Test 7: Finance

A state in which a mortgagee has equitable title to a secured property.

States differ in their interpretation of who owns mortgaged property. Those that regard the mortgage as a lien held by the mortgagee (lender) against the property owned by the mortgagor (borrower) are called lien-theory states. Those that regard the mortgage document as a conveyance of ownership from the mortgagor to the mortgagee are called title-theory states.

It is evidence of the borrower’s debt to the lender.

A valid mortgage or trust deed financing arrangement requires a note as evidence of the debt.

trust deed or mortgage.

The mortgage or trust deed is evidence of the collateral pledge of the purchased property as security for the loan.

mortgagor.

The mortgagor is the borrower and the mortgagee is the lender. As a memory aid, notice that ‘lender’ and ‘mortgagee’ both have two ‘e’s. ‘Mortgagor’ and ‘borrower’ both have two ‘o’s.

$1,000.

Multiply the rate times the loan amount and divide by 12 to calculate monthly interest. Thus, ($200,000 x 6%) ÷ 12 = $1,000.

$100,000.

The equation for the loan amount is (annual interest divided by the interest rate) = loan amount. Thus, ($500 x 12) ÷ .06 = $100,000.

7.5%.

The equation for the interest rate is (annual payment / loan amount) = interest rate. Thus ($3750 / $50,000) = 7.5%.

$12,000.

A discount point is one percent of the loan amount. Thus, one point on a $600,000 loan equals ($600,000 x 2%) or ($600,000 x .02), or $12,000.

Part of each periodic payment is applied to repayment of the loan balance in advance and part is applied to payment of interest in arrears.

In an amortizing loan, part of the principal is repaid periodically along with interest, so that the principal balance decreases over the life of the loan. The annual interest is never the same, since the principal balance to which the interest rate applies changes every year. Interest on a loan is always paid in arrears, not in advance.

private mortgage insurance.

Mortgage insurance protects the lender against loss of a portion of the loan (typically 20-25%) in case of borrower default. Private mortgage insurance generally applies to loans that are not backed by the Federal Housing Administration (FHA) or Veterans Administration (VA) and that have a down payment of less than 20% of the property value. The FHA has its own insurance requirement for loans with a down payment of less than 20%.

The fraction of the appraised value of the property offered as collateral which the lender is willing to lend.

The relationship of the loan amount to the property value, expressed as a percentage, is called the loan-to-value ratio, or LTV. If the lender’s loan to value ratio is 80%, the lender will lend only $80,000 on a home appraised at $100,000. The difference between what the lender will lend and what the borrower must pay for the property is the amount the borrower must provide in cash as a down payment.

buyer’s down payment.

Price less loan is the down payment. This is also the buyer’s initial equity.

refusing a loan because the borrower does not match the lender’s target market.

The Equal Credit Opportunity Act (ECOA) requires a lender to evaluate a loan applicant on the basis of that applicant’s own income and credit rating, unless the applicant requests the inclusion of another’s income and credit rating in the application. In addition, ECOA has prohibited a number of practices in mortgage loan underwriting, including refusing a loan on a property based on its geographic location.

$1680.

Monthly income qualification is derived by multiplying monthly income by the income ratio. Thus (72,000 / 12) x .28 = $1680. Remember to first derive the monthly income.

adjust the applicant’s debt ratio calculation and lower the loan amount.

Since a lender lends only part of the purchase price of a property according to the lender’s loan-to-value ratio, a lender will verify that a borrower has the cash resources to make the required down payment. If someone is lending an applicant a portion of the down payment with a provision for repayment, a lender will consider this another debt obligation and adjust the debt ratio accordingly. This can lower the amount a lender is willing to lend.

All loans secured by a residence.

Regulation Z applies to all loans secured by a residence. It does not apply to commercial loans or to agricultural loans over $25,000. Its provisions cover the disclosure of costs, the right to rescind the credit transaction, advertising credit offers, and penalties for non-compliance with the act.

the borrower has a limited right to cancel the transaction within a certain period.

A borrower has a limited right to cancel the credit transaction, usually within three days of completion of the transaction. The right of rescission does not apply to ‘residential mortgage transactions,’ that is, to mortgage loans used to finance the purchase or construction of the borrower’s primary residence. It does, however, apply to refinancing of mortgage loans, and to home equity loans. State law may require a rescission period and notice on first mortgage loan transactions as well.

ask the buyer/borrower about his/her religion or national origin.

ECOA prohibits discrimination in extending credit based on race, color, religion, national origin, sex, marital status, age, or dependency upon public assistance. A creditor may not make any statements to discourage an applicant on the basis of such discrimination or ask any questions of an applicant concerning these discriminatory items. A real estate licensee who assists a seller in qualifying a potential buyer may fall within the reach of this prohibition.

not FHA-insured or VA-guaranteed.

A conventional mortgage loan is a permanent long-term loan that is not FHA-insured or VA-guaranteed. FNMA does not ‘back’ loans; FHA only insures FHA loans; and the VA, not GNMA guarantees loans.

limited by when the loan was originated.

Rules for assumability vary according to when the FHA-insured loan was originated and whether the original loan was for an investment property or an owner-occupied principal residence. Loans originated before December 1, 1986, are generally assumable without restriction. Loans originated after December 1, 1986, require that the assumer show creditworthiness. Some mortgages executed from 1986 through 1989 contain language that is not enforced as a result of later Congressional action. Mortgages from that period are now freely assumable, despite any restrictions stated in the mortgage.

how much of a loan the VA will guarantee.

A veteran must apply for a Certificate of Eligibility to find out how much the VA will guarantee in a particular situation.

) Zero.

If a loan is fully amortizing, its loan balance is zero at the end of the loan term.

The buyer gives the seller a mortgage and note as part of the purchase price of the property.

With a purchase money mortgage, the borrower gives a mortgage and note to the seller to finance some or all of the purchase price of the property. The seller in this case is said to ‘take back’ a note, or to ‘carry paper,’ on the property.

hypothecation.

The process of securing a loan by pledging a property without giving up ownership of the property is called hypothecation.

The borrower gives the lender a note and a mortgage in exchange for loan funds.

When a borrower gives a note promising to repay the borrowed money and executes a mortgage on the real estate for which the money is being borrowed as security, the financing method is called mortgage financing.

The trustor conveys title to a trustee in exchange for loan funds from the beneficiary.

A deed of trust conveys title to the property in question from the borrower (trustor) to a trustee as security for the loan. The trustee is a third party fiduciary to the trust. While the loan is in place, the trustee holds the title on behalf of the lender, who is the beneficiary of the trust.

title-theory state.

States that regard the mortgage document as a conveyance of ownership from the mortgagor to the mortgagee are called title-theory states.

usury.

Many states have laws against usury, which is the charging of excessive interest rates on loans. Such states have a maximum rate that is either a flat rate or a variable rate tied to an index such as the prime lending rate.

$7,500.

A point is one percentage point of a loan amount. Thus, 2.5 points on a $300,000 loan equal (.025 x $300,000), or $7,500.

an amortized loan is paid off over the loan period.

Amortized loans retire the principal balance over the loan period. If a loan does not do this, one must make a balloon payment at the end of the loan term to complete the loan payoff.

it is a negotiable instrument.

A promissory note is a negotiable instrument, which means the payee may assign it to a third party. The assignee would then have the right to receive the borrower’s periodic payments.

may be required to execute a release of mortgage document.

Lenders may be required to release the mortgage or trust document to the borrower when the borrower has paid off the loan and all other sums secured by the document. The release clause, also known as a defeasance clause, may specify that the mortgagee will execute a satisfaction of mortgage (also known as release of mortgage and mortgage discharge) to the mortgagor.

an appraisal report.

Loan underwriting is the process of assessing the lender’s risk in giving a loan. Mortgage underwriting includes: evaluating the borrower’s ability to repay the loan; appraising the value of the property offered as security; and determining the terms of the loan.

the ability to re-pay, the value of the collateral, and the profitability of the loan.

A lender assesses risks by examining, or qualifying, both borrower and property. In qualifying a borrower, an underwriter weighs the ability of the borrower to repay the loan. In qualifying a property, an underwriter assesses the ability of the property value to cover potential losses. In this evaluation, a lender requires that the appraised value of the property be more than adequate to cover the contemplated loan and costs. Finally, the loan must make money for the lending organization as a basic business precept.

they want to ensure there is more than enough collateral to cover the loan amount.

Without an ample difference between the property value and the loan amount, a drop in property values could cause the loan balance to exceed the collateral itself. This greatly increases the risk of a loan loss should the borrower default since the balance could not be completely recovered in a foreclosure sale.

consider the income of a spouse in evaluating a family’s creditworthiness.

The Equal Credit Opportunity Act (ECOA) requires a lender to evaluate a loan applicant on the basis of that applicant’s own income and credit rating, unless the applicant requests the inclusion of another’s income and credit rating in the application. In such a case, a lender may not discount or disregard income from part-time work, a spouse, child support, alimony, or separate maintenance.

insure the buyer has the earning power to make the loan payments.

Both the income and debt ratios in borrower qualification quantify how much a borrower can safely afford to pay on a mortgage loan. The income ratio focuses on the borrower’s earning power.

debt payments divided by gross income.

The debt ratio formula is (debt obligations) ÷ (income).

the parties complete all loan origination documents and the loan is funded.

Closing of a mortgage loan normally occurs with the closing of the real estate transaction. At the real estate closing, the lender typically has deposited the funded amount with an escrow agent, along with instructions for disbursing the funds. The borrower deposits necessary funds with the escrow agent, executes final documents, and receives signed copies of all relevant documents.

Truth-in-Lending laws and Regulation Z.

Regulation Z, which implements the Truth-in-Lending Act, applies to all loans secured by a residence. It does not apply to commercial loans or to agricultural loans over $25,000. It prescribes requirements to lenders regarding the disclosure of costs, the right to rescind the credit transaction, advertising credit offers, and penalties for non-compliance with the Truth-in-Lending Act.

The Equal Credit Opportunity Act.

ECOA prohibits discrimination in extending credit based on race, color, religion, national origin, sex, marital status, age, or dependency upon public assistance.

the Real Estate Settlement and Procedures Act.

RESPA is a federal law which aims to standardize settlement practices and ensure that buyers understand settlement costs. RESPA applies to purchases of residential real estate (one- to four-family homes) to be financed by ‘federally related’ first mortgage loans. In addition to imposing settlement procedures, RESPA provisions prohibit lenders from paying kickbacks and unearned fees to parties who may have helped the lender obtain the borrower’s business.

Buying securities, changing the discount rate, and controlling banking reserves.

The Federal Reserve System regulates the money supply by means of three methods: selling or re-purchasing government securities, primarily Treasury bills, changing the reserve requirement for member banks; changing the interest rate, or discount rate, the system charges member institutions for borrowing funds from the Federal Reserve System.

It cycles funds back to primary lenders so they can make more loans.

Secondary mortgage market organizations buy pools of mortgages from primary lenders and sell securities backed by these pooled mortgages to investors. By purchasing loans from primary lenders, the secondary market returns funds to the primary lenders, thereby enabling the primary lender to originate more mortgage loans.

Fannie Mae, Freddie Mac, and Ginnie Mae.

As major players in the secondary market, the Federal National Mortgage Association (FNMA, ‘Fannie Mae’), Government National Mortgage Association (GNMA, ‘Ginnie Mae), and Federal Home Loan Mortgage Corporation (FHLMC, ‘Freddie Mac’) tend to set the standards for the primary market. FHA, VA, and the Federal Reserve are not organizations in the secondary mortgage market.

It purchases FHA-backed and VA-backed loans.

Fannie Mae buys conventional, FHA-backed and VA-backed loans; gives banks mortgage-backed securities in exchange for blocks of mortgages; and sells bonds and mortgage-backed securities. It does not guarantee, insure, or originate loans.

The FHA provides insurance for the mortgage.

FHA does not guarantee or originate loans.

It guarantees loans made by approved lenders.

The Veterans Administration (VA) offers loan guarantees to qualified veterans. The VA partially guarantees permanent long-term loans originated by VA-approved lenders on properties that meet VA standards. The VA’s guarantee enables lenders to issue loans with higher loan-to-value ratios than would otherwise be possible.

the loan payments gradually increase.

Graduated payment mortgages allow for smaller initial monthly payments which gradually increase. The interest rate remains fixed as does the loan term.

(c) Private mortgage insurance

If a loan’s LTV ratio is too high, a lender may require that the borrower purchase private mortgage
insurance, commonly called PMI. This insurance secures whatever portion of the loan amount takes the
LTV ratio above the typical ratio limit – which is usually 80% of the property’s value. This protects the
lender from the borrower’s default – which can become more likely if the borrower has very little equity in
the property.

the borrower pays additional interest at the onset in order to obtain a lower interest rate.

A buydown loan entails a prepayment of interest on a loan. The prepayment effectively lowers the interest rate and the periodic payments for the borrower. Buydowns typically occur in a circumstance where a builder wants to market a new development to a buyer who cannot quite qualify for the necessary loan at market rates.

(d) Agribusinesses

The Federal Agricultural Mortgage Corporation, or Farmer Mac. Farmer Mac (FAMC) is a federal agency
whose central function is to increase the availability and affordability of credit for American agriculture
and American rural communities.