

Normal discount points and closing costs, which are customarily paid by the seller,

or closing costs equally likely to be paid be either buyer or seller, will not be

considered as a concession for purposes of determining if the total concessions are

within the established limit.

VA Allowable Closing Costs

Discount points can be paid by either the buyer or the seller.

Origination fee is to be one percent of the loan amount.

Credit report fee is to be the actual charge.

Appraisal fee is $275 plus mileage the appraiser travels to the property.

Survey fee is to be the actual charge.

Recording fees are to be the actual charges.

Mortgagee’s title policy is $70 (versus $125 for conventional).

VA funding fee.

Tax and insurance escrow is the amount required by lender.

Should any amounts exceed these, the overage(s) must be paid by the seller and

not the buyer.


The Funding Fee

The funding fee is the cost of receiving a VA guarantee. It takes the place of the

Mortgage Insurance Premium in FHA loans. As of 10/01/2004, the VA funding fee is

a graduated schedule based on the amount of the borrower's down payment (DP)

and type of military service:

Regular Military

First Time Loan Use Subsequent Loan Use

2.15% = Funding Fee with < 5% DP 3.3% = Funding Fee with < 5% DP

1.50% = Funding Fee with 5 – 10% DP 1.5% = Funding Fee with 5 – 10% DP

1.25% = Funding Fee with > 10% DP 1.25% = Funding Fee with > 10% DP

Reserves/National Guard

First Time Loan Use Subsequent Loan Use

2.4% = Funding Fee with < 5% DP 3.3% = Funding Fee with < 5% DP

1.75% = Funding Fee with 5 – 10% DP 1.75% = Funding Fee with 5 – 10% DP

1.5% = Funding Fee with > 10% DP 1.5% = Funding Fee with > 10% DP

Required Down Payments

There is no required down payment on VA loans, provided the sale price and the VA

appraisal (known as the Certified Reasonable Value) amounts are equal and the

veteran has full entitlement.

If the appraisal is lower than the sale price, the veteran must pay the difference

between the appraisal value and the contract price as a down payment. Provided

the appraisal value (CRV) is equal to or greater than the agreed contract price, the

veteran may borrow the funds for the down payment, as long as he or she qualifies

for both payments. Gifts for down payment or closing costs are acceptable if

obtained from relatives or from someone with a close, personal relationship. A gift

letter and verification of the donor's ability to make the gift is required.


Certificate of Reasonable Value

A VA Certificate of Reasonable Value includes an appraised value of the home and

an expiration date after which the Certificate is no longer usable. Loans on property

less than one year old may be made only if that property meets VA standards for

construction and general acceptability. Also, builders of new homes must furnish

veterans with certain construction warranties before the VA will guarantee a loan.

The VA has established certain property requirements, which the appraiser will

evaluate to determine if a loan can be VA guaranteed. Properties considered must:

Be structurally sound.

Not be in close proximity to hazardous or noxious influences.

Have adequate public or on-site individual utilities (water well and septic

systems are acceptable when inspected by the County Health Department).

Not be engulfed by commercial or industrial properties.

Have a required termite inspection performed.

Be located on a publicly maintained road.

Be clear of any contingencies.

The Veterans Administration may refuse to appraise properties built by certain

builders who have previously failed to meet VA standards.

Qualifying the Buyer

A VA Loan Qualifying Worksheet is included for you here.


The VA uses one ratio to qualify buyers: a debt-to-income ratio of 41 percent. It will

also consider residual income and compensating factors for ratios over 41 percent.

Practice

Use the chart below to determine whether or not this veteran meets the VA debt

service ratio requirement to receive a guaranteed loan. To do this, you will need to

use the amortization calculator that was used in the previous lesson, found here.

Sale Price $79,900

Taxes $105

Insurance $30

Interest rate 10.5%

Term 30 years

Gross monthly income $3,200 (A)

Long-term debts $320

Using the previous chart, determine whether this veteran meets the VA debt service

ratio requirement to receive a guaranteed loan. Do not forget the amortization

calculator that was used in the previous lesson, found here.

VA Qualifying Worksheet

Combined Gross Monthly Income = $__________ (A)

Expenses:

Principle and Interest (PI) $

Taxes (T) +

Hazard Insurance (I) +

Long Term Debts +

Total Expenses $_______(B)




B / A = ____% (not to be in excess of 41%)

Solution

Using the amortization calculator we find that the amount and term of the loan

results in a monthly payment of $730.88. To see the calculations and amortization

chart.

Now, using the information given in the first chart we can complete the VA

qualifying worksheet.

Expenses:

Principal and Interest (PI) $730.88

Taxes (T) +105.00

Hazard Insurance (I) + 30.00

Long Term Debts +320.00

Total Expenses $1185.88 (B)

You can now calculate the total debt service ratio by dividing the borrower’s total

expenses (B) by gross monthly income (A):

$1,185.88 / $3200.00 = .3705 or 37.05%

This percentage, less than the required 41%, shows that this buyer would be

qualified for a VA loan.


http://www.webmath.com/cgi-bin/amort.cgi?amount=79900&years=30&period=12&rate=10.5&extra=0.


Lesson Summary

VA loans are loans guaranteed by the Veterans Administration and the federal

government. They are only for veterans of foreign wars, current servicemen, and

women and a select group of others, and they are only for owner-occupied one-to-

four family properties. The VA reimburses lenders for loss up to $60,000 in the

event of default by a VA borrower. The cost of this guarantee is a one-time funding

fee, which varies inversely as a function of the borrower’s down payment. The VA

sets limits on the allowable closing costs and requires that sellers pay the amount

of any overages at closing. It also requires that properties be appraised by the VA

and receive a Certificate of Reasonable Value. Any amount of the sale price of a

property that exceeds the appraisal value must be paid as a down payment. VA

loans are fully assumable but only by purchasers who also meet the eligibility

requirements of the Administration.


Lesson 5: The Basics of Real Estate Financing & Real

Estate Practice

Lesson Topics


Introduction

Loan Payment Plans

Additional Loan Payment Plans

Closing Real Estate Loans

Closing Costs

Real Estate Practice Problems

Case Studies




Follow the process and qualifications for assuming VA and FHA loans.

Name the other types of loans available.

Explain the components of an adjustable rate mortgage (ARM).

Explain the advantages and disadvantages of ARM loans.

Explain the processes involved in closing loans.

Apply this knowledge to underwrite and close loans.

Assist the consumer in working with the lender.

Provide the consumer the real estate agent’s perspective in evaluating

financing options.

Perform basic financing calculations for the consumer.

Ensure that the consumer will make a fully-informed decision on the

financing option she chooses.

Introduction

In the past three lessons we covered the three most common types of loans: FHA

loans, VA loans, and conventional loans, and who may receive such loans. While

these are the three most common types, they are not the only types. It is important

that real estate professionals are familiar with the other, less common types of

loans as well so that they can assist their clients in the best possible way.

This lesson will cover those types of financing that we have not yet touched upon.

In addition, it will place the previously covered loans as well as these new loans in

context to help the student formulate a “big picture” of the real estate finance. In

particular, this lesson will go over payment plans, discuss how real estate loans are

finally closed, and explain the costs and finance activities associated with closing a

property sale.


This module has covered many specifics over a relatively short period of time. To

ensure a comprehensive understanding of the material, we have integrated the

information provided in the module into a series of questions and case studies.

The next part of this lesson presents several comprehensive questions and

dilemmas. Please consider your response and then circle the answer choice that

seems best to you. Then read the corresponding feedback for whichever answer

you opted. The second half presents brief case studies illustrating the principles

and ideas presented in this module.





loan programs.

Loan Payment Plans

There are many different loan payment plans available in today's complex

mortgage market. This lesson will expose the real estate practitioners to various

alternatives that they can offer a borrower. Knowing these could be the difference

in making or not making a sale because financing is key to a successful transaction.

For each plan, the advantages and disadvantages will be discussed, as well as any

other special details or features.

We will first discuss the following types of loan payment plans and their

requirements:

Conventional Fixed Rate Mortgage

FHA Insured Mortgage

VA Guaranteed Mortgage

Adjustable Rate Mortgage (ARM)


Graduated Payment Mortgage (GPM)

Growth Equity Mortgage (GEM)

Permanent Buydown

Temporary Buydown

Conventional Fixed Rate Mortgage

The primary advantage of a conventional fixed rate mortgage is the stability of the

monthly payment. The main disadvantage is that the borrower will not be able to

take advantage of a drop in interest rates without refinancing. Consider the

following graphs:

From HSH Associates, Financial Publishers

FHA Insured Mortgage

FHA's mortgage insurance programs help low- and moderate-income families

become homeowners by lowering some of the costs of their mortgage loans. The

main advantage of an FHA loan is that it requires lower down payments than

conventional loans. The disadvantages include the expense of the mortgage

insurance premium paid by the borrower and the low limits on the loan amount.

http://library.hsh.com/?row_id=92


VA Guaranteed Mortgage

Since VA loans are guaranteed, there is no insurance fee. There is also usually no

down payment required. However, the major disadvantage is that these loans are

limited to veterans only. Furthermore, the borrower must pay a funding fee to

receive the guarantee and the guarantee is only partial, affectively limiting the

amount of a loan a veteran can usually take, although there are no legal limits.

Adjustable Rate Mortgage (ARM)

This loan is specifically tied to an economic indicator outside of the lender’s control.

It is customary for lenders to make mortgage and deed of trust loans at an interest

rate which remains constant over the life of the loan; however, in recent years

adjustable-rate loans have become increasingly popular among lenders.

Adjustable-rate mortgages (ARMs) are amortized loans where the interest rate

changes or “adjusts” at pre-determined periods, usually annually. Because the

interest on a mortgagor's loan may fluctuate up or down during the loan term in

relation to some agreed upon economic indicator, the mortgagor's loan payments

fluctuate as well. The amount of interest-rate adjustment is governed by the

movement of some government index, such as Treasury notes or bills.

Furthermore, the amount and frequency of adjustment are limited by the terms of

the note itself. All of these factors can be either favorable or unfavorable for the

borrower, depending on where the market goes.

All adjustable rate mortgages have four basic features.

1. Initial Interest Rate

2. Adjustment Interval

3. Index

4. Margin


Initial Interest Rate

This is the beginning rate on the ARM. It will stay the same until it is adjusted either

up or down on the adjustment date specified in the mortgage. The initial rate

usually is lower than the interest rate being charged for a long-term, fixed-rate

mortgage.

Adjustment Interval

This is the period of time between changes in either the interest rate and/or the

monthly payment. The interest rate on most ARMs may change after one, three, or

five years, although other adjustment intervals may be negotiated with the lender.

Index

The index is a published measure of interest rates on certain types of investments.

For example, the interest the government pays on bonds. An index for an ARM is

always based on external, economic factors that the lender does not control. Thus

the rate of an ARM increases or decreases independent of either the lender or

borrower’s desires or intentions.

Margin

This is an additional amount the lender adds to the index to account for business

expenses. This amount usually remains the same throughout the life of the loan.

The index is added to the margin every adjustment period. For example, if the

index is five percent at one adjustment period and the margin two percent, then

the interest rate on the loan for that period is seven percent.


Are ARMs a Good or a Bad Choice for Borrowers?

Whether ARMs are a good or bad choice generally depends on the borrower’s

financial situation. ARMs can be a good choice for financing a home under certain

conditions, such as:

1. Rising income expectations: If the purchaser expects his or her income to

increase each year and does not expect to accumulate extraordinary debts,

then she or he is a good candidate for an ARM.

2. High interest rates: When interest rates rise, they threaten to squeeze

potential homebuyers out of the housing market because fewer people can

qualify for a loan at the higher rates. ARMs have beginning interest rates

typically as much as one to three percentage points below those of fixed-rate

mortgages. Many lenders will make loans to homebuyers by qualifying them

with the lower initial interest rates available on ARMs, even though the same

borrowers could not qualify at the higher interest rates on a fixed-rate

mortgage.

3. Short-term homeownership: If a borrower expects to move within a relatively

short time because of a temporary job assignment or a transfer, an ARM

makes sense because the borrower gains the advantages of homeownership

with a lower interest rate and lower monthly payments. This is especially

important in such a situation because the build-up of home equity will

probably be minimal and minimizing cash outlay helps make up for this; the

borrower will not have to pay a disproportionate amount of interest on a

home he or she does not own.

The following questionnaire will help give you a clearer picture of what is involved

with an ARM.


Adjustable Rate Mortgage (ARM) Lender Questionnaire

What index are you currently using?

Can the index change during the loan term?

What is the margin?

Does your margin change during the life of the loan?

Does index plus margin equal rate every year of the loan?

Is there a prepayment penalty assessed for early payments?

What is the penalty and how long is it imposed?

What are the interest rate caps, i.e., the maximum allowed interest rate?

Per Adjustment Period?

Over the life of the loan?

What is the interest rate adjustment period?

Are there any payment caps, i.e., limits on the amount of payments?

Per Adjustment Period?

Over the life of the loan?

What is the payment adjustment period?

Is there a possibility of negative amortization?

Is there a negative amortization cap?

Does this loan contain a conversion option, allowing the borrower to switch

over to a fixed-rate loan?

When can the borrower exercise this conversion option?

Are there any cash costs to the borrower at the time of the conversion?

What interest rate will the borrower get at the time of the conversion?


Another skill the real estate practitioner will want to develop is being able to show a

borrower a worst case scenario. In the case of recommending whether or not a

buyer should consider an ARM, there are two ways to demonstrate the

disadvantages of an ARM:

In the form of unfavorable interest rate fluctuations

In the form of payment fluctuations

Interest rate is the simplest and easiest for most people to understand.

Example:

For a loan amount of $100,000 upon which there would be a fixed interest rate of

10% for 30 years, an ARM of 6% with adjustment caps of 2 points annually or 6

points over the life of the loan would appear, at first glance, to be advantageous.

However, should the index fluctuate as follows, the ARM would prove to have not

been a wise choice:

Pmt Year Fixed Interest ARM Index Interest +/-

1 10 6 +4

2 10 8 +2

3 10 10 0

4 10 12 -2

5 10 12 -2

6 10 12 -2

The Advantages of an ARM

1. Low initial payments

2. The borrower is most often qualified on the basis of the lower initial

payments


Disadvantages of an ARM

1. The potential of negative amortization

2. The potentially higher payments in the future

Alternatives to an ARM

The following alternatives to an adjustable rate mortgage will be discussed in the

following sections:

Temporary buydown

Permanent buydown

Equity participation mortgages

Graduated Payment Mortgage (GPM)

These loans are not readily available in today's mortgage market; however, a

salesperson needs to be aware of their existence when attempting to list a property

for sale. These loans were designed to negatively amortize and are sometimes

referred to as negative amortization loans. The initial payments are not high

enough to pay even the interest due on the loan. The payments increase (graduate)

over the next five years until they level off at a sufficient amount that fully

amortizes the loan over the remaining term of the loan period.

Advantages of a GPM

The borrower qualifies on the basis of the lower initial payments, resulting in more

potential qualifying purchasers.

Disadvantages of a GPM

The principal balance due on the loan increases instead of decreases in the first few

years, so resale during this period could result in a loss to the seller. And, the

increased payments may become impossible for the borrower to continue making

since the rise can be substantial.


Growth Equity Mortgage (GEM)

These loans take on many different forms in today's competitive financial arena.

The interest rate on these loans is fixed and available at an average of one full

percent below the 30-year fixed mortgage rate in any given market.

The payment increases annually by a pre-determined amount with all of the

increase being applied to principal reduction. This causes a GEM loan to be paid off

in an average of 12 to 17 years, depending on the amount of increase of the

payments, which are typically 3 percent, 5 percent, or 7.5 percent per year.

Advantages of a GEM Loan

A GEM is much like a fixed-rate loan that the borrower self-accelerates, but with

two differences: there is never a pre-payment penalty (as GEM “prepayments” are

just the regular, increased monthly payments) and the structure of the loan makes

acceleration mandatory, rather than optional. It also has the following benefits:

1. Lower initial interest rate

2. Simplicity of the loan

3. Known/predictable payments

4. Equity builds up quickly

5. Reduced interest costs

6. No chance of negative amortization

Disadvantages of a GEM Loan

The monthly payment increases over time. The borrower must determine up front

if she or he will be able to make the payments as they increase over the years.


Permanent Buydown

Another name for a permanent buydown is simply discount point, or sometimes

just point. Points are what lenders charge borrowers for providing a loan. Because

a lender will want to charge more for making higher loans and because when a

potential borrower first approaches a lender the exact amount of the potential loan

is unknown, lenders express their loan charges in percentages—that is, points—

rather than absolute dollar figures. One point is one percent of a loan amount. For

example, if a loan amount is $100,000, then a discount point would be $1,000.

When a potential borrower first approaches a lender, he or she will be told upfront

the amount of discount points that a lender charges.

There are two different perspectives that a professional real estate person should

be familiar with when it comes to discount points. There is the cash at closing side,

with which most brokers are already familiar, as well as the increased yield to the

investor side of discount points.

If a broker is familiar with the yield side of points, then the broker is better able to

negotiate transactions for buyers and sellers than his or her competition.

Since we are most often working with 30-year loans, the rule of thumb we are

dealing with is most often called the Rule of Eights: eight points increases the

investor’s yield by one percent.

In other words, for every point the lender charges, she or he is increasing his or her

profit by one-eighth of a percent of the loan. If the lender were to charge four

points, then, the yield would be increased by four-eighths or one-half of a percent.


Temporary Buydown

These loans are an alternative to the adjustable rate mortgage and/or graduated

payment mortgage. They provide the borrower with the temporary help she or he

needs without any chance of negative amortization and with a predictable payment

structure. The disadvantage is that there is a higher loan fee for this type of loan.

Under a buydown plan the subsidizing party—the borrower, seller, builder, etc.—

establishes a buydown fund, which is collected in cash at closing. The required

portion of the payment every payment period is paid from the buydown fund. The

borrower then makes payments at the bought down effective rate, which are lower

than at the actual lending rate. When the temporary buydown period is over, the

lending rate returns to normal.

The lender is collecting a level payment for the entire term of the loan, and any

amortization schedule should be calculated as such. To the lender, this is a level

payment fixed rate loan. To the borrower, however, this is a stair step or graduated

payment loan.

A typical 3-2-1 temporary buydown would be calculated as follows:

Note

Rate

Buydown

% Eff Rate

Pmt @ Note

Rate Pmt @ Eff Rate

Mo

Subs Ann Subs

10 3 7 877.57 665.30 212.27 2547

10 2 8 877.57 733.76 143.81 1726

10 1 9 877.57 804.62 72.95 875

10 -0- 10 877.57 877.57 -0- -0-

Total 5148


Here, the effective rate is the difference between the note rate and the buydown

percentage, and the monthly subsidy required is the difference between the

payment that would be collected at the note rate and the payment actually

collected at the effective rate. To establish the above buydown at three graduated

steps over three years would take a buydown fund of $5,148, the total amount of

subsidy required to be paid out over the years.

Advantages of a Temporary Buydown

Low initial payments.

The borrower is most often qualified on the basis of the lower initial

payments.

Disadvantages of a Temporary Buydown

Buydown plans are typically expensive and require a large payment at

closing.

A buydown is only temporary, and the borrower will have increased monthly

payments that may be difficult to afford.

Additional Loan Payment Plans

The following scenes will outline additional loan payment plans, including:

FHA 203K Property Rehabilitation Program

Equity Participation Mortgage

Seller Financing

Blanket Mortgage

Open-End Mortgage

Construction Loan

Reverse Annuity Mortgage

Wraparound Mortgage

Purchase Money Mortgage

Sale-Leaseback


As with any real estate transaction, the real estate licensee should advise both the

buyer and seller to seek legal counsel for guidance.

FHA 203K Property Rehabilitation Program

A government loan designed to preserve the nation's existing housing stock by

facilitating renovation and restoration. It features down payments of as little as

three percent and can involve loan amounts up to 110 percent of the home's after-

improved value.

Equity Participation Mortgage

An equity participation mortgage is a mortgage loan wherein the lender has a

partial equity interest in the property or receives a portion of the income from the

property during ownership (if an income producing property).

Seller Financing

This occurs when the seller of the real estate provides financing for the sale by

taking back a secured note in the form of a mortgage, land contract, or deed of

trust. Although risky for the seller, this also allows the seller to make the interest

income that the lender would normally make. A real estate sales professional

should advise BOTH the buyer and seller to seek legal counsel before agreeing to

this type of financing arrangement because terms can be added that can be

detrimental to one or the other party.

Blanket Mortgage

A blanket mortgage is a mortgage on more than one property. When getting a

blanket mortgage, it is important to ensure the agreement includes a release clause

that permits one or more of the properties to be released from the obligation of

the mortgage upon repayment of a determined amount of the mortgage balance.

This type of loan is commonly used for subdivision developers who need a loan

covering the whole subdivision with releases as each lot is sold.


Open-End Mortgage

Open-end mortgages are called ‘open-end’ because they allow the mortgagor to

borrow additional funds at a later date on top of the original loan amount. This is

useful, for example, to a new homebuyer who wishes to buy furniture or a washer

and dryer, etc., after the home purchase. Thus, the borrower may receive more

money without the necessity of refinancing. To pay off the new debts incurred, the

monthly payment or the loan term (sometimes both) will be increased, often with a

concurrent change in the interest rate. One important type of open-end mortgage

is the construction mortgage.

Construction Loan

Also known as interim financing, this loan is used by lenders for the purpose of

financing new construction or for renovating existing improvements. A long-term

mortgage requires the home to already be constructed before it can be used as

security. The borrower typically would get approved for a long-term mortgage first,

and then a bank will agree, based on a loan take out letter of guarantee from the

long-term mortgage lender, to lend up to that amount on a construction loan.

A construction loan is designed to be short-term (six months to two years) in

nature, with the funds advanced in stages as construction occurs. Repayment of

this loan is usually made from the permanent (long-term) mortgage loan carrier

when construction is completed. Commercial banks generally make this loan with a

slightly higher interest rate than the permanent long-term financing. Some banks

also offer One-Time Closing loans where they provide both the interim and

permanent loan—allowing the borrower to save the costs of closing two separate

loans, but, in some cases, involving more costs and other procedures and

provisions that end up costing the borrower more in the long run. (The prudent real

estate professional will have the borrower check with the lenders carefully when

considering this One-Time Closing arrangement.)


Reverse Annuity Mortgage

A reverse annuity mortgage is a very rarely used mortgage, but one with which the

real estate professional should be familiar. Under the terms of a regular amortized

loan, the mortgagor borrows a lump sum repaid in monthly payments. Simply

stated, a reverse mortgage works exactly as it sounds: in reverse. The lender makes

monthly payments to the borrower up to a pre-determined maximum amount.

Interest is charged only on the balance received by the mortgagor. The loan is

repaid upon the sale of the property or the death of the owner(s).

This type of loan is particularly valuable for couples who do not want to sell their

home, but whose retirement income is not quite enough to make ends meet. The

maximum loan amount is based upon the equity in the home and the lender's

actuarial tables. These tables attempt to determine, based upon a person's current

health, age, health habits, zip code, etc., how long they are likely to live and

compute a payment plan based on this chart.

Wraparound Mortgage

A wraparound mortgage is a second loan that encompasses a pre-existing loan,

along with additional funds. A wraparound mortgage can be between a buyer and

seller, or a consumer and third-party lender. The following example illustrates one

use of a wraparound mortgage that real estate licensees are likely to come across.

A seller owns said property. A buyer is interested in purchasing the property. The

seller still holds an outstanding loan for the property with a lender. Rather than

assume the seller's existing loan, the seller and buyer create a wraparound

mortgage in which the seller loans the buyer the money directly—the buyer pays

the seller a monthly amount slightly over the seller's mortgage payment. In

essence, the buyer makes payments to the seller under a wraparound mortgage,

and the seller, in turn, pays the lender.


The wraparound mortgage between the seller and the buyer is subordinate to the

first loan between the seller and the lender.

With some wraparound mortgages, like our example wrap, the seller takes on the

risk of buyer default. The wraparound mortgage creates a lien on the property, but

it is a lien subordinate to the lien created by the seller’s mortgage. Thus, if the seller

cannot pay back his lender because of buyer default, the lender’s right to recover

damages supersedes the seller’s. The profit that the seller stands to receive after

she or he makes his or her mortgage payments is what the seller buys with this

risk.

Sometimes the wraparound loan is held by a third-party lender. This party loans

funds to the buyer and uses them to pay back the original mortgage of the seller,

while keeping the difference. Often, it is the lender of the first mortgage who issues

the wraparound. These types of loans could be for a variety of reasons. For

example, if a homeowner wanted to improve upon a property, she or he could take

out money for the project, and then combine the previous mortgage with the new

improvement loan under a wraparound.

Purchase-Money Mortgage

A purchase-money mortgage, like a wraparound mortgage, involves the buyer

receiving funds from the seller in the form of a mortgage loan to purchase the

property. In a purchase-money mortgage, however, there is no encumbrance from

an original mortgage remaining on the property.


Sale-Leaseback

In a sale-leaseback, the owner of a parcel of real estate sells it and immediately

leases it back. This type of arrangement is mostly used by commercial investors

who desire to turn their illiquid real estate into cash without losing the use of the

asset. In addition, an investor can claim a tax deduction for rent paid on property

he or she uses for business. The selling investor will often reserve the right to

repurchase the property at the end of the lease period.

The sale-leaseback is beneficial to the purchasing party because (a) the party

receives a steady stream of rental income, more or less guaranteed, and (b) the

party profits by reselling the property to its original owner at its new market price. If

the sellback price were set at the beginning of the lease, the purchase price would

be considered a loan for tax purposes, and the selling party would lose many of the

tax benefits of the arrangement.

Closing Real Estate Loans

As of October 1, 2015 the Consumer Finance Protection Bureau (CFPB) has

instituted some amended and integrated closing disclosure requirements.

Information on the amended closing guidelines is provided in the next section.

Summary of TILA‐RESPA Integrated Disclosure Rule

The Consumer Financial Protection Bureau (CFPB) issued a final rule amending

Regulation Z (Truth in Lending Act) and Regulation X (Real Estate Settlement

Procedures Act) to integrate mortgage loan disclosures. To view the Rule and CFPB

summaries here.

http://www.consumerfinance.gov/regulatory-implementation/tila-respa/


What is the new TILA/RESPA rule?

The TILA/RESPA rule consolidates four existing disclosures required under TILA and

RESPA foreclosed‐end credit transactions secured by real property into two forms:

a Loan Estimate that must be delivered or placed in the mail no later than the third

business day after receiving the consumer’s application, and a Closing Disclosure

that must be provided to the consumer at least three business days prior to

consummation.

While this rule includes major changes to mortgage loan disclosures and delivery

requirements, due to ICBA advocacy, no proposed changes requiring creditors to

disclose an all‐inclusive annual percentage rate (APR) were finalized.

Loans Covered By the Rule

The TILA‐RESPA rule applies to most closed‐end consumer credit transactions

secured by real property, but does NOT apply to:

Home Equity Lines of Credit (HELOCs);

Reverse mortgages; or

Chattel‐dwelling loans, such as loans secured by a mobile home or by a

dwelling not attached to real property.

The rule also does not apply to loans made by a person or entity that makes five or

fewer mortgages in a calendar year.

Note

Certain types of loans that are currently subject to TILA but

not RESPA are subject to the TILA/RESPA rule’s integrated

disclosure requirements, including:

Construction‐only loans

Loans secured by vacant land or by 25 or more acres


Effective Date

The new Integrated Disclosures must be provided by a creditor or mortgage broker

that receives an application from a consumer for a closed‐end credit transaction

secured by real property on or after October 1, 2015.

Creditors will still be required to use the current Good Faith Estimate (GFE), HUD‐1,

and Truth-in‐Lending forms for applications received prior to October 1, 2015. As

the applications received prior to August 1, 2015 are consummated, withdrawn, or

cancelled, the use of the GFE, HUD‐1 and Truth‐in‐Lending forms will no longer be

used for most mortgage loans.

The TILA/RESPA rule includes some new restrictions on certain activity prior to a

consumer’s receipt of the Loan Estimate. These restrictions take effect on October

1, 2015, regardless of whether an application has been received on that date. These

activities include:

Imposing fees on a consumer before the consumer has received the loan

estimate

Providing written estimates of terms or costs specific to consumers before

they receive the loan estimate without a written statement informing the

consumer the terms and costs may change

Requiring submission of documents verifying information related to the

consumer’s application before providing the loan estimate

The Loan Estimate Disclosure

For closed‐end credit transactions secured by real property (other than reverse

mortgages), the creditor is required to provide the consumer with good‐faith

estimates of credit costs and transaction terms on a new form called the Loan

Estimate.

Model/sample forms can be found here.



This new form integrates and replaces the existing RESPA GFE and the initial TILA

disclosure for these transactions. The creditor is generally required to provide the

Loan Estimate within three business days of the receipt of the consumer’s loan

application.

Loan Estimate must contain a good faith estimate of credit costs and

transaction terms.

Loan Estimate must be in writing.

The creditor must deliver the Loan Estimate or place it in the mail no later

than the third business day after receiving the application.

Creditors generally may not issue revisions to Loan Estimates because they

later discover technical errors, miscalculations, or underestimations of

charges.

Creditors can issue revised Loan Estimates only in certain situations such as

when changed circumstances result in increased charges.

If a mortgage broker receives a consumer’s application, either the creditor or

the mortgage broker may provide the Loan Estimate.

Mandatory Use of Model Forms

For any loans subject to the TILA/RESPA rule that are federally related mortgage

loans subject to RESPA (which will include most mortgages), form H‐24 is a standard

form, meaning creditors must use form H‐24.

For other loans subject to the TILA‐RESPA rule that are not federally related

mortgage loans, form H‐24 is a model form, meaning creditors are not strictly

required to use form H‐24 but the disclosures must contain the exact same

information and be made with headings, content, and format substantially similar

to form H‐24.


Page 1 of the Loan Estimate includes general information:

A Loan Terms table

A Projected Payments table

A Costs at Closing table

A link for consumers to obtain more information about loans secured by real

property at a website maintained by the CFPB

In addition, page 1 of the Loan Estimate includes the title “Loan Estimate” and a

statement of “Save this Loan Estimate to compare with your Closing Disclosure.”

The top of the page also includes the name and address of the creditor. If there are

multiple creditors, use only the name of the creditor completing the Loan Estimate.

If a mortgage broker is completing the Loan Estimate, use the name of the creditor

if known. If not known, leave space blank.

Page 2 of the Loan Estimate includes closing cost details:

A good‐faith itemization of the loan costs and other costs associated with the

loan

A Calculating Cash to Close table

For transactions with adjustable payments, an Adjustable Payment table

For transactions with adjustable interest rates, an Adjustable Interest Rate

table

Page 3 of the Loan Estimate includes additional information about the loan:

Contact information

A Comparisons table

An Other Considerations table

If desired, a signature statement for the consumer to sign to acknowledge

receipt


Delivery of the Loan Estimate Disclosure

Generally, the creditor is responsible for ensuring it delivers or places in the mail

the Loan Estimate form no later than the third business day after receiving the

consumer’s application.

A “business day” is a day on which the creditor’s offices are open to the public for

carrying out substantially all of its business functions.

Application consists of the submission of the following six pieces of information:

The consumer’s name;

The consumer’s income;

The consumer’s social security number to obtain a credit report;

The property address;

An estimate of the value of the property;

The mortgage loan amount.

Note. A creditor or other person may not condition providing the Loan Estimate on

a consumer submitting documents verifying information related to the mortgage

loan application before providing the Loan Estimate.

If a creditor determines within the three‐business‐day period the consumer’s

application will not or cannot be approved on the terms requested by the

consumer, or if it the application is withdrawn within that period, the creditor does

not have to provide the Loan Estimate.

If a mortgage broker receives a consumer’s application, the mortgage broker may

provide the Loan Estimate to the consumer on the creditor’s behalf. However, the

creditor is expected to maintain communication with the mortgage broker to

ensure the Loan Estimate and its delivery satisfy all requirements and the creditor

is legally responsible for any errors or defects.


If a mortgage broker provides the Loan Estimate, the mortgage broker must comply

with the three‐year‐record‐retention requirement.

Creditors must act in good faith in obtaining information for the Loan Estimate. If

information is unknown, creditors may use estimates if they are designated as such

on the Loan Estimate.

Any revised Loan Estimate Disclosures must be delivered or placed in the mail no

later than three business days after receiving the information. This must be

delivered or placed in the mail no later than seven business days before

consummation of the transaction.

For purposes of the “seven‐business‐day” requirement, business day is

defined as all calendar days, except Sundays and legal public holidays.

A consumer may modify or waive the seven‐business‐day waiting period

after receiving the Loan Estimate if the consumer determines the mortgage

loan is needed to meet a bona‐fide personal financial emergency, such as

imminent sale of the home at foreclosure.

Accuracy Requirement for the Loan Estimate Disclosure

Creditors are responsible for ensuring the figures stated in the Loan Estimate are

made in good faith with the best information reasonably available at the time they

are disclosed.

Generally, if the charge paid by or imposed on the consumer exceeds the amount

disclosed on the Loan Estimate, it is not in good faith.


A creditor may charge the consumer more than the amount disclosed in the Loan

Estimate when:

Certain variations between the amount disclosed and the amount charged

are expressly permitted by the TILA‐RESPA rule;

The amount charged falls within a tolerance threshold; or

Changed circumstances permit a revised Loan Estimate or a Closing

Disclosure that permits the charge to be changed:

An event beyond the control of the parties occurs

Information the creditor relied upon was inaccurate

New information specific to the consumer or transaction that the

creditor did not rely on is found

Creditors may charge consumers more than the amount on the Loan Estimate

without any tolerance limitation for:

Prepaid interest

Property insurance premiums

Amounts placed into an escrow, impound, reserve or similar account

Services required by the creditor if the creditor permits the consumer to

shop and the consumer selects a third party service provider not on the

creditor’s list of service providers

Charges paid to third‐party service providers for services not required by the

creditor

The creditor may charge the consumer more than the amount disclosed on the

Loan Estimate for any of the following, so long as the total sum of the charges does

not exceed the sum of all such charges disclosed on the Loan Estimate by more

than 10 percent:

Recording fees

Charges for third‐party services where:

The charge is not paid to the creditor or their affiliate


The consumer is permitted by the creditor to shop for the third‐party service and

the consumer selects a third‐party service provider on the creditor’s written list of

service providers.

If a consumer chooses a provider not on the creditor’s list of providers, then the

creditor is not limited in the amount that may be charged for the service.

For all other charges, creditors are not permitted to charge consumers more than

the amount disclosed on the Loan Estimate under any circumstances other than

changed circumstances that permit a revised Loan Estimate. Zero tolerance charges

include:

Fees paid to the creditor, mortgage broker, or an affiliate of either

Fees paid to an unaffiliated third party if the creditor did not permit the

consumer to shop for a third‐party service provider for a settlement service

Transfer taxes

If the amounts paid by the consumer at closing exceed the amounts disclosed on

the Loan Estimate beyond the tolerance threshold, the creditor must refund the

excess to the consumer no later than 60 calendar days after consummation.

For charges subject to zero tolerance, any amount charged beyond the amount

disclosed on the Loan Estimate must be refunded to the consumer.

For charges subject to a 10 percent cumulative tolerance, to the extent the total

sum of the charges added together exceeds the sum of all charges disclosed on the

Loan Estimate by more than 10 percent, the difference must be refunded.


Limits on Fees

A creditor or other person may not impose any fee on a consumer in connection

with the application for a mortgage transaction until the consumer has received the

Loan Estimate and has indicated intent to proceed with the transaction. This

includes limits on imposing:

Application fees

Appraisal fees

Underwriting fees

Any other fees

The exception to this exclusion is for reasonable fees for obtaining a consumer’s

credit report.

A consumer’s intent to proceed is shown when the consumer communicates, in any

manner, they choose to proceed after the Loan Estimate has been delivered, unless

a manner of communication is required by the creditor.

The creditor must document the communication to satisfy record retention

requirements.

Other Estimates of Costs and Terms

The new TILA/RESPA rule does not prohibit a creditor or other person from

providing a consumer with estimated terms or costs prior to the consumer

receiving the Loan Estimate.

However, if a written estimate is provided before the Loan Estimate, it must clearly

and conspicuously state at the top of the front of the first page, “Your actual rate,

payment, and costs could be higher. Get an official Loan Estimate before choosing

the loan.”


This statement must be in 12‐point font size or larger; and there must be no

headings, content, or format substantially similar to the Loan Estimate or the

Closing Disclosure. To access the form H‐26 for a model click here.

Closing Disclosures

For loans that require a Loan Estimate and that proceed to closing, creditors must

provide a new final disclosure reflecting the actual terms of the transaction called

the Closing Disclosure. The form integrates and replaces the existing HUD‐1 and

the final TILA disclosure for these transactions. To access the Model/sample forms

click here.

The creditor is generally required to ensure the consumer receives the Closing

Disclosure no later than three business days before consummation of the loan.

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. This point in time depends on

applicable state law.

The Closing Disclosure generally must contain the actual terms and costs of the

transaction.

Creditors may estimate disclosures using the best information reasonably available

when the actual term or cost is not reasonably available to the creditor at the time

the disclosure is made. However, creditors must act in good faith and use due

diligence in obtaining the information. The creditor normally may rely on the

representations of other parties in obtaining the information, including, for

example, the settlement agent. The creditor is required to provide corrected

disclosures containing the actual terms of the transaction at or before

consummation.




If the actual terms or costs of the transaction change prior to consummation, the

creditor must provide a corrected disclosure. If the creditor provides a corrected

disclosure, it may also be required to provide the consumer with an additional

three‐business‐day waiting period prior to consummation.

Mandatory Use of Model Forms

For any loans subject to the TILA/RESPA rule that are federally related mortgage

loans subject to RESPA, form H‐25 is a standard form that creditors must use. For

other transactions subject to the TILA/RESPA rule that are not federally related

mortgage loans, form H‐25 is a model form, so creditors are not strictly required to

use the form but disclosures and format must be substantially similar to form H‐25.

Page 1 of the Closing Disclosure must include:

General information

The Loan Terms table

The Projected Payments table

The Costs at Closing table


The Loan Costs table

The Other Costs table

Note

The number of items in these tables can be

expanded and deleted to accommodate

the disclosure of additional line items.

Items required to be disclosed even if they are not charged to the consumer cannot

be deleted.


Loan costs and other costs tables can be disclosed on two separate pages if the

page cannot accommodate all the costs required to be disclosed on one page.


The Calculating Cash to Close table

Summaries of Transactions tables

For transactions without a seller, a Payoffs and Payments table may substitute for

the Summaries of Transactions table and be placed before the alternative

Calculating Cash to Close table.


Loan disclosures

The Adjustable Payment table

Adjustable Interest Rate table


The Loan Calculations table

Other disclosures

Contact information

Confirmation of receipt

Delivery of Closing Disclosure

The creditor must arrange for delivery as follows:

By providing it to the consumer in person

By mailing or emailing it

If mailed or emailed, the consumer is considered to have received the Closing

Disclosure three business days after it is delivered or placed in the mail.


Settlement agents may provide the Closing Disclosure on the creditor’s behalf;

however, the creditor is legally responsible for any errors or defects with delivery.

The settlement agent must provide the seller its copy of the Closing Disclosure no

later than the day of consummation.

Disclosures must be provided separately to each consumer who has the right to

rescind the transaction under TILA. In transactions that are not rescindable, the

Closing Disclosure may be provided to any consumer with primary liability on the

obligation.

Revisions and Corrections to the Closing Disclosures

Creditors must re‐disclose terms or costs on the Closing Disclosure if certain

changes occur to the transaction after the Closing Disclosure was first provided that

cause it to become inaccurate. Changes that require a corrected Closing Disclosure

include:

Changes that occur before consummation that requires a new three‐business‐day

waiting period, such as:

The disclosed APR becomes inaccurate

The loan product changes

A prepayment penalty is added

Changes that occur before consummation and do not require a new three‐business

day waiting period (which includes all other changes).

For these changes, the creditor must ensure only that the consumer receives the

revised Closing Disclosure at or before consummation.


Changes that occur after consummation, such as:

An incorrectly disclosed recording fee

Other post‐consummation events not related to settlement, such as tax

increases, do not require a revised Closing Disclosure

However, creditors must provide a corrected Closing Disclosure if an event in

connection with the settlement occurs during the 30‐calendar‐day period after

consummation that causes the Closing Disclosure to be inaccurate and result in a

change to an amount paid by the consumer from what was previously disclosed.

In this case, the corrected Closing Disclosure must be delivered or placed in the

mail no later than 30 calendar days after receiving information the event occurred.

Creditors must provide revised Closing Disclosures to correct clerical errors no later

than 60 calendar days after consummation.

If a creditor cures a tolerance violation by providing a refund to the consumer, the

creditor must deliver or place in the mail a corrected Closing Disclosure no later

than 60 calendar days after consummation.

Delivery of the Special Information Booklet

Creditors must provide a copy of the special information booklet to consumers who

apply for a consumer credit transaction secured by real property, except:

If the consumer is applying for a Home Equity Line of Credit (HELOC), the

creditor can instead provide a copy of the brochure entitled, “When Your

Home is On the Line: Lines of Credit.”


The creditor need not provide the special information booklet if the

consumer is applying for a real property‐secured consumer credit

transaction that does not have the purpose of purchasing a one‐to‐four

family residential property, such as a refinancing, a closed‐end loan secured

by a subordinate lien, or a reverse mortgage.

Creditors must deliver or place in the mail the special information booklet no later

than three business days after receiving the consumer’s loan application.

This need not be provided if the creditor denies the application or the application is

withdrawn.

For multiple applicants, the creditor may provide a copy of the special information

booklet to just one of them. If used, the mortgage broker must provide the special

information booklet instead of the creditor.

Escrow Closing Notice

This notice must be provided prior to cancelling an escrow account to consumers

for whom an escrow account was established on a closed‐end mortgage secured by

a first lien, except for a reverse mortgage.

This additional notice must be provided no later than three business days before

the consumer’s escrow account is cancelled.

Notice is not required if the escrow account being cancelled was established in

connection with the consumer’s delinquency or default on the debt obligation or

when the debt obligation is terminated.


The notice must include:

The date on which the account will be closed

That an escrow account may also be called an impound or trust account

The reason why the escrow account will be closed

That without the account, the consumer must pay all property costs, such as

taxes and insurance directly, in one or two large payments a year

A table titled “Cost to You” that has an itemization of the amount of any fee

the creditor or servicer imposes on the consumer in connection with the

closure of the escrow account, labeled “Escrow Closing Fee,” and a statement

the fee is for closing the escrow account

Under the reference “In the future”:

The consequences if the consumer fails to pay property costs;

A telephone number the consumer can use to request additional

information about the cancellation of the escrow account;

Whether the creditor/servicer offers the option of keeping the escrow

account open and a telephone number the consumer can use to

request the account be kept open

Whether there is a cut‐off date to request the account be kept open

The creditor/servicer may also, at its option, disclose:

Its name or logo

The consumer’s name, telephone number, mailing address, and property

address

The issue date of the notice

The loan number or consumer’s account number

The disclosures must also:

Contain a heading

Be clear and conspicuous

Be written in 10‐point font or larger


Be consolidated on the front side of a one‐page document, separate from all other

materials, and substantially similar to model form H‐29 found here.

Record Retention Requirements

The creditor must retain copies of the Closing Disclosure (and all documents

related to the Closing Disclosure) for five years after consummation.

The creditor, or servicer if applicable, must retain the Post‐Consummation Escrow

Cancellation Notice (Escrow Closing Notice) and the Post‐Consummation Partial

Payment Policy disclosure for two years. For all other evidence of compliance with

the Integrated Disclosure provisions of Regulation Z (including the Loan Estimate),

creditors must maintain records for three years after consummation of the

transaction.

If a creditor sells, transfers, or otherwise disposes of its interest in a mortgage and

does not service the mortgage, the creditor shall provide a copy of the Closing

Disclosure to the new owner or servicer of the mortgage as a part of the transfer of

the loan file. Both the creditor and such owner or servicer shall retain the Closing

Disclosure for the remainder of the five‐year period.

Closing Costs

Non-Recurring Closing Costs not associated with the Lender

Upon selling a property there are many small fees that are not associated with the

lender that will need to be paid at closing. Familiarity with these fees is important

for all real estate professionals. The following scenes will outline many of these

common, one-time closing fees.

Closing/Escrow/Settlement Fee: A fee paid to the settlement agent or escrow

holder.



Title Insurance: Assurance to the potential homeowner that he or she is receiving

clear title to the property being purchased—free of liens and encumbrances, and, if

a survey was done, discrepancies in boundaries and area.

Legal or Document Preparation Fee: Fee paid to lawyer or law firm for

preparation of legal documents for transaction and lender required forms.

Notary Fees: Fee for forms that must be attested to, or notarized.

Recording Fees: Fee for recording legal documents with local County recorder.

Pest Inspection/Treatment: Fee for inspection and/or treatment and repairs of

pest infestations, wood rot, and water damage (as a lender may require as a pre-

condition of procuring the loan).

Home Inspection: Fee if a homebuyer has her or his home inspected and has not

prepaid when the inspection was completed.

Home Warranty: Optional fee paid for an insurance policy covering items such as

major appliances, etc., not to be confused with a warranty provided by the builder

of a new home that would cover the structure itself.

Courier Fee: Deals with the costs associated with delivering documents to the

buyer, seller, lender, title company, law firm, county recorder, etc., to facilitate the

closing process.

Homeowner’s Association Transfer Fee: The fee charged by a Homeowner’s

Association for transferring all of its ownership documents to the new owner.


Option Fee: A negotiated fee paid by the potential purchaser at the time of

contracting for an option to terminate the contract with a stated amount of days, as

stated in the earnest money contract.

Non-Recurring Closing Costs Associated with the Lender

The following costs are only collected at closing and do not continue to be collected

during the loan period (non-recurring). The exact amount of each fee should

appear on the original good faith estimate provided by the lender to the borrower

at loan application. As a real estate professional, you should assist the borrower in

reviewing and explaining each of these fees prior to closing. Also, compare the

good faith estimate with the Closing Disclosure Statement for any discrepancies; if

found, contact your lender immediately for an explanation.

Loan Origination Fee: As previously stated, the loan origination fee is often

referred to as points. On an FHA loan, the loan origination fee is one point. On a VA

loan, the loan origination fee is set by the individual lender. Anything in addition to

one point (on government loans) is called discount points. A point is equal to one

percent of the whole loan amount. This amount is paid directly to the lender as a

fee to set up the loan.

Appraisal Fee: Fee paid to a licensed real estate appraiser, usually by the lender, to

appraise the value of the property. The appraisal fee varies, depending on the value

of the home and the difficulty involved in justifying value. Appraisal fees on VA and

FHA loans are higher than on conventional loans because they require the

appraiser to inspect items not strictly associated with value (but such inspections

are NOT for the borrower and should not be substituted for an independent

inspection done for a borrower prior to purchase—if the borrower so chooses).

This fee is usually negotiated directly with the lender, who orders the appraisal.


Credit Report Fee: Fee paid to a credit reporting service for reviewing the

borrower’s credit history.

Mortgage Broker Fee: Broker processing fees. Borrowers should direct questions

about broker processing fees to the broker directly. As the student probably knows,

these fees are negotiable and set by the broker.

Tax Service Fee: Fee for a service checking to make sure property tax payments

are made or have been made.

Flood Certification Fee: Fee for a service hired to determine whether a property is

located in a federally designated flood zone or not.

Flood Monitoring Fee: Fee paid for a service monitoring whether or not a re-

mapping affects the flood zone designation status of a property (i.e., makes it so a

property previously outside a flood zone is now within a flood zone, or makes it so

a previously flood-zoned property is no longer flood-zoned).

Escrow Waiver Fee: Fee paid on loans made when an escrow account is not

established to cover the cost of a service monitoring the payment of taxes and

insurance on behalf of a lender over the course of the loan. It is possible to avoid

an escrow account in loans less than 80 percent of the sale price.

Some fees are not consistently charged. The following list outlines fees applying to

certain transactions. These should be listed on the Hud-1 Settlement Statement.

Underwriting Fee: Fee sometimes charged by lender if reselling the loan in the

secondary market.


Administration Fee: Additional fee sometimes charged by lender to establish the

loan.

Appraisal Review Fee: Fee sometimes charged by lender for a second appraiser to

review the original appraisal when findings are considered questionable.

Wire Transfer Fee: Fee charged if funds are wire transferred at closing for a buyer

or seller.

Warehousing Fee: Fee charged by lender as additional amount for establishing

loan.

Real Estate Practice Problems

Review Exercise 1

How is a loan qualifying ratio used to determine the maximum monthly

payment a borrower can make, with respect to the borrower’s gross monthly

income and long-term debt?

1. The borrower’s total housing expense ratio is multiplied by the borrower’s gross

monthly income to find the maximum allowable housing expense with respect to

housing expenses. Then, the total debt service ratio is multiplied by the difference

between gross monthly income and long-term debt to find the maximum allowable

housing expense with respect to the borrower’s debt. The greater of the two

maximum expenses is the maximum allowable housing expense.

2. The borrower’s total housing expense ratio is multiplied by the borrower’s gross

monthly income to find the maximum allowable housing expense with respect to

housing expenses.


Then, the total debt service ratio is multiplied by the difference between gross

monthly income and long-term debt to find the maximum allowable housing

expense with respect to the borrower’s debt. The lesser of the two maximum

expenses is the maximum allowable housing expense.

Feedback:

1. Incorrect. Choosing the greater expense would exceed the limit placed by the

lower expense. We should never have a housing expense figure that exceeds either

of these limits because the maximum allowable housing expense is an upper limit

on housing expense, greater than which borrowers should not pay.

2. Correct. Choosing the lesser expense gives us a figure less than or equal to both

maximum housing expense figures, not in excess of either. We should never have a

housing expense figure that exceeds either of these limits because the maximum

allowable housing expense is an upper limit on housing expense, greater than

which borrowers should not pay.

Review Exercise 2

In which of the following situations should a veteran’s remaining entitlement

be calculated?

1. If a veteran who has paid a VA loan in full wants to buy a second home with the

intention of leasing the property, the veteran’s remaining entitlement must be

calculated in order to determine what loan amount the veteran can get to purchase

the property.

2. If a veteran sells his or her home to another party who does not assume the VA

loan, it is important to calculate the veteran’s remaining entitlement in order to

determine what loan amount the veteran can get to purchase a new home.


Feedback:

1. Incorrect. VA loans are available veterans who intend to occupy the property, not

for investment or rental purposes. This veteran is not eligible for a VA loan;

therefore, entitlement need not be calculated.

2. Correct. A veteran may obtain a second VA loan while the first VA loan is still in

effect. However, the veteran’s entitlement must be calculated to determine how

much of a loan she or he is eligible to receive. When the first VA loan is paid off, the

veteran is eligible to receive the maximum entitlement.

Case Studies

Case Study 1: Conventional Loan

A customer wants to buy a house that is listed at its appraised value of $90,000. He

makes a salary of $39,000 a year but he is worried he will not be able to qualify for

the 30-year loan he wants because he is currently paying off his new truck and his

daughter’s college education. Annual taxes on the property are 2.4 percent of the

appraised value; insurance is 0.75 percent; and the homeowner’s fee is $30/month.

If the current interest rate is 7.35 percent, can we qualify him for a loan?

We sit him down with a conventional loan qualifying worksheet. His gross monthly

income is $39,000 annually, or $3,250 a month. We must determine whether or not

his total housing expense is less than 28 percent of $3,250 and his total debt

service is less than 36 percent of $3,250.

To determine total housing expense, we calculate the PITI payment. Since the loan

to value ratio is 100 percent, which in turn is higher than 80 percent, Customer A

must purchase private mortgage insurance, which at its cheapest now, we find, is

0.5 percent annually.


Since principal, interest, taxes, and insurance are all given in percentages, it is best

to calculate the amortization payments on a loan relative to one rate, the sum of all

the others.

7.35% interest + 2.4% taxes + 0.75% hazard insurance + 0.5% PMI = 11% total rate.

The amortization schedule—indicates that a 30-year loan of $90,000 at 11 percent

takes a monthly payment of $9.52 to fully amortize over the term. With a monthly

income of $3250.00:

Question 1: What is the monthly payment required for an 11%, 30-year loan of

$90,000?

Answer 1: $90,000, 30-year loan takes monthly payments of $857.09 to fully

amortize.

Question 2: Now, we must add the $30/ month homeowner’s fee to the

monthly payment to calculate the total housing expense.

Answer 2: $857.09 + $30 = $887.09 total housing expense.

Question 3: What is the borrower’s housing expense to income ratio?

Answer 3: The borrower’s housing expense to income ratio is:

$887.09 / $3,250 = 27.29%, just less than the qualifying ratio of 28 percent.



Question 4: Does the borrower automatically qualify for the loan?

Answer 4: No, the borrower does not automatically qualify for the loan. His total

debt service ratio must also be calculated.

We must now calculate the borrower’s total debt service ratio. He is currently

paying $3,000 a year for his daughter’s college education and $220 a month for his

vehicle. That’s $470 a month. His total debts add up to $470 + $887.09 = $1357.09 a

month.

Question 1: What is the borrower’s total debt service ratio?

Answer 1: The total debt service ratio is calculated by dividing total debts by

monthly income. Therefore, $1357.09 / $3,250 = 0.4175, or 41.75%.

Question 2: Does the borrower qualify for the loan?

Answer 2: The borrower does not qualify for a loan. His total debt ratio is 41.75%,

well over the required 36%.

Case Study 2: Adjustable Rate Mortgages

Perhaps we can still help this customer. His daughter graduates in three more

years and his truck only has 12 months more worth of payments. The goal would

be to get him a loan with low initial payments and increased later payments. We

know a few lenders who are willing to offer an adjustable rate mortgage, but these

are worrisome because the rate may fluctuate too high for him to pay. Remember:

he is well over the minimum required total debt service ratio.


The best ARM we find offered has an initial interest rate of 4.35 percent, three

whole percentage points below the going rate for 30-year conventional loans. The

total rate on the loan will be eight percent (4.35% interest + 2.4% taxes + 0.75%

hazard + 0.5% PMI). At this rate, according to our schedule, the loan will require

monthly payments of $660.39 to fully amortize in 30 years at eight percent. To this

we add our $30 homeowner’s fee and the $470 truck and college payment to get

the total debt service: $1,160.39. This is only 35.7 percent of his $3,250 gross

monthly income and would qualify him for the loan.

But in some cases, qualifying is not enough. We have to consider the worst case

scenario. The margin on this loan is 0.35 percent and the rate adjusts annually,

capped at two percent per interval. The index is U.S. Treasury Bonds, currently

paying four percent. If the rate increases by the full two percent next year, this

customer will have paid off his truck, but the effective rate he will be paying is ten

percent. This requires payments of $789.81, and a total debt service of $789.81 +

$30 homeowner’s fee + $250 college payment = $1,069.81, only 32.92 percent.

However, suppose the interest rate went up yet again over the next two years, say,

only one percent per year. Then the interest rate would be 12 percent and the total

debt service payments, $1,205.75. This would be 1.1 percent in excess of the

minimum ratio requirement and this customer might be at a high risk of default.

And this is only at a one percent per year increase: the cap is two points per year.

While it is unlikely this worst-case scenario will come to pass, it is still possible. We,

as real estate licensees must explain the situation to our customer and make a

decision as to whether or not the both of us are willing to take the risk. Remember:

it is our risk too—the default of one of our clients reflects a bad judgment on our

part.


Case Study 3: Graduated Payment Mortgages

Another loan we might consider finding for Customer A is the graduated payment

mortgage or GPM. These are not loans readily available in today’s market, but

suppose that we know a lender who is willing to offer one at our request. The

graduated payments are $400 the first year, $550 the second year, $700 the third

year, $850 the fourth, and $950 the fifth.

The payments of interest to us are those in the first year, right before the truck is

paid off; the third year, right before his daughter leaves college; and the fifth year,

when the monthly payments are highest. Customer A should meet the required

ratios at each of these critical points before he decides to take the loan. We fill out

the following chart:

Year Monthly Loan

Payment

Long Term

Debt

Total Monthly

Payments

Total Debt

Service

Year 1 $400 $500 $1,173.75 36.12%

Year 3 $700 $280 $1,259.72 38.76%

Year 5 $950 $30 $1,243.90 38.27%

To find the total monthly payments we must calculate the taxes and insurance for

each year. These calculations are tedious because we do not have the use of an

amortization schedule (a GPM is often called a negative amortization loan). In

essence, we multiply the interest rate by the first year’s principal, as well as the tax

and insurance rate. Since the taxes and insurance are paid month to month, they

are not considered in calculating the next year’s principal. The principal is figured by

adding the interest and subtracting 12 times the monthly loan payment for the

year.


Then the figures are calculated on the next year’s principal, and so on. Here is what

the result looks like:

Year Principal Interest (at 7.35%)

Taxes and Insurance

Mo. Payment x 12

1 $90,000.00 $6,615.00 $3,285.00 $4,800

2 $91,815.00 $6,748.40 $3,351.25 $6,600

3 $91,963.40 $6,759.31 $3,356.66 $8,400

4 $90,322.71 $6,638.72 $3,296.79 $10,200

5 $86,761.43 $6,376.97 $3,166.79 $12,000

Notice how in the first few years the principal increases, as is to be expected with a

GPM. The tax and insurance payments are divided by 12 to find the monthly tax

and insurance payments, and added to the monthly loan payment and long-term

debt payment to find the total monthly payment.

Since the total debt service exceeds 36 percent for years one, three, and five, this

customer does not qualify for this loan. However, the numbers are not excessively

far off. If the customer could cut some of his long term expenses or increase his

income slightly, then he might be able to make the payments.

Case Study 4: Permanent Buydown

A permanent buydown or discount point is an amount of the loan the borrower

pays in cash to “buydown” the interest rate over the life of the loan. The lender

does not lose profit: he just gets it earlier. In a 30-year loan we use the “Rule of

Eights:” every discount point (one percent of the loan amount) is worth a one-eighth

reduction in the interest rate. How many discount points does a customer need to

buy in order to qualify for his FHA loan?

One point reduces the PITI rate from 11.075% to 10.95%. The monthly payment is

then $853.69 + $30 homeowner’s fee + $220 truck payment + $250 college tuition =

$1,353.69. This is 41.65% of the loan amount.


Two points reduce the rate to 10.825%. The payment is then $845.21 + $30 + $220 +

$250 = $1,345.21. This is 41.39% of the loan amount.

Three points reduce the rate to 10.7%. The payment is then $836.75 + $30 + $220 +

$250 = $1,336.75. This is 41.13% of the loan amount.

Four points reduce the rate by half a point to 10.575%. The payment then is

$828.32 + $30 + $220 + $250 = $1,328.32. This is 40.87% of the loan amount and

thus qualifies the buyer for the loan.

Four discount points constitute four percent of the loan amount and thus cost 0.04

x $90,000 or $3,600. The seller can pay these points, but only up to a three percent

contribution because the loan-to-value ratio is greater than 90 percent. The buyer

would then have to contribute $900 plus the minimum investment requirement of

$2,700, totaling once again $3,600 (remember discount points do not count toward

the minimum investment required in an FHA loan). If a customer has this money on

hand, he can buy the points and qualify for the loan.

Case Study 5: VA Loans

A veteran is interested in purchasing a new home. He served in the Korean War and

meets all the qualifications for a loan guaranteed by the Veterans Administration.

What he wants to know is whether he is better off getting a VA Loan or a

conventionally financed loan.

Since the interest rate on VA loans is fixed by the government, it does not change as

often as the market rate. The VA rate is now 8.5 percent compared to the 7.35

percent market rate. The closing costs for both loans are essentially the same, with

the following exceptions: the origination fee on the VA loan is one percent and on

the conventional loan, 1.5 percent.


Also, the VA charges a 2.15 – 1.25 percent funding fee in addition to the other

closing costs, and the VA appraisal is $75 more than the lender’s usual appraisal.

However, the conventional loan requires private mortgage insurance, since the LTV

is below 80 percent, and the cost of this insurance is 0.75 percent annually.

The house this veteran is interested in buying costs $65,000. He wants to put 10

percent down. He is looking for the answer to two questions:

Which loan will cost him more per month?

Which loan will cost him more over time?

Assume a 30-year term.

The VA Loan

The VA Loan costs him a one percent origination fee and a 1.5%percent funding fee

up front (because he is putting 10% down, the funding fee will be 1.5% rather than

2.15%). The Rule of Eights tells us every discount point is worth one-eighth of a

reduction in the interest rate. So the lender’s profit from interest is essentially eight

times the interest rate multiplied by the original loan amount.

8 x .085 = 0.68 = 68%

The loan will cost the veteran 1 + 0.1 + 0.15 + .68 = 1.93 times the loan amount over

its life, plus the $75 extra for the appraisal.

The loan amount is 90 percent of $65,000 (the portion of the selling price not paid

up front), or $58,500. This loan will take a payment of $449.81 to amortize over 30

years at the VA rate.

It will cost the veteran (1.93 x $58,500) + $75 = $112,980 total.


The Conventional Loan

The conventional loan costs the veteran a 1.5% origination fee and an annual rate

of 7.35% interest + 0.75% PMI. By the Rule of Eights the interest rate is equivalent to

8 x (0.0735 + 0.0075) = 0.648 or 64.8% of the loan amount. Thus the total cost of the

loan is 166.3% of $58,500 or $97,285.50—plus 1.5% of $58,500, for a grand total of

$98,163, which is less than the cost of the VA loan.

Moreover, the monthly payments are less too. The interest plus the insurance rate

is 8.1 percent, which requires a payment of $433.34 to fully amortize over 30 years.

It seems as though the veteran would be better off taking out a conventional loan,

even though he qualifies for a VA-guaranteed one.

Case Study 6: Entitlement

A veteran who has purchased a home requiring a VA loan of $60,000 desires to sell

it at that price and buy a new home for $180,000. She is selling to a non-veteran

who cannot assume her original loan. If she wishes to take out a second VA loan for

the new home, can she get it?

To answer this question we must determine how much entitlement the veteran

currently has, and what the amount of the loan is that she can get with that

entitlement.

The entitlement used for a loan between $56,251 and $144,000 based on the

sliding scale is 40% of the loan amount. So the veteran is currently using 40% x

$60,000 = $24,000 of his entitlement. Thus, her current entitlement is $60,000 (the

amount that VA guarantees) − $24,000 = $36,000.

She needs to take out a loan to pay the difference of the sale price on her original

house and the sale price of the house she is purchasing, or $180,000 − $60,000 =

$120,000.


Since lenders will typically loan up to four times the amount of a veteran’s

entitlement, the veteran can likely get a loan of 4 x $36,000 = $144,000.

This amount is enough to cover the $120,000 she needs.

Case Study 7: Income

A customer enters our office looking to purchase a home. She wants a 30-year loan

and the current market interest rate is eight percent. She has no idea what price

range is available to her, but she gives us the following information:

She works two jobs: her primary job at a salary of $72,000 a year and a

secondary job which she works for approximately 20 hours a week at $15 an

hour. She has had the first job for 10 years now, but has only been working

the second for 18 months.

On average, she keeps $7,000 in her checking and savings accounts

combined.

She has two credit cards, each with limits of $5,000, which have required

payments of at least 10 percent of the monthly balance with a 10 dollar

minimum payment.

She is paying for her car at $300 a month plus $150 a month for insurance.

She has 32 months remaining on the car. She is also paying off a washer,

dryer, and refrigerator at $48 a month for all three.

Assuming all these figures are roughly correct, we calculate her income as follows:

gross monthly income is dependent only on her primary job, as she does not have

a two-year history with the second job. This pays:

$72,000/12 = $6,000 a month


We know the lenders we deal with typically calculate worst-case credit card

payments, as though the cards a borrower owned were maxed out. This gives her a

payment of:

($5,000 x 0.10 x 2) = $1,000

We add to this $450 for her car payment and insurance and $48 for her other long-

term debts and arrive at a total debt service of $1,498.

We know for a conventional loan:

Maximum monthly housing expense = 0.28 x gross monthly income

= 0.28 x $6,000

= $1,680

or, if it is less:

Maximum monthly housing expense = 0.36 x (GMI − Total Debt Service)

= 0.36 x ($6,000 − $1,498)

= 0.36 x $4,502

= $1,620.72

So the maximum payment this customer can make a month cannot exceed

$1,620.72.

Looking at our amortization charts, we see that $1,620.72 per month will amortize a

30-year loan at eight percent interest whose principal is $220,877.38. The range of

houses we will consider are those of $160,000 to $220,000 in value.


Case Study 8: Principal and Interest

A 30-year loan of $50,000 at six percent interest takes monthly payments of

$299.78 to fully amortize. After three years, what percentage of the monthly

payment is going toward interest and what toward principal?

The initial loan amount is $50,000 and the monthly interest is (0.06 / 12 months) =

0.005 or 0.5 percent. So the interest this first month is $50,000 x 0.5% = $250, which

is 83.39 percent of the monthly payment.

The principal in the second month is the initial principal, less the monthly payment

amount that went directly to the principal: $50,000 − ($299.78 -$250.00) = $50,000 –

49.78 = ____________.

Answer: $49,950.22. The interest is $49,950.22 x 0.5% = $249.75, or 83.31 percent

of the monthly payment.

As you can see, very little of the monthly payment is applied to the principal at the

outset of the loan. The deeper into the loan the payor gets, the more of each

payment goes toward the principal, and less toward the interest. This is the nature

of amortization.

Formulas, equations, spreadsheets, and calculators exist to calculate these

amounts, but, as you have seen in this course, the simplest method to delineating

these amounts is the use of mortgage calculating software, many examples of

which can be found on the web. This one was used in this course——but most

financial institutions provide this service on line.



Using the one we have been using, we find that after 36 months only $59.57 is

going to the principal, whereas the remainder of the $299.78 monthly payment—or

$240.21—is still going to interest. It is not until the 223 month that more of each

monthly payment is going to principal than interest.

Lesson Summary

In addition to the three most common types of loans, VA, FHA, and conventional

fixed-rate loans, there are several other loan payment plans available. One

important loan type of this sort is the adjustable rate mortgage or ARM. ARMs have

an initial interest rate generally below conventional rate loans that is adjusted

periodically in relation to some economic indicator, an index, stipulated in the loan.

To the index a lender adds stays the same over the life of the loan. ARMs typically

have either a rate cap or a payment cap for either the adjustment period or the

term of the loan, or both. Other loan payment plans are often variations on the

conventional loan and can have increased payments over time like a graduated

payment mortgage or a temporary buydown; an increasing interest rate, as with a

growth equity mortgage; or a decreased rate, as with a permanent buydown. The

loan and purchase process is governed by several government acts, including the

Real Estate Settlement Procedures Act (RESPA), the Federal Fair Credit Reporting

Act, and the Equal Credit Opportunity Act (ECOA). A real estate professional must

be familiar with the provisions of these acts in order to avoid violating the law.

The formal process by which ownership of real property passes from seller to buyer

is known as “closing.” There are costs at closing associated with the lender and

other professionals and professional services. For example, upon closing a real

estate transactions fees must be paid to lawyers, couriers, homeowners’

associations, insurers, inspectors, and appraisers among others.


Lenders typically charge a loan origination fee for originating a loan, a mortgage

broker fee for processing, a credit report fee for obtaining a credit report, a tax

service fee to ensure that a property’s taxes are current, and other fees from

services in the course of closing.

Please return to the course player to take the Module Quiz.

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