Real Estate Finance Workbook

Second Edition

Real Estate Finance Workbook

Texas

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional advice. If legal advice or other expert assistance is required, the services of a competent professional should be sought.

President: Dr. Andrew TemteChief Learning Officer: Dr. Tim SmabyExecutive Director, Real Estate Education: Melissa Kleeman-MoyDevelopment Editor: Kari Domeyer

TEXAS REAL ESTATE FINANCE WORKBOOK SECOND EDITION©2015 Kaplan, Inc.Published by DF Institute, Inc., d/b/a Kaplan Real Estate Education332 Front St. S., Suite 501La Crosse, WI 54601

All rights reserved. The text of this publication, or any part thereof, may not be reproduced in any manner whatsoever without written permission from the publisher.

Printed in the United States of America

ISBN: 978-1-4754-2841-4PPN: 2138-9102

iii

Contents

U N I T 1

Financing Relationships and Instruments of Real Estate Finance 1Key Points—Unit 1 2

Lecture Outline and Notes 2

Unit 1 Quiz 19

Unit 1 Quiz Answers 20

U N I T 2

Real Estate Financing Programs 21Key Points—Unit 2 22


Unit 2 Quiz 30


U N I T 3

The Secondary Mortgage Market and How to Determine Return on Investment 32Key Points—Unit 3 33


Unit 3 Quiz 38


U N I T 4

Processing Real Estate Loans 40Key Points—Unit 4 41


Unit 4 Quiz 48


1

1U N I T

■■ LEARNING OBJECTIVES When you have completed this unit, you will be able to

■■ explain the differences between a mortgage banker and a mortgage broker,

■■ distinguish between lien theory and title theory, and■■ analyze the purposes and differences of a note, a deed of trust, and a

mortgage.

Study Plan

Before class:

■■ Complete the reading assignment in the Essentials of Real Estate Finance textbook listed in your syllabus.

■■ Read the Key Points (on the following page).

After class:

■■ Complete the quiz.

Financing Relationships and Instruments of Real Estate Finance

2

■■ KEY POINTS—UNIT 1

■■ Real estate involves the pledging of the real property as collateral to back up the promise to repay the loan.

■■ Property values are affected by supply and demand and other variables in the local market. When demand goes up, supply goes down. When demand goes down, supply goes up.

■■ Loan sources extend from banks, thrifts, and life insurance companies, through the bankers and brokers to the private lending companies, and finally to the sell-ers who carry back loans to sell their own properties.

■■ Real estate loans are made by primary lenders or financial intermediaries. Insti-tutional lenders play a vital part in this process.

■■ The lender has collateral or equitable rights to the property, and borrowers may retain their legal rights to their property.

■■ A trust deed is executed by the trustee to transfer a legal fee ownership note used with a deed of trust; when used to finance real estate, it is called a deed of trust.

■■ A note by itself is legal evidence of a debt; a mortgage always needs a note in order to be legally enforceable.

■■ An acceleration clause outlines the consequences of a failure to pay on the part of the mortgagor.

■■ In real estate finance, subordination involves placing an existing encumbrance or right in a lower position to a new loan secured by the same collateral.

■■ Predatory lending is defined as the practice of charging interest rates and fees that are higher than justified by risk-based financing.

■■ LECTURE OUTLINE AND NOTES

■■ Relationships in financing■■ Institutional lenders■■ Seller/owner financing■■ Equitable right of redemption/lien theory■■ Note and deed of trust (trust deed)■■ Note and the mortgage■■ Assumption versus “subject to”■■ Novation■■ Subordination clause

3Unit 1 Financing Relationships and Instruments of Real Estate Finance

I. FINANCING RELATIONSHIPS

A. Real estate as collateral

1. Real estate finance involves pledging the real property as to back up the promise to repay the loan.

2. If a borrower defaults on repayment promises, the lender is legally able to .

B. Alternate way to describe real estate finance

1. The borrower is the legal owner and retains the right of possession, while the lender secures an title to the property.

a) Equitable title confers no rights, except after loan .

C. Mortgage lending activities in the primary market

1. banks

2. banks

3. companies

D. Secondary market

1. The loans originated by primary market lenders are then packaged and sold to the secondary market (will be discussed later).

II. INSTITUTIONAL LENDERS

A. Commercial banks

1. Commercial banks primarily rely on deposits, which are better known as accounts.

2. Most commercial banks participate fully in home mortgages.

a) Kept in their own

b) Packaged and in the secondary market

c) Also compete for home loans

3. Real estate mortgage trusts (REMTs) derive income from mortgage interest, loan fees, and profits from buying and selling mortgages.

B. Mutual savings banks

1. Mutual savings banks play an important role in local real estate financing activities by providing -term mortgage loans.

2. Mutual savings banks prefer to make loans their home offices in order to supervise these loans.

4 Texas Real Estate Finance Workbook Second Edition

C. Savings associations or

1. Federal Home Loan Bank system chartered to regulate member organizations

a) Determines requirements

(1) When the Fed lowers the reserve requirements for commercial banks, more money will become available for lending.

b) Sets discount rates

(1) The discount rate is the rate the Federal Reserve charges its member banks.

(2) If the rate was raised by 25 basis points, the rate would increase by 0.25%.

(a) A basis point equals 1/100th of a percent.

c) Provides for their depositors

D. Mortgage brokers and bankers

1. Mortgage broker

a) Earns

b) Typically does not service the loan

c) Responsible for qualifying the borrower

2. Mortgage banker

a) Manages real estate loans

b) Derives income from originating and loans

c) Lacks financial capacity to lend monies to develop a package for investors

(1) Seeks the aid of a commercial banker for a short-term loan, called a line of credit

(2) Banker can draw on committed warehouse of

E. Bonds

1. Bonds can be used to secure funds for financing real estate projects in two distinct ways:

a) The issue and sale of mortgage bonds by business firms, usually corporations, to raise capital

b) The issue and sale of bonds by states, local governments, school districts, and other forms of government to finance community improvements

(1) Example: Which type of bond could a city issue to finance a new toll bridge?

2. The value of a bond will fluctuate with the money market.

3. Debentures are unsecured bonds against the general assets of a corporation.


III. FINANCE DOCUMENTS

A. Promissory note

1. A promissory note is a negotiable instrument.

2. It creates the evidence of the debt and the obligation to pay.

3. The mortgage or deed of trust is used to create the security or collateral for the note.

a) Recording the mortgage or deed of trust creates the lien on the property.

4. The note and mortgage/deed of trust include an acceleration clause allowing the lender to accel-erate the full amount owed if the borrower .

5. A note by itself is evidence of a debt; a mortgage/deed of trust always needs a note in order to be legally enforceable.

6. The note specifies the amount of money borrowed and the conditions of the debt.

a) The debt is discharged when the of the note are met.

b) If the terms are not met, a lender may choose to or foreclose.

c) A note does have to be tied to a mortgage.

d) A note without any collateral is called an note.

e) Unsecured notes are used by banks and lenders for short-term loans.

f) States differ in which document is preferred. Texas uses deeds of trust.

7. A promissory note typically includes the following:

a) Date signed

b) Participants’ identities

c) Promise to

d) Payment due dates, , and amounts

e) Acceleration clause

B. Deed of trust

1. Definition of a trust

a) A trust is a right of property, real or personal.

b) It is held by one party for the benefit of another.

c) Parties to a trust include the , who grants rights to a , who holds the property in trust for the .

2. Key points

a) A deed of trust is executed by the to convey the property as collateral.

b) A deed of trust conveys property as collateral to the name of the , who holds title on behalf of the until the terms of the loan are met.


c) The note and the deed of trust must be by the borrowers and by the trustees, with acknowledgments, until the terms of the note are fulfilled.

3. Foreclosure

a) If the loan goes into foreclosure, the trustee is empowered to on the prop-erty through the power-of-sale clause.

b) By law, lenders must give adequate and appropriate time to the property.

(1) In Texas, notice must be posted at the courthouse at least days before the auction.

(2) In Texas, the foreclosure sale is conducted in the vicinity of the courthouse.

c) The deed of trust expedites the process, making it easier to fore-close than with a mortgage.

d) Excess sale proceeds belong to the borrower/trustor.

e) Insufficient sale proceeds may result in a judgment to the lender.

f) A borrower’s legal right to redeem property after default but prior to the foreclosure sale is called the .

g) A borrower’s legal right to redeem property after the foreclosure sale is called the .

(1) Texas has a statutory right of redemption for nonpayment of tax foreclosure for two years (six months for investment properties). Texas also has a 180-day statutory right of redemption for foreclosure for nonpayment of homeowners association liens.

h) Alternatives to foreclosure include

(1) refinancing,

(2) a deed in lieu of foreclosure, or

(3) a short sale.

i) The Mortgage Forgiveness Debt Relief Act of 2007 relieves the borrower from the liability to pay taxes on any monies forgiven by a bank due to a short sale or a foreclosure. This does not apply if the loan was a purchase money mortgage.

j) Under the Troubled Asset Relief Program, HOPE NOW was created to maximize outreach efforts to homeowners at-risk of foreclosure. Homeowners can call the HOPE Hotline to talk to HUD-approved credit counselors about their options.

C. Loan payoff

1. When the loan is paid in , the trustee will convey the property to the trustor through the clause.

2. The trustee provides a deed of reconveyance.

3. A reconveyance deed proves payments are in full and are recorded by the borrower.


D. Provisions

1. Deed of trust provisions vary.

2. For their protection, lenders will the deed of trust or the mortgage.

3. Any rights in real estate owned by the borrower may be as collateral for a loan.

4. All property pledged as collateral must be described accurately.

E. Covenant of seisin

1. This is a clause stating that the trustees have title to the property described and can it as collateral.

2. Borrowers will and property being pledged as free and clear of other liens.

3. Lenders rely on title examination and to protect their interests and often require the borrower to provide a to create this protection.

F. Property taxes

1. Property taxes must be paid by the borrower.

2. Any assessments, adverse claims, and liens that may jeopardize the priority position of the mort-gage must also be paid.

3. The payment of insurance and taxes is often addressed in the loan documents and included in the borrower’s .

a) In addition to principal and interest, the lender often collects monthly amounts needed to pay annual taxes and insurance.

(1) These amounts are called impound funds or escrow funds and are determined by dividing the total amounts due each year by 12.

(2) Impound and escrow accounts may contain no more than two months of additional taxes and insurance.

G. Insurance

1. Insurance must be kept current for the protection.

H. Maintaining the physical condition

1. Maintaining the collateral and not committing waste are required by the terms of the loan docu-ments to preserve the .

I. Acceleration clause

1. This clause outlines the consequences of the borrower’s failure to pay.

a) The lender can the note due and payable.

b) The lender can collect as contracted.

c) The lender can sue or .

2. The acceleration clause is protection for the lender; it allows the lender to call the full amount due and payable.


J. Due-on-sale clause (also called alienation clause)

1. The due-on-sale clause stipulates that the borrower shall not , transfer, encumber, assign, convey, or in any manner dispose of the collateral property or any part thereof or turn over the management or operation of any business on the collateral property to any other person, firm, or corporation, without the express consent of the lender.

K. Defeasance clause

1. This clause defeats the mortgage, making it null and void when the note is paid in full.

L. Lock-in clause

1. This clause prohibits prepayment before a specified date or prohibits it altogether.

2. Lenders have prepayment penalties because they do not want buyers to prematurely pay high-yield loans.

IV. ASSUMPTION VERSUS “SUBJECT TO”

A. Assumption

1. If a loan is assumed, the buyer, along with the original borrower and any intervening buyers who have assumed the loan, become personally to the lender for full repayment.

B. “Subject to”

1. A buyer may purchase a property with an existing encumbrance but stipulate that the purchase is subject to the lien of the debt. This approach the buyer’s contingent personal liability in the event of a deficiency judgment.

C. Assumption or “subject to”

1. Whether the buyer assumes the loan or buys it subject to the lien, the original maker of the note and mortgage remains primarily responsible to the lender until the loan is paid in .

V. NOVATION

A. What is novation?

1. Novation is a technique in which the seller of a property can end personal legal liability as the originator of a real estate loan when the loan is being assumed.

a) The new borrower must qualify and be accepted by the lender, which includes a credit analysis.

b) The old borrower is then completely released from .

c) Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) loans are assumable.


VI. SUBORDINATION CLAUSE

A. Subordination

1. In real estate finance, subordination involves placing an existing encumbrance or right in a lower position to a new loan secured by the same collateral.

a) Examples include a developer who is purchasing land to develop and already has a construc-tion loan for building the homes and a land lease in which the interests of a landlord are subordinated to a new mortgage secured by a tenant in order to develop a parcel of land.

2. Lenders may be reluctant to modify or refinance a loan agreement because a secondary lienholder might move into the priority position.

VII. LIEN THEORY/TITLE THEORY

A. Key points

1. In title theory states, the mortgagor/borrower actually gives legal title to the mortgagee/lender (or some other designated individual) and retains equitable title. Legal title is returned to the mortgagor only when the debt is paid in full (or some other obligation is performed). In theory, the lender actually owns the property until the debt is paid.

2. In lien theory states, the mortgagor/borrower retains both legal and equitable title. The mort-gagee/lender simply has a lien on the property as security for the mortgage debt.

VIII. LENDER FEES

A. Interest

1. Interest is the charge to borrow money.

a) Interest is charged from the day the money is borrowed until the day the loan is paid in full.

b) The charge is typically expressed as a percentage of the total loan amount and is called the interest rate or the nominal interest or note rate.

c) Interest is charged on an annual basis. Interest rates are expressed as annual rates, although interest is often paid monthly. A 4% interest rate means that the interest charged annually will be 4% of the total principal.

d) When a loan payment is made, the interest owed is always paid first and then any balance left is paid toward the principal.

2. The formula for calculating simple interest is principal (loan amount) × interest rate = annual interest amount.

a) When two elements in the interest formula are known, the third can be calculated:

■■ principal (loan amount) × interest rate = annual interest amount

■■ annual interest amount ÷ principal (loan amount) = interest rate

■■ annual interest amount ÷ interest rate = principal (loan amount)


b) Example: What is the annual interest earned by a bank on a $50,000 loan at 9% annual interest?

■■ Solution:

— $50,000 (loan) × 0.09 (annual rate) = $4,500 (annual interest)

— Most interest payments are made on a monthly basis, so the annual interest must be divided: $50,000 (loan) × 0.09 (annual rate) = $4,500 (annual interest) ÷ 12 = $375 per month.

3. Loans are often paid back at intervals greater than one year. If a loan is paid back at the end of multiple years, multiply the amount of annual interest by the number of years for which interest is owed.

a) Example: What amount of simple interest is due at the end of two years on a $25,000 loan at 8% annual interest?

■■ Solution:

— $25,000 (loan) × 0.08 (annual rate) = $2,000 (annual interest)

— $2,000 (annual interest) × 2 (years) = $4,000

4. Loans may also be paid back at intervals less than one year. In this case, determine a monthly or daily amount of interest and multiply it by the number of months or days for which interest is owed. Six months = 6/12 = ½ or 0.5 year, and 15 months = 15/12 = ⁵⁄₄ = 1.25 years.

a) Example: What amount of simple interest would be due at the end of three months on a $6,000 loan at 10% annual interest?

■■ Solution:

— $6,000 (loan) × 0.1 (annual rate) = $600 (annual interest)

— $600 (annual interest) ÷ 12 (months) × 3 (months due) = $150

5. Interest payments may be made annually, semiannually, quarterly, or monthly. To calculate the interest payment amount, compute the annual interest amount, and then divide by the number of payments per year.

a) Example: What will be the quarterly interest payments on a loan of $5,000 at 10.5% per annum?

■■ Step 1: Compute the annual interest.

— $5,000 × 0.105 = $525

■■ Step 2: Divide by the number of payments per year.

— $525 ÷ 4 = $131.25

— The quarterly interest payments will be $131.25.

6. Practice questions

a) What is the interest on a $10,000 small business loan at 7% for three years?

(1) Solution: $10,000 × 0.07= $700; $700 × 3 = $2,100.


b) Find the amount of interest on a $6,000 office equipment loan at 8% for nine months.

(1) Solution: $6,000 × 0.08 = $480; $480 ÷ 12 × 9 = $360.

c) A homeowner borrowed $4,000 to paint her house, and the lender charged 9.5% inter-est. The loan was repaid in three months. What amount was repaid (the loan in full plus interest)?

(1) Solution: $4,000 × 0.095 = $380; $380 ÷ 12 × 3 = $95 (rounded); $4,000 + $95 = $4,095

d) What will be the quarterly interest payments for a $600,000 loan with an interest rate of 5⁷/₈%?

(1) Solution: 5⁷/₈% = 0.05875 as a decimal equivalent; $600,000 (total) × 0.05875 (rate) = $35,250 (part); $35,250 ÷ 12 × 3 = $8,812.50 or $35,250 ÷ 4 = $8,812.50.

e) A borrower wants to purchase a property valued at $277,000 and has been granted a 30-year mortgage loan equal to 75% of its value. If the interest rate is 5%, what is the amount of interest charged for the first month of the loan?

(1) Solution: The loan-to-value ratio is 75%. $277,000 × 0.75 = $207,750; $207,750 × 0.05 ÷ 12 = $865.63 (rounded).

f) Using the loan information from the previous question, what will be the homeowner’s monthly principal and interest payment if the loan payment factor is 5.37?

(1) Solution: $207,750 ÷ $1,000 × 5.37 = $1,115.62 (rounded).

g) Using the previous information, if the borrower’s monthly payment is $1,115.62, what will be the balance of the principal of the loan next month?

(1) Solution:

(a) Step 1: The monthly interest on the full principal was already computed earlier: $865.63.

(b) Step 2: Find the amount of payment that will be applied to reducing the principal: $1,115.62 total payment – $865.63 monthly interest = $249.99 amount applied to principal.

(c) Compute the new principal balance: $207,750 old principal balance – 249.99 reduction = $207,500.01 new principal balance.

(d) Note: There will be a difference of a few cents in the answer if you leave the num-bers in the calculator and perform the chain functions instead of writing down each answer, clearing the calculator, and then reentering the numbers for the next step in the problem. Greater accuracy is obtained if the numbers are left in the calculator and then the next calculation is performed.

B. Par Rate

1. Par rate is the interest rate a borrower will qualify for without any adjustment up or down.


C. Discount points

1. One discount point is equal to 1% of the loan amount.

2. Lenders charge discount points to increase on loans in which they have allowed the borrower to have a low interest rate.

a) Example: $100,000 loan for 30 years at 5% would net the lender $150,000 in interest. The same loan for 4.5% would net the lender $135,000. The lender charges 2 points or $2,000 for the lower rate to increase the yield to $137,000.

D. Loan origination

1. The loan origination is the fee charged by the lender for doing the loan paperwork, similar to a commission.

2. It is typically 1% of the loan amount.

3. Discount points and loan origination fees are charged on the , not the .

E. Prepayment penalties

1. A prepayment penalty is a charge by the lender if the loan is paid off early.

a) Excessive fees and prepayment penalties were used in subprime lending by predatory lenders.

F. Private mortgage insurance (PMI)

1. PMI is required on all conventional loans when the loan-to-value (LTV) ratio exceeds .

2. Mortgage insurance is used to protect the lender in case of default.

3. When the LTV reaches of the original value, then PMI terminates.

a) Example:

■■ Loan amount of $175,000, up-front fee is 0.75%, loan and monthly fee is 0.64%

■■ Formula for up-front: Loan amount × PMI factor (dictated by lender in real world)

■■ Formula for monthly: Loan amount × Monthly PMI factor

■■ Calculate both fees

— Upfront:

— Monthly:

4. A borrower may avoid paying a PMI premium by using a split loan or a piggy-back loan, which executes a first and second mortgage simultaneously.

a) For example: 80/10/10 split or 80/15/5 split. The first number represents the first mortgage, which remains at 80% LTV and requires no PMI. The second number represents a second mortgage that is held by the same lender but at a slightly higher rate and shorter term.


IX. SUBPRIME AND PREDATORY LENDING

A. Subprime loans

1. A higher-than-prime rate is charged because the borrower and/or the property used as security is a than a (e.g., prime rate might be 6%, while subprime is 8%).

2. The prime rate is set by each individual bank.

3. Subprime loans are packaged with prime loans and sold to investors on the secondary market.

4. A borrower with a low credit score and high debt may only qualify for a subprime loan.

5. Subprime loans often include flexible rate loans (e.g., ARMs) that adjust beyond the borrower’s ability to pay.

a) Borrowers qualify at a lower rate, and once the rate adjusts up, they often go into foreclosure.

b) Mortgage brokers and bankers receive higher fees on these loans.

6. These loans are often coupled with down payment assistance (a second mortgage), so borrowers don’t make a down payment, which makes them more likely to default.

a) Example: Subprime loan with 80% LTV

(1) Down payment (second mortgage): 20% LTV

(2) Total loan: 100% with no money from the borrower

B. Predatory lending

1. Predatory lending is an umbrella term for unfair or illegal lending practices.

a) Most often, this type of lending occurs in the subprime market.

2. Target groups include the elderly, minorities, those who are less educated, and persons who do not speak English as their first language.

3. Predatory practices include the following:

a) Making loans to borrowers who have no ability to repay

b) Urging borrowers to refinance repeatedly, when it is not in their best interest

c) Originating loans with high prepayment penalties

d) Using one set of terms at application and pressing the borrower to accept higher terms at closing

e) Offering loans with low monthly payments and a balloon payment at the end that is higher than the other payments (e.g., an interest-only loan for 30 years)

f) Offering only subprime rates to borrowers who can qualify for prime rates and terms

4. Many states now have predatory lending laws and require lenders and originators to be licensed.

a) The Secure and Fair Enforcement Mortgage Licensing Act (SAFE Act) encourages states to establish minimum standards for the licensing and registration of mortgage loan originators to provide more consumer protection and to reduce fraud.


b) All mortgage loan originators are required to register with the Nationwide Mortgage and Licensing System and Registry.

c) In Texas, The Texas Department of Savings and Mortgage Lending enforces the Texas Mort-gage Broker License Act.

X. FEDERAL AGENCIES

A. U.S. Treasury

1. The U.S. Treasury’s basic duties include

a) collecting taxes, duties, and monies paid to and due to the United States;

b) paying all bills of the United States;

c) producing currency and coinage;

d) supervising national banks and thrift institutions;

e) enforcing federal finance and tax laws; and

f) investigating and prosecuting tax evaders, counterfeiters, and forgers.

2. The U.S. Treasury collects funds from

a) social security receipts,

b) the sale of securities, and

c) federal income tax payments.

B. Federal Reserve

1. The Fed is the nation’s monetary manager.

2. The Fed’s open market operations influence the money supply and interest rates by buying and selling Treasuries.

C. Federal Deposit Insurance Corporation (FDIC)

1. The FDIC insures bank deposits for up to $250,000 for each deposit account.

2. The FDIC examines depository institutions that offer FDIC insurance.

D. Federal Housing Finance Agency (FHFA)

1. FHFA regulates Fannie Mae, Freddie Mac, and the Federal Home Loan Bank (FHLB).

E. Federal Home Loan Bank (FHLB)

1. The FHLB is designed to provide a central credit clearing facility for all member savings associa-tions and to establish rules and regulations for its members.

2. It provides fully collateralized loans to member institutions.

F. Consumer Financial Protection Bureau (CFPB)

1. The CFPB was created to protect consumers by carrying out federal consumer financial laws.

2. It includes the TILA-RESPA Integrated Disclosure rule.


a) This rule consists of two new disclosures:

(1) Loan Estimate

(2) Closing Disclosure

b) These disclosures replace the following:

(1) Good Faith Estimate

(2) Initial Truth-in-Lending Disclosure

(3) HUD-1 and final Truth-in-Lending Disclosure

c) Closing disclosure must be given no less than three business days prior to closing.

(1) The consumer is considered to have received the Closing Disclosure three business days after it is delivered or placed in the mail.

■■ If it is not personally delivered, the three-day time frame for receipt would apply and closing would be further delayed until after the expiration of the third business day thereafter (i.e., 3 business days + 3 business days = 6 business days).

d) The implementation date is August 1, 2015.

XI. FEDERAL LEGISLATION

A. Changes after the 2007/2008 recession

1. Subprime and predatory lending brought about the recession of 2007/2008.

2. The Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) had a far reaching impact on lending.

a) Anyone who originates a mortgage loan must be licensed as a mortgage loan originator.

(1) Each state is charged with creating prelicense education and licensing based on federal and state laws.

3. The Dodd-Frank Act brought major changes to consumer loan disclosures.

a) Two laws governed the disclosure of lender’s fees to consumers: the Truth-in-Lending Act/Regulation Z and the Real Estate Settlement Procedures Act (RESPA).

b) The Truth-in-Lending Act applies to all consumer lending, not just real estate, and requires lenders to disclose the total cost of obtaining credit.

(1) The annual percentage rate (APR), also known as the effective rate, expresses the rela-tionship of the total finance charge to the amount financed.

(2) The APR will be than the face rate or nominal rate because it includes fees such as origination costs and discount points.

(3) This law includes a three-day right of rescission for refinance, remodeling, and home equity loans.

(4) The right of rescission does not include the or construction loans.


(5) Price and/or APR are the only specific finance terms allowed in an advertisement with-out triggering a full disclosure requirement.

c) RESPA was intended to inform consumers purchasing real estate of the total cost of settle-ment fees.

(1) A good-faith estimate (GFE) was required to be supplied to borrowers no later than days after a loan application was made.

■■ Prepaid interest is not shown on the GFE.

■■ Lender origination fee is limited to 1%.

■■ Origination fee may differ by up to 10% at closing.

(2) The HUD-1 Settlement Statement was supplied to borrowers at closing to show the final costs.

4. The Consumer Financial Protection Bureau (CFPB) was charged with integrating both laws into two disclosure forms.

a) The new Loan Estimate form must be provided to the borrower within three business days after making a loan application.

b) The new Closing Disclosure form must be provided to the borrower three days prior to closing.

c) This integrated mortgage disclosure rule is effective as of August 1, 2015.

B. Equal Credit Opportunity Act (ECOA)

1. The Equal Credit Opportunity Act (ECOA) is Title VII of the Consumer Protection Act. Its primary purpose is to prevent discrimination by lenders and ensure that all qualified persons have equal access to credit.

2. ECOA prohibits lenders from denying credit to qualified borrowers based upon the borrower’s

a) ,

b) color,

c) religion,

d) national origin,

e) ,

f) marital status,

g) age, or

h) dependency on public assistance.

3. The basic provisions of ECOA include the following:

a) The lender may not ask whether the applicant is or widowed.

b) However, the lender may ask whether the borrower is married, , or separated.


c) The lender may not ask about the receipt of alimony or child support, unless the borrower intends to use such income to for the loan. The lender may ask about any obligation to pay alimony or child support.

d) The lender may not seek any information about birth control practices, childbearing capa-bilities, or intentions of the borrower or co-borrower.

e) The lender may not discount or exclude any income because of the source of that income.

f) The lender must report information about married couples separately in the name of each spouse.

g) The lender may not request information about the spouse or former spouse of the appli-cant, unless that person will be contractually liable for repayment or if the couple lives in a property state.

h) The lender ask about the race or national origin of the applicant, but the borrowers can to answer without fear of jeopardizing the loan.

C. Community Reinvestment Act (CRA)

1. CRA provides that financial institutions meet the credit needs of all citizens in a community.

2. CRA regulates lenders and requires them to invest in local communities and neighborhoods.

D. Interstate Land Sales Full Disclosure Act (ILSFDA)

1. ILSFDA applies to subdivisions with or more lots.

2. A developer must provide HUD with a statement of record that includes explanations and descriptions of existing and proposed encumbrances, improvements, utilities, schools, recreation areas, roads, and all services to be provided for the residents’ use.

3. A property report must be delivered to the buyers prior to the purchase of the property.

4. If the report is not received within the allotted time, the buyers may legally rescind their con-tract at any time.

E. Home Mortgage Disclosure Act (HMDA)

1. All mortgage originators are required to report information relating to income level, racial char-acteristics, and gender of mortgage applicants.

a) This includes loans originated as well as applications rejected.

F. Housing and Economic Recovery Act of 2008 (HERA)

1. HERA helps first-time homebuyers by providing a direct tax credit of 10%, up to $7,500.

G. Neighborhood Stabilization Program (NSP)

1. NSP provides funds for

a) rehabilitating abandoned homes,

b) demolishing blighted structures, and

c) purchasing foreclosed homes.


H. Usury

1. Usury is charging an interest rate higher than the maximum rate allowed.

a) Usury laws are set at the state level.

XII. TEXAS FINANCING PROGRAMS

A. Programs for Texas veterans

1. Texas Veterans Land Board (VLB)

a) Provides low-interest, long-term loans to Texans to purchase land

2. Veterans Housing Assistance Program (VHAP)

a) Provides financing of up to $417,000 toward the purchase of a home

b) Can only be used as a first lien on a primary residence

c) Two married, eligible veterans may have only one active VHAP loan at a time

3. Veterans Home Improvement Program (VHIP)

a) Provides low-cost loans of up to $25,000 for up to 20 years to make substantial repairs to an existing primary residence

(1) For loans of less than $10,000, the maximum term is 10 years.

19

UNIT 1 QUIZ

1. The secondary mortgage market is made up of all of the following entities EXCEPTa. Fannie Mae.b. Freddie Mac.c. Federal Home Loan Bank.d. Sallie Mae.

2. Primary markets include all of the following EXCEPT a. savings banks.b. commercial banks.c. life insurance companies.d. Fannie Mae.

3. What is the main source of capital for the funds needed by a commercial bank?a. Checking accounts b. Savings associationsc. Federal Reserve depositsd. Interbank loans

4. The primary purpose of the Equal Credit Oppor-tunity Act (ECOA) is toa. prevent discrimination by lenders.b. avoid discrimination by sellers.c. provide mortgage loans to low-income

families.d. require the full disclosure of all costs of

borrowing.

5. A mortgage broker may do all of the following EXCEPTa. receive a placement fee.b. service the loan.c. investigate the soundness of the

investment.d. bring the borrower and the lender together.

6. A buyer couple is working with a lender who will find them the best financing, see the loan through closing, and also service the loan. This lender is aa. mortgage banker.b. mortgage broker.c. financial fiduciary.d. financial investor.

7. A good-faith estimate (GFE) of all closing costs must be given to borrowers within three days of application according to which congressional act?a. Real Estate Settlement Procedures Actb. Equal Credit Opportunity Actc. Truth-in-Lending Actd. Home Mortgage Disclosure Act

8. Which clause outlines the consequences of fail-ure to pay on the part of the mortgagor?a. Release clauseb. Developer’s clausec. Subordination claused. Acceleration clause

9. A subprime loan hasa. a higher interest rate and fees.b. an interest rate below the prime rate.c. an interest rate below the current market

rate.d. a lower interest rate and fees.

10. The Equal Credit Opportunity Act (ECOA) prohibits discrimination by lenders on the basis of all of the following EXCEPTa. sexual orientation.b. religion.c. marital status.d. dependence on public assistance.

20

UNIT 1 QUIZ ANSWERS

1. d2. d3. a4. a5. b6. a7. a8. d9. a

10. a

21

2U N I T


■■ compare various types of loans,■■ differentiate between home equity and a home equity line of credit

(HELOC), and■■ evaluate the guidelines for the Federal Housing Administration (FHA)

program and the U.S. Department of Veterans Affairs (VA) loan guarantee.

Study Plan

Before class:



After class:


Real Estate Financing Programs

22


■■ Adjustable-rate mortgages (ARMs) are tied to an index and usually have a life-time margin cap and adjustment cap.

■■ A home equity line of credit (HELOC) provides homeowners with a line of credit against the equity in their home.

■■ Private mortgage insurance (PMI) is required on all conventional loans when the loan-to-value (LTV) ratio exceeds 80%.

■■ A graduated payment mortgage has lower payments in the early years of a loan; payments increase gradually until they are sufficient to fully amortize the loan.

■■ Conventional conforming loan products meet Fannie Mae’s and Freddie Mac’s qualifying guidelines.

■■ A blanket mortgage is when a lender requires a borrower to pledge more than one property as collateral to back up a mortgage.

■■ A package mortgage includes collateral, fixtures, and personal property.■■ The FHA operates from self-generated income through the proceeds of mort-

gage insurance premiums paid by borrowers.■■ The VA guarantees the top 25% of VA loans.


■■ Leverage ■■ Fixed-rate mortgage■■ Adjustable-rate mortgage (ARM)■■ Graduated payment mortgage (GPM)■■ Blanket mortgage■■ Package mortgage ■■ Reverse mortgage■■ Home equity loan■■ Home equity line of credit (HELOC)■■ Federal Housing Administration (FHA) insured ■■ VA loan guarantees loans ■■ Seller/owner financing

23Unit 2 Real Estate Financing Programs

I. LEVERAGE

■■ Financial leverage is when borrowed funds are used to acquire property.

II. CONVENTIONAL CONFORMING LOAN PRODUCTS

A. Conform to Fannie Mae/Freddie Mac qualifying guidelines

1. Conventional loans are not backed by the government so those with loan-to-value ratios (LTV) over 80% require PMI.

2. Principal, interest, taxes, property insurance, private mortgage insurance, and any applicable condo or homeowners association fees shall not exceed 28% of the borrower’s gross monthly income.

a) All of these plus monthly debts may not exceed 36% of the borrower’s gross monthly income.

3. Borrowers must have

a) credit, and

b) stable .

B. Fully amortized fixed-rate mortgage

1. The interest rate remains fixed over the of the loan.

a) The borrower is less likely to default because all of the payments are the same for the term of the loan.

b) Traditionally, the most popular type of loan is a 30-year fixed rate mortgage.

C. Partially amortized mortgage

1. Equal payments of principal and interest

2. Lump-sum payment

D. Term/straight mortgage

1. payments until maturity or at end of term

2. Entire principal paid back in one lump sum

E. Adjustable-rate mortgage (ARM)

1. Tied to an index

a) There is an adjustment period.

b) The initial rate is often called the teaser rate.

c) The note rate, or the calculated rate, is the rate.

d) The qualifying rate depends on the market.


e) The is the starting point for adjusting a borrower’s applicable interest rate. The most commonly used are

(1) the one-year Constant Maturity Treasury Index (CMT),

(2) the 11th District Court of Funds Index (COFI), and

(3) the London Interbank Offered Rate (LIBOR).

2. Margin

a) The margin is added by each lender as a rate to the index at every adjust-ment period to derive the new note rate.

(1) Interest rate caps are important because they govern how much the payment can increase or at the adjustment period.

3. Home Affordable Refinance Program (HARP)

a) HARP is a federal loan program that allows a homeowner to refinance from an ARM to a fixed-rate loan, even if the owner has little or no equity.

4. Practice questions

a) Question 1: What is the interest rate for the first year of the loan?

■■ Rate = index + margin

■■ Rate = 5.5% + 2% = 7.5%

b) Question 2: After the first year, the three-year Treasury bond is earning 6.5%. What is the new rate?

■■ Rate = index + margin

■■ Rate = 6.5% + 2% = 8.5%

■■ Increase of 1% does not exceed 1.5% adjustment cap

F. Graduated payment mortgage (GPM)

1. This loan offers lower payments in the early years of the loan.

2. The payments increase gradually until they are sufficient to amortize the loan fully.

3. It may have negative amortization (the payments do not cover the amount of interest due) in which the balance will increase, not decrease.

a) This is more likely to create borrower default.

G. Blanket mortgage

1. A lender may require a borrower to pledge more than one property as collateral to back up a mortgage.

2. When or more properties are as collateral for loan, it is often necessary to include a clause.

3. This release clause enables a property or parcel of a property to be from the lien of a blanket mortgage.


H. Package mortgage

1. A package mortgage includes collateral, fixtures, and personal property.

2. The advantage to the borrower is that these items are paid over the life of the loan.

3. The disadvantage to all parties is that the property may not at the amount needed, and many lenders will not allow property to be included.

I. Reverse annuity mortgage

1. A reverse annuity mortgage is designed for seniors who own their homes and .

a) Homeowners over 62 years of age can use the equity in their home.

b) The lender pays the borrower a fixed annuity.

c) The property is pledged as collateral and the monies may be paid

(1) monthly,

(2) as an initial lump sum, or

(3) as a line of credit.

J. Participation mortgage

1. There are three types of mortgage participation:

a) Partnership among several mortgages

b) Teaming of several mortgagors

c) Partnership between a mortgagee and a mortgagor

(1) The lender may accept a higher loan-to-value ratio, lower the interest rate, or make other concessions in return for an equity position in the project.

K. Construction/interim mortgage

1. Made available in installments (obligatory advances) as improvements are completed

2. Typically adjustable-rate/short-term loans

III. HOME EQUITY AND HOME EQUITY LINE OF CREDIT (HELOC)

A. Definition of equity

1. A property’s market value less any debts against it is known as the owner’s .

B. Home equity loan

1. A home equity loan is based on the in the home plus the equity loan, called a com-bined loan-to-value ratio (CLTV), which is determined by the lender for the percentage the homeowner can receive.

a) It establishes the equity loan as a second or junior mortgage.

b) Closing costs can be rolled into the loan.

c) One lump sum payment is made at closing.


d) The advantage is that the homeowner can use equity money .

e) The disadvantage is when the home is sold, the borrower will have money.

C. Home equity line of credit (HELOC)

1. A HELOC uses the same criteria as a home equity loan.

2. There is no lump sum payment; the borrower has a credit line.

a) The borrower may use the equity up to the amount of the loan.

IV. GOVERNMENT LOANS

A. Federal Housing Administration (FHA)—insures lenders against loss

1. History

a) FHA was established under the provisions of the National Housing Act of 1934.

b) It was organized to stimulate new jobs by increasing activities in the construction industry; to stabilize the real estate mortgage market; and to facilitate the financing of repairs, additions, and sales of existing homes.

(1) The construction industry is vital to the country’s economic well-being and thus is important to the real estate industry.

c) FHA designates qualified lenders to underwrite loans directly without submitting applica-tions to the FHA.

(1) These lenders participate in the direct endorsement program.

2. Overview

a) FHA operates from self-generated income through the proceeds of mortgage premiums (MIP) paid by .

(1) MIP acts like private mortgage insurance and is used to protect the lender against loss if the borrower defaults.

b) FHA loans are often used for buyers.

c) FHA loans work well for borrowers who have credit scores or limited cash for the payment.

d) FHA Section 203(loans make it possible for the purchaser to obtain a single long-term loan to cover both the acquisition and the rehabilitation of a property.

(1) This is a good option when the seller is not willing to make the repairs before closing and the buyer has limited cash for the payment.

e) FHA loans can be used to purchase manufactured housing.

3. Underwriting guidelines

a) Maximum loan limits set

b) Down payment of

(1) Borrower’s own funds


(2) Family member

(3) Grant from local, state, or nonprofit down payment assistance program that does not receive any financial benefit from the transaction

c) Income qualification based on two , which are higher than conventional ratios

(1) Housing ratio

(2) Total obligation ratio

■■ Housing ratio could be raised if the borrower has other compensating factors.

d) Mortgage insurance premium (MIP)

(1) Purchase-money loans and refinances have an up-front MIP of .

(2) No up-front MIP is charged on loans.

(3) The annual premium, which is included in the monthly payment, is 1¼% with a mini-mum down payment of 3½%.

(a) Example

(4) The borrowers have a secured a loan of $260,000 and wish to finance the up-front MIP, which is 1¾%. Calculate the amount that will be added to the loan.

■■ $260,000 × 0.0175 =

(5) Calculate the monthly MIP. The factor is 1¼%.

■■ $260,000 × 0.0125 = 3250 ÷ 12 =

B. VA loan guarantee program— lenders against loss on loans to veterans

1. Loan criteria

a) Up to a 100% loan-to-value ratio is allowed.

b) Individuals must be veterans, active National Guard members, or retired military reserve members.

(1) Parents of veterans are not eligible.

2. VA maximum loan amounts

a) The maximum loan amount is $104,250 or of the current Freddie Mac loan limit of $417,000.

b) Lenders consider the guaranteed amount the same as 25% down, so they will lend the vet-eran times the guaranty amount.

c) If the borrower defaults, the VA guarantees the lender against the loss.

3. Certificate of eligibility

a) Veterans receive their certificate of eligibility with their from the service.

b) There is no time limit on the entitlement, which remains in effect until it is completely up.


c) The DD214 (certificate of release or dischargmay be obtained through the local VA office or ordered .

d) Once a loan is paid off, the veteran’s eligibility is .

4. Certificate of reasonable value (CRV)

a) VA requires a VA-assigned real estate appraiser.

b) The appraiser issues a certificate of value (CRV).

(1) Good for months for existing properties

(2) Good for months for new construction

(3) May not be

c) If the sale is made subject to the CRV and the appraisal comes in than sales price, the following may occur:

(1) The buyer can make up the difference in .

(2) The seller can accept the amount as the sales price.

(3) The buyer and the seller can .

(4) The transaction can be .

d) If a home is purchased for an amount in excess of the maximum guaranteed VA loan amount with no money down, the difference is required to be paid in .

5. Qualifying requirements

a) The qualifying ratio is 41% of gross monthly income.

(1) Includes principal, interest, taxes, insurance, utilities, repairs, and other obligations

b) income is based on geographic region and family size.

c) Acceptable compensating factors are the following:

(1) Excellent history

(2) use of consumer credit

(3) Minimal consumer debt

(4) Long-term

(5) Significant liquid assets

(6) Sizable payment

(7) Existence of equity in refinancing loans

(8) Little or no increase in shelter expense

(9) High income

(10) Low debt-to-income ratio


(11) Tax credits for child care

(12) Tax benefits of home

6. Funding fee

a) It is used to cover expenses in case of borrower .

b) It may be paid in or .

c) Financing of funding fee may exceed the CRV.

d) Total financing is not to exceed allowable loan amount.

e) Funding fee is required for all loans, except the following:

(1) Veterans receiving compensation for service-related disabilities

(2) Veterans receiving retirement pay in lieu of disability compensation

(3) Spouses of veterans who died in service or died from service-connected disabilities

(4) In some cases, when a large down payment is made

V. SELLER/OWNER FINANCING

A. Sellers as lenders

1. This is when sellers finance a portion of the sales price with carryback/installment loans.

2. The seller may be the only lender or may be in the second position.

3. Sellers can use a contract for deed/land contract or purchase money mortgages.

4. An appraisal is not required with seller financing.

30

UNIT 2 QUIZ

1. Traditionally, the MOST popular type of loan isa. 15-year fixed rate.b. 30-year fixed rate.c. adjustable rate.d. interest only.

2. To avoid being required to purchase private mortgage insurance, a borrower will have to make a down payment of a. 20%.b. 5%.c. 10%.d. 15%.

3. A reverse annuity mortgage (RAM) is particu-larly beneficial toa. elderly homeowners.b. first-time homebuyers.c. investors.d. rehab specialists.

4. FHA protects itself against the risk of defaulting borrowers by requiringa. a higher rate of interest.b. a larger down payment.c. mortgage insurance premiums.d. low qualifying ratios.

5. The 3½% down payment on an FHA loan can come from any of the following EXCEPTa. the borrower’s savings.b. a gift from a family member.c. the seller.d. a grant from a nonprofit assistance program.

6. A borrower has a $100,000 mortgage loan at 8%. Using the rate factor of 7.34, the principal and interest (P&I) payment on this loan would be $734. However, the lender has agreed that the P&I payment will be $600 for the first year, $650 for the second year, and increasing incre-ments through the fifth year. What type of loan does this borrower have?a. Graduated-payment mortgageb. Adjustable-rate mortgagec. Fully amortized loand. Term loan

7. Even with no down payment, VA loans are acceptable to lenders becausea. the VA guarantees the first 25% of the

allowable loan.b. they are insured loans.c. interest rates are much higher.d. it is faster to obtain loan approval.

8. The amount of entitlement for which the vet-eran is eligible is shown ona. VA form 1064.b. the DD214.c. the certificate of eligibility.d. the discharge papers.

9. If the certificate of reasonable value (CRV) is less than the contract sales price, the seller has the option toa. require the veteran to pay the contract

price.b. accept the CRV value as the sales price.c. carry back a second mortgage for the

difference.d. submit an independent appraisal.

10. All of the following are true of a home equity loan EXCEPTa. the equity loan is a second mortgage.b. closing costs cannot be rolled into the loan.c. one lump sum payment is made at closing.d. the homeowner can use equity money now.

31

UNIT 2 QUIZ ANSWERS

1. b2. a3. a4. c5. c6. a7. a8. c9. b

10. b

U N I T

32

3U N I T


■■ compare and contrast the major participants in the secondary market,■■ discuss Fannie Mae and Freddie Mac underwriting standards, and■■ analyze the role of Ginnie Mae in the secondary market.

Study Plan

Before class:



After class:


The Secondary Mortgage Market and How to Determine Return on Investment

33


■■ The secondary market deals with the buying and selling of real estate mort-gages (including loans made using a deed of trust).

■■ When mortgages are purchased from primary lenders, the money generated replenishes the supply needed for continued lending activities.

■■ When mortgages are sold to investors, funds are recirculated nationally.■■ Major participants in the secondary market are Fannie Mae, Freddie Mac, and

Ginnie Mae.■■ Fannie Mae and Freddie Mac are government-sponsored enterprises that have

dominated the market for conforming loans.■■ Fannie Mae was established to expand the flow of mortgage money.■■ Freddie Mac buys mortgages that meet stated guidelines and product stan-

dards, packages the loans, and sells the securities to investors.■■ Ginnie Mae provides affordable housing using mortgage-backed securities.■■ Other players in the secondary mortgage market include FHLB, Farmer Mac,

and REMICs.


■■ Major participants in the secondary market■■ Fannie Mae (Federal National Mortgage Association or FNMA) and Freddie Mac

(Federal Home Loan Mortgage Corporation or FHLMC)■■ Ginnie Mae (Government National Mortgage Association or GNMA)■■ Federal Home Loan Bank (FHLB)■■ Federal Agricultural Mortgage Corporation (Farmer Mac)■■ Real estate mortgage investment conduits (REMICs)■■ Real estate investment trusts (REITs) ■■ Return on investment


I. MAJOR PARTICIPANTS IN THE SECONDARY MARKET

A. Fannie Mae (Federal National Mortgage Association or FNMA) and Freddie Mac (Fed-eral Home Loan Mortgage Corporation or FHLMC)

1. Fannie Mae and Freddie Mac are government-owned enterprises that are regulated by the Fed-eral Housing Finance Agency (FHFA).

2. Fannie Mae was created for the sole purpose of providing a secondary market for qualified loans.

3. Freddie Mac was originally created as a secondary mortgage market for loan products originated by saving and loan associations.

4. Fannie Mae and Freddie Mac have the following loan purchase requirements:

a) Buy mortgages that meet stated

b) Package loans into mortgage-backed (MBSs)

c) Sell the securities to on Wall Street

5. Fannie Mae and Freddie Mac have the following underwriting guidelines:

a) Loan limits are set annually.

b) Any loan with an LTV ratio of more than 80% must have insurance (PMI).

c) A 20% down payment can be entirely from funds.

d) Sellers can contribute up to with 5% down and up to with 10% down.

B. Ginnie Mae (Government National Mortgage Association or GNMA)

1. Mission is to provide affordable housing

a) Ginnie Mae does not buy or loans; it issues certificates that are backed by the full faith and credit of the U.S. government.

b) Ginnie Mae guarantees that investors will receive timely payments of principal and interest on mortgage-backed securities (MBSs).

c) These MBSs are backed by the FHA, Rural Housing Service (RHS), VA, and Office of Native American Programs (ONAP).

2. Mortgage-backed securities

a) Pools of mortgages used as for the issuance of securities

b) certificates

c) Principal and interest being passed through to the

C. Federal Home Loan Bank (FHLB)

1. The FHLB supports housing ; its purpose is to serve as a reliable source of for its membership.

35Unit 3 The Secondary Mortgage Market and How to Determine Return on Investment

D. Federal Agricultural Mortgage Corporation (Farmer Mac)

1. Its mission is to improve the availability of long-term credit at stable interest rates to America’s farmers, ranchers, rural homeowners, businesses, and communities.

2. This is accomplished by purchasing qualified loans from agricultural mortgage lenders.

3. It provides them with funding to make additional loans.

E. Real estate mortgage investment conduits (REMICs)

1. REMICs are companies that hold pools of mortgages that back up collat-eralized by the mortgage flow.

2. REMICs contributed to the opening of general capital markets to real estate lenders.

3. Fannie Mae, Freddie Mac, and Ginnie Mae all offer REMIC securities.

F. Real estate investment trusts (REITs)

1. REITs are designed to provide vehicles by which real estate investors can enjoy the special income tax benefits already granted to mutual funds and other regulated investment companies.

a) To sell interests in a REIT, a salesperson needs a securities license.

2. REITs derive income using the net profits from the rental and sale of rental properties.

a) REITs earn money from apartments, houses, offices, and shopping centers.

II. RETURN ON INVESTMENT

A. Investors

1. Investors invest in what they believe will get them the greatest return.

a) Depending on what is happening in a given market, investors may choose the stock market, real estate, metals, precious stones, and so forth.

b) Typically, the following two criteria are used:

(1) Return on the investment

(2) The investor’s knowledge of the investment

2. Investors want to know what their return will be.

3. The formula for determining the rate of return on a real estate investment is the following:

■■ Net operating income (NOI) ÷ investment amount = rate of return

■■ NOI ÷ rate of return = investment amount

■■ Investment amount × rate of return = NOI

a) Examples

(1) What is the investment amount of an apartment building that is expected to produce an annual NOI of $14,000 and has a 10% rate of return?

■■ $14,000 ÷ 10% = $140,000


(2) What is the rate of return of an apartment building with an investment amount of $140,000 and NOI of $14,000?

■■ $14,000 ÷ $140,000 = 10%

(3) What is the NOI if the rate of return is 10% with an investment amount of $140,000?

■■ $140,000 × 10% = $14,000

b) Practice questions

(1) If an investor had $120,000 to invest and wanted a 10% return on the investment, what net income would a property have to produce to meet the required return?

(a) Answer choices:

■■ $9,000

■■ $10,000

■■ $11,000

■■ $12,000

(b) Solution: $120,000 × 0.1 = $12,000.

(2) Assume that a property produces an NOI of $26,250 per year. What would the rate of return be if the investment amount was $210,000?

(a) Answer choices:

■■ 0.125%

■■ 12.5%

■■ 15.2%

■■ 26.25%

(b) Solution: $26,250 ÷ $210,000 = 0.125 or 12.5%.

(3) A buyer paid $175,000 for an older fourplex that produced an annual NOI of $16,850. What is the rate of return on the amount of the investment?

(a) Answer choices:

■■ 0.96%

■■ 9.6%

■■ 10.39%

■■ 29.48%

(b) Solution: $16,850 ÷ $175,000 = 0.096 or 9.6%.

37Unit 3 The Secondary Mortgage Market and How to Determine Return on Investment

(4) An investor bought a parcel of commercial real estate for $820,000 and wants a 12% capitalization rate. What annual NOI does the investor expect?

(a) Answer choices:

■■ $82,000

■■ $89,400

■■ $96,000

■■ $98,400

(b) Solution: $820,000 × 0.12 = $98,400.

(5) The effective gross income from an apartment building is $270,500, and annual expenses are $140,000. If the owner expects to get a 9% return on the investment, what is the amount invested in the property?

(a) Answer choices:

■■ $1,450,000

■■ $1,540,000

■■ $1,555,555

■■ $3,005,555

(b) Solution: First, compute the net income: $270,500 – $140,000 = $130,500. Ask, $130,500 is 9% of what amount? Use the formula NOI ÷ rate of return = investment amount. $130,500 ÷ 0.09 = $1,450,000.

38

UNIT 3 QUIZ

1. Fannie Mae and Freddie Mac are able to replen-ish their own funds, enabling them to purchase loans from primary lenders bya. borrowing from the Federal Reserve Bank.b. borrowing from each other.c. requesting grant funds through HUD.d. selling mortgage-backed securities.

2. Lenders may order a mandatory or standby com-mitment to sell loans to Fannie Mae through thea. federal open market.b. stock exchange.c. free market auction.d. administered price system.

3. Which statement regarding Fannie Mae guide-lines is TRUE?a. Loans with a higher than 80% LTV ratio

require PMI.b. Maximum loan limits are set annually by

each individual lender.c. The seller may contribute up to 6% toward

the borrower’s closing costs on all loans.d. Homebuyer education and counseling is

required of all borrowers.

4. The BEST description of a nonconforming loan is one thata. exceeds loan limits set annually by Fannie

Mae and Freddie Mac.b. does not meet Fannie Mae and Freddie Mac

qualifying guidelines.c. is restricted to four family units.d. is limited to low-income housing.

5. All of the following are government-sponsored enterprises EXCEPT a. Fannie Mae.b. Freddie Mac. Ginnie Mae. d. Federal Home Loan Bank.

6. Freddie Mac was originally chartered toa. compete with Fannie Mae.b. provide a secondary market for conven-

tional loans (not FHA or VA).c. purchase government loans.d. provide mortgage loans for qualified

applicants.

7. The agency established to ensure the financial safety and soundness of Fannie Mae and Freddie Mac is thea. Federal Deposit Insurance Corporation.b. Office of Thrift Supervision.c. Federal Reserve System.d. Federal Housing Finance Agency.

8. The MOST important role of Ginnie Mae today isa. originating FHA loans.b. purchasing VA loans.c. overseeing Fannie Mae and Freddie Mac.d. guaranteeing FHA and VA mortgage-

backed securities.

9. All of the following are true about FHA EXCEPTa. it falls under the direction of HUD.b. it provides financing for special assistance

programs.c. it falls under the direction of the Federal

Reserve.d. its mission is to provide America with

affordable housing.

10. An apartment building earns an annual net operating income of $25,000. If the property sells for $175,000, what is its overall rate of return?a. 14%b. 14.3%c. 14.5%d. 14.7%

39

UNIT 3 QUIZ ANSWERS

1. d2. c3. a4. b5. c6. b7. d8. d9. c

10. b $25,000 ÷ $175,000 = 0.14286 = 14.3%

40

U N I T4■■ LEARNING OBJECTIVES When you have completed this unit, you will be able to

■■ identify the four basic procedures in loan processing,■■ calculate the amount of payment a buyer may qualify for based on

various qualifying ratios, and■■ analyze the process of qualifying the property as adequate collateral.

Study Plan

Before class:



After class:


Processing Real Estate Loans

41


■■ Loan processing includes four basic procedures: — Determining the ability of a borrower to repay the loan — Estimating the value of the property being pledged as collateral to guaran-

tee the payment — Preparing the documents necessary to approve the borrower — Closing the loan transaction

■■ Qualifying the borrower includes an analysis of the borrower’s assets and liabili-ties. The potential borrower’s data is verified using credit information provided by credit reporting agencies.

■■ The collateral is qualified through an appraisal that determines the value.


■■ Processing a loan for mortgage lending■■ Qualifying the borrower■■ Financial qualifying■■ Data verification■■ Collateral■■ Appraisal


I. PROCESSING A LOAN FOR MORTGAGE LENDING

A. Loan processing includes four basic procedures:

1. Determining the ability of a borrower to the loan

2. Estimating the value of the property being pledged as to guarantee the payment

3. Preparing the documents necessary to approve the borrower

4. Closing the loan transaction

II. QUALIFYING THE BORROWER

A. Majority of loans

1. The fully amortized loan with monthly payments of principal and interest are the framework for most loans.

B. Changing times

1. In the past, 100% LTV ratios were allowed, but the financial crisis has resulted in the return to lower LTV ratios.

2. down payments are now being required.

3. In most cases, conventional loans require at least 5% down, and mortgage insurance is required.

C. Loan application

1. The standardized loan application form identifies the property to be pledged, the borrower, and the amount of money requested.

2. Most loan applications show the borrower’s employment and record, a statement of assets and liabilities, and a list of credit references.

III. FINANCIAL QUALIFYING

A. Assets

1. Assets are all things of value, encumbered or not, that are owned by the applicant.

a) consists of money in hand, money on deposit in checking and savings accounts, and cash given as a deposit on the property.

b) A strong cash balance develops a sense of in a borrower’s ability to maintain payments and meet other obligations.

c) Stocks, bonds, notes, and accounts receivable are included in the financial statement under assets.

d) Assets also include the current, not the , price of an automobile; the surrender value of life insurance policies; and personal property.

B. Liabilities

1. Liabilities are all monetary obligations of the borrower-applicant.

a) The top priority is any payable and then installment payments.

43Unit 4 Processing Real Estate Loans

b) Long-term liabilities include alimony or child support payments.

c) Liabilities include any encumbrances on the real estate listed as assets, taxes, security obliga-tions on personal property, loans on life insurance policies listed as assets, and any other debt for which the applicant is responsible.

C. Goal

1. The goal is that the total assets will exceed the total liabilities, with the difference being an applicant’s worth.

2. Best case is that there is a current ratio.

3. If total liabilities exceed total assets, a loan would probably be .

D. Income evaluation

1. Income that is stable, regular, and is considered for qualifying purposes.

2. A co-borrower’s income is considered.

3. A cosigner’s income is .

a) Cosigners on a note are individually and collectively responsible for .

b) A cosigner does not take title to the property, but a co-borrower does.

4. A second or part-time job is considered if it will continue for years and if there is a good reason to believe it will continue.

5. Child support is considered if it is a result of a court order, if it has a proven record, and typically if it will continue for or more years.

6. Government entitlement funds are considered.

7. For self-employed individuals, at least years of established income is considered.

8. Alimony can be counted as income, but it requires a year history of payment receipts and reasonable assurance that it will continue.

9. Child support and alimony are counted the applicant as debts.

E. Loan qualifying income ratios

1. The front-end or housing ratio refers to the total of principal, interest, taxes, insurance, and homeowners or condominium association fees as a of the monthly income. See Figure 4.1.

Loan Type Housing Ratios Total Debt Ratio

Conventional 28% 36%

FHA Loan 31% 43%

VA Loan – 41%

F I G U R E 4.1

Loan Qualifying Income Ratios

2. The back-end or total debt ratio refers to the above plus installment obligations (eliminating payments that will end in months or less).


IV. DATA VERIFICATION

A. Credit reporting agencies

1. Most data involved in qualifying can be obtained from the three credit reporting agencies: Experian, , and TransUnion.

B. Verification of bank accounts

1. Deposits are signed by the borrower for verification of bank account amounts.

2. Without this form, information could not be obtained due to the Federal Right to Act.

3. This permission form must be signed by the borrower for each account.

C. Employment verification permission

1. Employment verification permission is also given by the borrower to verify the following:

a) Wages

b) Length of employment

2. This helps to evaluate the employer’s prognosis for continued employment and any possible advancement.

D. Calculating loan qualification ratios

1. Example: A young couple has a combined gross monthly income of $3,600. They are under contract on a $100,000 house and plan to obtain a $90,000 loan at 6% for 30 years. The monthly principal and interest payment on the house is $540, the hazard insurance premium is $41, and the property taxes are $95. Due to the LTV of 90%, the financed private mortgage insurance pre-mium is $26.25. Their only long-term debt is a $300 car payment. Can they qualify for the loan?

a) Solution:

— $540 principal and interest + $41 insurance + $95 taxes + $26.25 PMI = $702.25 total house payment

— $702.25 total house payment ÷ $3,600 income = 19.5% (rounded)—must not exceed 28%, so they qualify on the front end

— $702.25 total house payment + $300 car payment = $1,002.25 total debt payment

— $1,002.25 total debt payment ÷ $3,600 income = 27.8% (rounded)—must not exceed 36%, so they qualify on the back end

— This couple should easily qualify for the loan because their ratios are less than those required.


2. Practice qualification questions

a) The buyers have a gross income of $47,000 per year. Their recurring debts total $725 monthly. They are applying for a conventional loan for 30 years at 6.5%. What maximum payment (PITdo they qualify for?

(1) Solution: $47,000 ÷ 12 = $3,916.67 per month

$3,916.67 × 28% = $1,096.67

$3,916.67 × 36% = $1,410

$1,410 – $725 = $685

b) The buyers have a gross income of $51,000 per year. Their recurring debts total $600 monthly. They are applying for a conventional loan that will have a payment of $1,175 (PITI). Do they qualify for this loan?

(1) Solution: $51,000 ÷ 12 = $4,250 per month

$4,250 × 28% = $1,190

$4,250 × 36% = $1,530

$1,530 – $600 = $930

Do they qualify? No.

c) A man has an annual income of $38,000 and his wife has an annual income of $35,000. They currently have recurring obligations (excluding housing expenses) of $600 per month. What is the maximum monthly payment for which this couple can qualify using an expense-to-income ratio of 28% of gross income and 36% of gross income less other recurring obligations?

(1) Solution: Total gross income × 28% ratio and total income − expenses × 36% ratios

$38,000 + $35,000 = $73,000 (gross income)

$73,000 × 0.28 = $20,440 ÷ 12 = $1,703.33

$73,000 × 0.36 = $26,280 − $7,200 (annual expenses) = $19,080 ÷ 12 = $1,590

d) A man earns an annual income of $60,000, and his wife earns $2,400 a month. What monthly loan payment would the couple qualify for using a 28% ratio?

(1) Solution: Total gross income × 28% ratio

$60,000 ÷ 12 = $5,000 + $2,400 = $7,400 combined monthly income

$7,400 × 0.28 = $2,072

E. Credit report

1. The credit report shows the of current accounts.

2. It shows the quality of and the number of payments made, including their , delinquency, and outstanding balance.


3. The report shows the of the borrower, good or bad.

4. Most credit agencies must the borrower’s permission before sending any information.

F. Credit scores

1. Fair Isaac Corporation (FICO) assigns relative risk rankings to applicants based on analysis of credit histories.

a) FICO scores range from 300 to 850.

b) Applicants who pay bills on time and have limited credit use have credit scores.

c) A FICO score is based on the following percentages:

(1) Payment history: %

(2) Amount owed: 30%

(3) Length of credit: 15%

(4) New credit: 10%

(5) Other factors: %

G. Obtaining your credit report

1. Everyone has the right to order free credit report per from each of the three major reporting agencies:

a) Equifax: 800-685-1111, www.equifax.com

b) Experian: 866-200-6020, www.experian.com

c) TransUnion: 800-888-4213, www.transunion.com

2. Lenders may order credit scores at a low cost.

3. Most lenders today order a tri-merge report containing information from all three credit report-ing agencies.

a) Generally, the lender will use the score, not an average.

b) Be aware that electronic credit files might contain possible .

c) Find a lender who will work with your borrower to clear fixable items.

V. THE COLLATERAL

A. Qualifying the collateral

1. An accurate estimate of the of the collateral is another important factor in the lending process.

B. Definition of value

1. Value is defined as the to satisfy, directly or indirectly, the needs or desires of human beings.

a) Economists call it value in use.


2. When the value of an object is measured in terms of its power to purchase, it is called value in exchange.

3. Value is a function of and .

4. An appraiser must make an objective estimate of value based on and in the marketplace.

5. value is the price a property would most likely bring if it were exposed for sale in the open market for a reasonable price.

a) In market value, cost is a measure of past expenses and may reflect current market value.

b) Price is a present but could be affected by unusual circumstances:

(1) Unique financing

(2) Slow market with abundance of listings

(3) Fast market with shortage of listings

VI. THE APPRAISAL

A. Definition

1. An appraisal is an of a property’s value at a specific point in time.

a) It must be in writing, using the Uniform Residential Appraisal Report.

B. Appraiser requirements

1. All lenders are required to select an appraiser who meets the following criteria:

a) Selected in compliance with Appraiser Independence Requirements (AIR)

b) Certified or in the state where the property is located

c) Familiar with the local market

d) Competent to appraise the subject property type

e) Has access to the data sources needed

2. Lenders can choose from a rotating of appraisers.

3. Lenders also may choose appraisers from a preapproved list or panel as long as any employee of the lender involved in the list selection is not connected to any of the appraisers.

4. The methods of appraisal are predominantly mathematical; appraisal is a that is artfully interpreted.

C. Loan underwriting

1. Underwriting is the evaluation of the risks involved when issuing a new mortgage or deed of trust.

a) This process determines whether the borrower and the meet minimum requirements to be able to sell in the secondary market.

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UNIT 4 QUIZ

1. The first basic procedure in processing a loan is toa. document the borrower’s ability to repay

the loan.b. estimate the value of the property to be

used for collateral.c. research the title.d. prepare the documents for closing.

2. The average life of a real estate loan isa. 7 to 8 years.b. 10 years.c. 15 years.d. 30 years.

3. The MOST important aspect of a credit report is that it shows the borrower’sa. personal attitude toward handling credit

and debt.b. number of current accounts.c. outstanding balances.d. number of late payments.

4. A recorded deed, or recorded note and mort-gage, is considered a. actual notice.b. constructive notice.c. a title abstract.d. an opinion of title.

5. An appraiser who is assigned the task of apprais-ing a unique property, such as a church, would probably use thea. cost approach.b. income approach.c. gross rent multiplier.d. direct sales comparison approach.

6. A cloud on the title that is difficult to remove may require thata. the price on the property be raised.b. the price on the property be lowered.c. a suit to quiet title be filed.d. an affidavit of release be signed by the

seller.

7. A type of title insurance that includes the state as the guarantee of title is calleda. an abstract and opinion of title.b. the Torrens system.c. a standard title insurance policy.d. an ALTA policy.

8. In which circumstance would an ALTA title insurance policy NOT protect both the lender and the new owner?a. If the signature has been forgedb. If there is an error on the surveyc. If there is an unrecorded easementd. If a mechanic’s lien is filed a year after

settlement

9. A couple would like to buy a home with a PITI of $1,875 a month. The PMI will be $55 a month and the homeowners association fee will be $850 a year. They have other recurring debts of $1,250 a month (less housing expenses). What is the minimum monthly income needed for this couple to qualify using ratios of 28% and 36%? a. $7,146 b. $6,696 c. $9,030 d. $5,558

10. What is the PITI payment on a $209,000 twenty-year mortgage loan at 5% interest with a mortgage factor of $5.84 per $1,000? The annual taxes are $2,345, and the homeowners insurance is $789 annually. a. $1,678.59 b. $1,481.73 c. $1,220.56 d. $1,415.98

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1. a2. a3. a4. b5. a6. c7. b8. d9. c $1,875 (PITI) + $55 (PMI) + $70.83 (HOA

monthly) = $2,000.83 $2,000.83 ÷ 0.28 = $7,145.82 $2,000.83 + $1,250 = $3,250.83 $3,250.83 ÷ 0.36 = $9,030.08 The higher of the two results is the income needed: $9,030.08.

10. b 5.84 ÷ 1,000 = 0.00584 209,000 × 0.00584 = $1,220.56 PI 2,345 + 789 = 3,134 ÷ 12 = 261.17 TI 1,220.56 + 261.17 = $1,481.73

UNIT 4 QUIZ ANSWERS

Real Estate Finance Workbook

Documents

Transcript of Real Estate Finance Workbook