Kap Real Estate Chapter 15: Financing Practices

Question 1

The real estate financing market has historically had the following three basic components:

Answer 1

Government influences, primarily the Federal Reserve System, but also the Home Loan Bank System and the Office of Thrift Supervision

The primary mortgage market

The secondary mortgage market

Question 2

Dodd-Frank Wall Street Reform and Consumer Protection Act / Dodd -Frank Act

Answer 2

This act was tasked with the most comprehensive overhaul of financial regulation since the 1930s

The Dodd-Frank Act created the Consumer Financial Protection Bureau (CFPB) as the oversight agency for consumer protection within seven federal agencies including the Fed, HUD, and the Federal Trade Commission

CFPB enforces regulations for banks, most credit unions, and mortgage-related businesses. CFPB is also tasked with administering all the major laws and regulations that touch mortgage lending and will be discussed in detail elsewhere in this text:

Truth in Lending Act, Equal Credit Opportunity Act, Fair Credit Reporting Act, Real Estate Settlement Procedures Act, Secure and Fair Enforcement for Mortgage Licensing Act, and the Interstate Land Sales Full Disclosure Act.

Question 3

The Consumer Financial Protection Bureau (CFPB) was created as the oversight agency for consumer protection and enforces regulations for banks, most credit unions, and mortgage-related business. (T/F)

Answer 3

True

**The CFPB was created as a response to the abuse and deceptive lending practices experienced during the financial crisis.

Question 4

The purpose of the Dodd-Frank Act was the duplication of lender disclosures. (T/F)

Answer 4

False

The purpose of the Dodd-Frank Act was the consolidation of lender disclosures.

Question 5

Federal Reserve System (the Fed)

1) What is their role?

2) How do they do their job?

3a) How many federal reserve districts are there?

3b) All nationally chartered banks must _______ the Fed and _____________ in its district reserve banks.

Answer 5

1)is to maintain sound credit conditions, help counteract inflationary and deflationary trends, and create a favorable economic climate

2) It does this by regulating the supply of money and interest rates.

3) The Federal Reserve System divides the country into 12 Federal Reserve Districts, each served by a Federal Reserve Bank. All nationally chartered banks must join the Fed and purchase stock in its district reserve banks. Qualified state-chartered banks may also join the Fed.

Question 6

open market operations

Answer 6

The Fed also can regulate the money supply through theFederal Open Market Committee, which buys and sells U.S. government securities on the open market. The sale of securities removes the money paid by buyers from circulation. When it buys them, it infuses its own reserves back into the general supply.

Question 7

Reserve Requirements

Answer 7

The Federal Reserve System requires that each member bank keep a certain amount of assets on hand as reserve funds. These reserves are unavailable for loans or any other use. This requirement not only protects customer deposits, but it also provides a means of manipulation for the flow of cash in the money market.

By increasing its reserve requirements, the Fed in effect limits the amount of money that member banks can use to make loans. When the amount of money available for lending decreases, interest rates rise. By causing interest rates to rise, the government can slow down an overactive economy by limiting the number of loans that would have been directed toward major purchases of goods and services.

The opposite is also true—by decreasing the reserve requirements, the Fed can encourage more lending. Increased lending causes the amount of money circulated in the marketplace to rise, while simultaneously causing interest rates to drop.

Question 8

Discount Rates

Answer 8

The discount rate is the rate charged by the Fed when it lends to its member banks

The federal funds rate is the rate recommended by the Fed for the member banks to charge each other on short-term loans. These rates form the basis on which the banks determine the percentage rate of interest they will charge their loan customers. The prime rate, the short-term interest charged to a bank’s largest, most creditworthy customers, is strongly influenced by the Fed’s discount rate. In turn, the prime rate is often the basis for determining a bank’s interest rate on other loans, including mortgages. These rates are usually higher than the prime rate.

In theory, when the Fed’s discount rate is high, bank interest rates are high. When bank interest rates are high, fewer loans are made and less money circulates in the marketplace. On the other hand, a lower discount rate results in lower overall interest rates, more bank loans, and more money in circulation.

Question 9

The prime rate is the rate charged by the Federal Reserve System (Fed) when it lends to its member banks. (T/F)

Answer 9

False

The discount rate is the rate charged by the Fed when it lends to its member banks.

Question 10

The role of the Federal Reserve System is to limit lending and overborrowing by consumers. (T/F)

Answer 10

False

The role of the Federal Reserve System is to maintain sound credit conditions, to counteract inflationary and deflationary trends, and to create a favorable economic environment.

Question 11

The Primary Mortgage Market

Answer 11

is made up of the lenders that originate mortgage loans. These lenders make money available directly to borrowers. From a borrower’s point of view, a loan is a means of financing an expenditure; from a lender’s point of view, a loan is an investment.

Question 12

For a lender, a loan must generate enough income to be attractive as an investment. Income on the loan is realized from the following two sources:

Answer 12

1) Finance charges collected at closing, such as loan origination fees and discount points

2) Recurring income, that is, the interest collected during the term of the loan

Question 13

Savings associations, or thrifts, and commercial banks (Major Lender)

Answer 13

These institutions are known as fiduciary lenders because of their fiduciary obligations to protect and preserve their depositors’ funds. Mortgage loans are perceived as secure investments for generating income and enable these institutions to pay interest to their depositors.

Fiduciary lenders are subject to standards and regulations established by government agencies such as the Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift Supervision (OTS). These agencies govern the practice of fiduciary lenders. The various government regulations are intended to protect depositors against the reckless lending that characterized the savings and loan industry in the 1980s.

Question 14

Insurance companies (as a lender)

Answer 14

Insurance companies amass large sums of money from the premiums paid by their policyholders. While a certain portion of this money is held in reserve to satisfy claims and cover operating expenses, much of it is invested in profit-earning enterprises, such as long-term real estate loans. Although insurance companies are not considered primary lenders, they tend to invest their money in large, long-term loans that finance commercial, industrial, and larger multifamily properties rather than single-family home mortgages.

Question 15

Credit unions (as a lender)

Answer 15

Credit unions are cooperative organizations in which members place money in savings accounts, usually at higher interest rates than other savings institutions offer. In the past, most credit unions made only short-term consumer and home improvement loans, but in recent years they have been branching out to longer-term first and second mortgages and trust deed loans.

Question 16

Pension funds ( as a lender)

Answer 16

Pension funds usually have large amounts of money available for investment. Because of the comparatively high yields and low risks offered by mortgages, pension funds have begun to participate actively in financing real estate projects. Most real estate activity for pension funds is handled through mortgage bankers and mortgage brokers.

Question 17

Endowment Funds (as lenders)

Answer 17

Many commercial banks and mortgage bankers handle investments from endowment funds. The endowments of hospitals, universities, colleges, charitable foundations, and other institutions provide a good source of financing for low-risk commercial and industrial properties.

Question 18

Investment group financing (as lenders)

Answer 18

Large real estate projects, including highrise apartment buildings, office complexes, and shopping centers, are often financed as joint ventures through group financing arrangements such as syndicates, limited partnerships, and real estate investment trusts (REITs).

Question 19

Mortgage banking companies (as lenders)

Answer 19

Mortgage banking companies originate mortgage loans with money belonging to insurance companies, pension funds, and individuals, and with funds of their own. They make real estate loans with the intention of selling them to investors and receiving a fee for servicing the loans. Mortgage banking companies are generally organized as stock companies.

As a source of real estate financing, they are subject to fewer lending restrictions than are commercial banks or savings associations. Mortgage banking companies often are involved in all types of real estate loan activities and often serve as intermediaries between investors and borrowers. They are NOT mortgage brokers.

Question 20

Mortgage Brokers (as lenders)

Answer 20

Mortgage brokers are NOT lenders. They are intermediaries who bring borrowers and lenders together. Mortgage brokers locate potential borrowers, process preliminary loan applications, and submit the applications to lenders for final approval. Frequently, they work with or for mortgage banking companies.

They do not service loans once the loans are made. Mortgage brokers also may be real estate brokers who offer these financing services in addition to their regular real estate brokerage activities. Many state governments are establishing separate licensure requirements for mortgage brokers to regulate their activities.

Question 21

There are three major government institutions in the secondary market:

Answer 21

Fannie Mae, Ginnie Mae, and Freddie Mac. These three agencies are sometimes referred to as government-sponsored enterprises or GSEs

Question 22

Secondary Mortgage Market

Answer 22

purchases, services, and sometimes re-sells existing mortgages and mortgage-backed securities created by the primary market lenders.

This process replenishes funds to the primary mortgage market so they can originate more mortgage loans for the house-buying public, thereby helping homeownership become more affordable for all Americans.

There are three major government institutions in the secondary market: Fannie Mae, Ginnie Mae, and Freddie Mac. These three agencies are sometimes referred to as government-sponsored enterprises or GSEs.

Question 23

Fannie Mae

Answer 23

created in September 2008

originally named the Federal National Mortgage Association (FNMA), became a federally owned enterprise that provides a secondary market for mortgage loans—conventional loans as well as FHA and VA loans. Until that time, Fannie Mae was a privately owned corporation that issued its own stock

Fannie Mae buys a block or pool of mortgages from a lender in exchange for mortgage-backed securities that the lender may keep or sell. Fannie Mae was instrumental in developing the uniform underwriting guidelines that helped assure investors of the quality of the mortgage-backed securities. As the oldest and largest of the secondary mortgage market institutions, a visit to the Fannie Mae website will yield a wealth of information

Question 24

Ginnie Mae

Answer 24

originally called the Government National Mortgage Association (GNMA), exists as a corporation without capital stock and has always been a division of HUD. Ginnie Mae is designed to administer special-assistance programs and work with Fannie Mae in secondary market activities. Fannie Mae and Ginnie Mae can join forces in times of tight money and high interest rates through their tandem plan.

Basically, the tandem plan provides that Fannie Mae can purchase high-risk, low-yield (usually FHA) loans at full market rates, with Ginnie Mae guaranteeing payment and absorbing the difference between the low yield and current market prices.

Ginnie Mae also guarantees investment securities issued by private offerors (such as banks, mortgage companies, and savings associations) and is backed by pools of FHA and VA mortgage loans. The Ginnie Mae pass-through certificate lets small investors buy shares in a pool of mortgages that provides for a monthly pass through of principal and interest payments directly to certificate holders. Ginnie Mae guarantees such certificates.

Question 25

Freddie Mac

Answer 25

originally the Federal Home Loan Mortgage Corporation (FHLMC), functioning as a government-owned enterprise similar to Fannie Mae, provides a secondary market for mortgage loans, primarily conventional loans originated by savings associations. Freddie Mac has the authority to purchase mortgages, pool them, and sell bonds in the open market with the mortgages as security.

Many lenders use the standardized forms and follow the guidelines issued by Fannie Mae and Freddie Mac because use of these forms is mandatory for lenders that wish to sell mortgages in the agency’s secondary mortgage market. The standardized documents include loan applications, credit reports, and appraisal forms.

Question 26

Subprime mortgage

Answer 26

a mortgage made by lenders who charge higher than prime rates to borrowers who have poor or no credit ratings

Question 27

The purpose of the secondary market is to originate mortgage loans (T/F)

Answer 27

False

The purpose of the primary market is to originate mortgage loans. The secondary market purchases, serves, and sometimes re-sells existing mortgages created in the primary market.

Question 28

Mortgage brokers are lenders (T/F)

Answer 28

False

Mortgage brokers are not lenders; they are intermediaries who bring borrowers and lenders together.

Question 29

Conventional Loan

Answer 29

is a loan that is not backed—that is, made, insured, or guaranteed—by any government agency. In other words, the lender bears all the risk of borrower default when making a conventional loan. A conventional loan is viewed as the most secure loan because its loan-to-value ratio (LTV) is lowest. A mortgage loan is generally classified based on its LTV, which is the ratio of debt to value of the property.

Value is the sales price or the appraised value, whichever is less. The lower the ratio of debt to value, the higher the down payment by the borrower will be. For the lender, the higher down payment means a more secure loan, which minimizes the lender’s risk.

Question 30

Conforming Loan

Answer 30

A standardized conventional loan that meets Fannie Mae’s or Freddie Mac’s purchase requirements.

guidelines for first mortgages secured by one to four family unit residences include a maximum loan amount; a minimum down payment; limits on seller contributions; and borrower qualifying ratios.

The Housing and Economic Recovery Act of 2008 has expanded the definition of conforming loan to allow higher loan limits in high cost areas as determined by the Federal Housing Finance Agency. Due to this change, maximum loan limits should be verified for specific areas.

Most guidelines require a 5% minimum down payment (although some have required less) that necessitates the purchase of private mortgage insurance (PMI). Generally, the borrower must personally provide at least 5% of the purchase price even if family members contribute additional down payment. Maximum contributions by the seller (or any third party) vary with different loan conditions but are capped at 6% of the sales price. Borrower qualification requirements will be discussed later in the unit.

Question 31

nonconforming loans

Answer 31

Those that do not meet Fannie Mae/Freddie Mac standards and thus, cannot be sold on the secondary market.

Subprime loans made to borrowers who cannot meet the qualification requirements for a conforming loan are a good example of nonconforming loans. In addition, nonconforming loans include loans that exceed the maximum loan limits for conforming loans and are called jumbo loans.

Question 32

Private Mortgage Insurance (PMI)

Answer 32

One way a borrower can obtain a conventional mortgage loan with a smaller down payment is under a PMI program. When the LTV ratio is higher than a specified percentage, typically 80%, the lender requires additional security to minimize its risk. The borrower purchases insurance from a PMI company as additional security to insure the lender against borrower default.

LTVs of up to 95% of the appraised value of the property are possible with PMI. PMI protects a certain percentage of a loan, usually 20% to 30%, against borrower default. Normally, the borrower is charged a fee for the first year’s premium at closing and a monthly renewal fee while the insurance is in force. The premium may be financed or the fee at closing may be waived in exchange for slightly higher monthly payments.

When a borrower has limited funds for investment, these alternative methods of reducing closing costs are very important. Because only a portion of the loan is insured, once the loan is repaid to a certain level (usually 75% or 70% of the value of the property), the lender may agree to allow the borrower to terminate the coverage.

Question 33

Piggyback loans

Answer 33

By taking out a first and second mortgage simultaneously, the PMI requirement could be avoided. The most common arrangements were either 80/10/10 or 80/15/5; both used a first mortgage LTV of 80%, a second mortgage LTV of either 10% or 15%, and then down payment in the amount of 10% or 5%

Question 34

Under the Homeowners Protection Act

Answer 34

a borrower with a good payment history will have PMI canceled when he or she has built up equity equal to 20% of the purchase price or the appraised value. Lenders are required by the law to inform borrowers of their right to cancel PMI.

Before this law was enacted, lenders could (and often did) continue to require monthly PMI payments long after borrowers had built up substantial equity in their homes and the lender no longer risked a loss from the borrower’s default.

Question 35

The Federal Housing Administration (FHA)

Answer 35

was created in 1934 under the National Housing Act to encourage improvement in housing standards and conditions, provide an adequate home-financing system through insurance of housing credit, and exert a stabilizing influence on the mortgage market.

The FHA was the government’s response to the lack of housing, the excessive foreclosures, and the collapsed building industry that occurred during the Great Depression.

operates under the Department of Housing and Urban Development (HUD), neither builds homes nor lends money to purchase single-family housing. Rather, it insures loans on real property made by approved lending institutions

The FHA does not insure property; it insures lenders against loss in case of borrower default.

Question 36

FHA-insured loan

Answer 36

refers not to a loan that is made by the agency but to a loan that is insured by it. FHA-insured loans are made by FHA-approved lenders, which are free to set the interest rates on the loans.

Question 37

Most popular FHA program is

Answer 37

Title II, Section 203(b), fixed-interest-rate loans for 10 years to 30 years on one-family to four-family residences.

The FHA does not fix interest rates on these loans. These rates can be lower than those on conventional loans because the protection of FHA mortgage insurance makes them of less risk to lenders.

Question 38

Technical requirements established under congressional authority must be met before the FHA will issue the insurance. Three of these requirements are as follows:

Answer 38

1) In addition to paying interest, the borrower pays a one-time mortgage insurance premium for the FHA insurance. This amount (currently 1.5 to 3.0% of the loan amount depending on loan requirements but subject to change) may be paid at closing by the borrower or someone else, or it may be added to the loan amount. (For example, on a $100,000 loan, the one-time premium would equal $1,500, to be either paid in cash at closing or added to the loan amount.) Also, the borrower is charged an annual renewal premium of one-half of 1% of the loan amount.

2) The mortgaged real estate must be appraised by an approved FHA appraiser. The loan amount generally cannot exceed either of the following: (1) 98.75% for loans over $50,000 (for loans less than $50,000, the buyer must contribute 3% of the sales price to the down payment and closing costs) or (2) 97.75% of the sales price or appraised value, whichever is less

3) The FHA regulations set standards for type and construction of buildings, quality of neighborhood, and credit requirements for borrowers.

Question 39

Prepayment privileges (FHA Loan)

Answer 39

When a mortgage loan is insured by the FHA and the real estate given as security is a single-family dwelling or an apartment building with no more than four units, the borrower has the privilege of prepaying the debt without penalty. On the first day of any month before the loan matures, the borrower may pay the entire debt or an amount equal to one or more monthly payments on the principal.

The borrower must give the lender written notice of intention to exercise this privilege at least 30 days beforehand; otherwise, the lender has the option of charging up to 30 days’ interest in lieu of such notification. This is also known as having no prepayment penalty.

Question 40

Assumption rules

Answer 40

All FHA assumptions require the assuming buyer to qualify, and the borrower must occupy the property. All FHA loans made under the 203(b) program are for owner-occupied properties only.

Question 41

Title I (FHA Loan)

Answer 41

Title I: Home improvement loans are covered under this title. Such loans are for relatively low amounts and have repayment terms of no longer than 7 years and 32 days

Question 42

Title II Section 234

Answer 42

Title II, Section 234: Loans made to purchase condominiums are covered under this program, which in most respects is similar to the basic 203(b) program

Question 43

Title II, Section 245

Answer 43

Graduated payment mortgages, as discussed in Unit 13, are allowed under this program. Depending on interest rates, the LTV ratio of such loans might range from 87% to 93%

Question 44

Title II, Section 251

Answer 44

Adjustable-rate mortgages (ARMs) are allowed under this program. The interest rate cannot change more than 1% per year or more than 5% over the life of the loan

Question 45

Points (FHA Loans)

Answer 45

The lender of an FHA-insured loan can charge discount points in addition to a 1% loan origination fee. The payment of points is a matter of negotiation between the seller and the buyer. However, if the seller pays more than the maximum percent allowed of the costs normally paid by the buyer—such as discount points, the loan origination fee, the mortgage insurance premium, buydown fees, prepaid items, impound or escrow amounts, and the like—the lender is to treat such payments as sales concessions, and the price of the property for purposes of the loan must be reduced.

Question 46

Interest rates (FHA Loans)

Answer 46

Neither HUD nor the FHA regulates the interest rates paid on FHA-insured loans. The rates fluctuate from lender to lender, and the buyer is responsible for obtaining the lowest interest rate possible.

Question 47

Lead paint notification

Answer 47

HUD now requires that a lead paint notification form be given to residential buyers to sign on or before the date the purchaser executes (signs) the sales contract. The FHA requires that the lender be provided with a copy of the notification form at the time of the loan application.

In the event the purchaser does not receive and sign the form on or before the date the sales contract is executed, the contract must be re-executed. This HUD guideline is required for FHA-insured loans on homes built prior to 1978.

Question 48

VA-Guaranteed (GI) Loans

Answer 48

Under the Servicemen’s Readjustment Act of 1944 and subsequent federal legislation, the Department of Veterans Affairs (VA) is authorized to guarantee loans to purchase or construct homes for eligible veterans. (Unremarried widows or widowers of veterans may also be eligible.)

Eligibility status varies and is determined by length of service during peace or war times. Nonactive veterans wishing to use their entitlement cannot have received a dishonorable discharge from the military. The VA also guarantees loans to purchase mobile homes and plots on which to place them. GI loans assist veterans in financing the purchase of homes with little or no down payment at comparatively low interest rates.

From time to time, the VA issues rules and regulations setting forth the qualifications, limitations, and conditions under which a loan may be guaranteed.

Question 49

VA-guaranteed loan

Answer 49

then, refers not to a loan that is made by the agency, but to one that is guaranteed by it. The guarantee works to protect the lender in case of default much like private mortgage insurance or FHA’s MIP.

Although there is no maximum VA loan amount, lenders will generally loan up to four times a veteran’s available entitlement without a down payment.

Maximum loan terms are 30 years for one-family to four-family dwellings and 40 years for farms

The VA also will issue a certificate of reasonable value (CRV) for the property being purchased, stating its current market value based on a VA-approved appraisal. The CRV places a ceiling on the amount of a VA loan allowed for the property; if the purchase price is greater than the amount cited in the CRV, the veteran may either pay the difference in cash or must be permitted to terminate the purchase agreement without penalty.

Also, the seller may agree to lower the purchase price to the amount named in the CRV, or both the buyer and the seller may renegotiate the sale and each make a concession on the price.

Question 50

Assumption rules (VA Loans)

Answer 50

VA loans require lender approval of the buyer and an assumption agreement. Even when a VA loan is assumed, the original veteran borrower remains personally liable for the repayment of the loan unless the lender approves a release of liability.

Question 51

To obtain a release of liability, the veteran must meet three requirements (Va Loans):

Answer 51

First, the loan must be up-to-date (there are no past-due payments).

Second, the assumptor must have sufficient income and a good enough credit history to qualify for the loan.

Third, the assumptor must agree to assume the veteran’s obligation for the loan. Note that any release of economic liability issued by the lender does not release or restore the veteran’s entitlement that is tied to the loan. This must be obtained separately from the VA.

Question 52

restoration of entitlement (VA Loan) (Name the two ways it can be restored)

Answer 52

If the veteran is selling a current VA-financed home, entitlement can be restored. For instance, if the first house is sold and the original VA loan is paid off, the veteran’s entitlement will be restored and the veteran will be eligible for another VA home loan that can be used to purchase a replacement home.

A veteran’s entitlement also can be restored if the veteran sells the home to another veteran who is willing to assume the existing loan and if the buyer’s entitlement is substituted for the entitlement of the selling veteran. The basic rule, with little exception, is that veterans can only have one property in their name at a time that is or was financed by a VA-guaranteed loan.

Question 53

Prepayment (VA Loan)

Answer 53

As with an FHA-insured loan, the borrower under a VA-guaranteed loan can prepay the debt at any time without penalty

Question 54

Points (VHA Loan)

Answer 54

Points are payable by either the veteran borrower or the seller. There also is a funding fee, which the veteran pays the VA at closing. Generally, all veterans using the VA home loan program must pay a funding fee. Similar to the mortgage insurance required in an FHA loan, the funding fee reduces the loan’s potential cost to taxpayers since VA loans require no down payment and has no monthly mortgage insurance.

The funding fee is a percentage of the loan amount which varies based on the type of loan and the veteran’s military category, amount of down payment (if any), and whether or not the veteran is a first-time loan user. Vets have the option to finance the VA funding fee or pay it in cash, but the funding fee must be paid at closing time. The funding fee is a sliding fee, ranging from 0.5% to 3.33%. The funding fee can be added to the note.

Question 55

U.S. Department of Agriculture (USDA)

Answer 55

The U.S. Department of Agriculture (USDA) offers programs to help purchase or operate family farms. It also provides loans to help purchase or improve single-family homes in rural areas—generally areas with a population of fewer than 10,000 that are not suburbs of urban areas.

Loans are made to low-income and moderate-income families, and due to subsidized interest rates, the interest rate charged can be as low as 1%, depending on the borrower’s income. The loan programs fall into two categories—guaranteed loans, made and serviced by a private lender and guaranteed by the agency, and direct loans from the agency.

Question 56

Direct Single Family Housing Loan

Answer 56

is designed for families with low to very low income—80% or less of county median income. These loans can be used to buy, build, improve, or repair rural homes.

Eligibility requirements include:

(1) a rural area with a population of less than 10,000

(2) families who are without safe and decent housing,

(3) families to whom financing is not otherwise available.

Loans may be made up to 100% of the appraised value. Interest rates are normally set at market rate, and the term of the loan is typically 33 years, but may be as long as 38 years.

Question 57

Guaranteed Single Family Housing Loan

Answer 57

is designed for moderate-income families who have limited down payment capability. Loans are processed by approved lenders and guaranteed by the U.S. government.

Eligibility requirements are similar to the direct loan as discussed above. Maximum loan amounts range from $78,660 to $116,850, depending on the county in which the property is located. Interest rates are negotiable and fixed, with a 30-year loan term.

Question 58

Purchase money mortgages

Answer 58

Takes back refers to the fact that the seller has taken back some interest in the property in exchange for financing. It may be a first or second deed of trust, and it becomes a lien on the property when the title passes. The borrower holds title under a purchase money mortgage. In the event of foreclosure on a purchase money mortgage, this lien takes priority over judgment liens against the borrower and over mechanics’ liens. In North Carolina, a seller-lender is not entitled to a deficiency judgment.

Question 59

What is a Package Loan?

Answer 59

includes not only the real estate but also all fixtures and appliances installed on the premises. In recent years, this type of loan has been used extensively in financing furnished condominium units.

Such loans usually include the kitchen range, refrigerator, dishwasher, garbage disposal, washer and dryer, freezer, and other appliances, as well as furniture, drapes, and carpets. In other words, the lender has packaged both real and personal property in the same loan.

Question 60

What is a Bridge Loan?

Answer 60

is a short-term loan to cover the period between termination of one loan and the beginning of another loan. It’s typically taken out for a period of two weeks to three years pending the arrangement of larger or longer-term financing. For example, purchasers of a new home may need bridge financing between the construction loan and a permanent loan

Consumers also use bridge loans when they can’t sell their current residence but wish to acquire a new one. The bridge loan may be a second mortgage under these circumstances

Question 61

What is a Blanket Mortgage?

Answer 61

covers more than one parcel of land and usually is used to finance subdivision developments, though it can be used to finance the purchase of improved properties as well. These loans usually include a provision, known as a partial release clause, so that the borrower may obtain the release of any one lot or parcel from the lien by repaying a definite amount of the loan at closing without triggering a due-on-sale clause for the rest of the financed property.

Question 62

What is an Open-End Mortgage?

Answer 62

act as a line of credit or equity line, allowing the mortgagee to make additional future advances of funds to the mortgagor, and are generally set up as home equity loans.

The mortgagee may have a prior lien for the amount of additional future advances if the mortgagee is obligated to make advances, as in construction loans. For unobligated future advances, the lien may be subordinate to other liens that may be created before the additional advancements are made.

Question 63

What is a Construction Loan?

Answer 63

is made to finance the construction of improvements on real estate—homes, apartments, office buildings, and so forth. Under a construction loan, the lender commits the full amount of the loan but makes partial installment payments or draws as the building is being constructed.

Installment payments are made to the general contractor for that part of the construction work that has been completed since the previous payment. Prior to each payment, the lender inspects the construction site. The general contractor must provide the lender with adequate waivers of lien releasing all mechanic’s lien rights (see Unit 2) for the work covered by the payment.

Construction financing is generally short-term, or interim, financing. The borrower is expected to arrange for a permanent loan—also known as an end loan or a take-out loan—that will repay, or take out, the construction financing lender when the work is completed. Construction loans normally pose a greater degree of risk to lenders than any other types of loans.

Question 64

What is a Buydown?

Answer 64

is a way to lower the initial interest rate on a mortgage or deed of trust loan. Perhaps a homebuilder wishes to stimulate sales by offering a lower-than-market interest rate. Or, a first-time residential buyer may have trouble qualifying for a loan at the prevailing rates; relatives or the sellers might want to help the buyer qualify.

In any case, a lump sum is paid in cash to the lender at closing. The payment offsets (and so reduces) the interest rate and monthly payments during the mortgage’s first few years. Typical buydown arrangements reduce the interest rate by 1% to 3% over the first year to third year of the loan term. After that, the rate rises. The assumption is that the borrower’s income also will increase and that the borrower will be more able to absorb the increased monthly payments

A common type of buydown is called the 3-2-1 buydown. The interest rate is bought down by 3% in the first year, 2% in the second year, and 1% in the third year. For the fourth and succeeding years, the interest rate is the fixed note rate.

Question 65

Home Equity Loan

Answer 65

are a source of funds for homeowners who wish to finance the purchase of expensive items; consolidate existing installment loans on credit card debt; or pay for medical, educational, home improvement, or other expenses. This type of financing has been used increasingly, partly because tax laws no longer allow deductibility of interest on debts not secured by real estate (consumer interest). Home equity loans are secured by the borrower’s residence, and some or all of the interest charged may be deductible

A home equity loan can be taken out as a fixed loan amount or as an equity line of credit. With the home equity line of credit (HELOC), the lender extends a line of credit that the borrowers can use whenever they want. The borrowers receive their money through checks sent to them, deposits made in a checking or savings account, or a book of drafts the borrowers can use, up to their credit limit

Question 66

Reverse mortgages

Answer 66

is one in which regular monthly payments are made to the borrower, based on the equity the homeowner has invested in the property given as security for the loan. A reverse mortgage allows senior citizens on fixed incomes to utilize the equity buildup in their homes without having to sell the property.

The borrower is charged a fixed rate of interest, and the loan is eventually repaid from the sale of the property or from the borrower’s estate on the borrower’s death.

Question 67

Mortgage Priorities

Answer 67

Mortgages and other liens normally have priority in the order in which they have been recorded. A mortgage on land that has no prior mortgage lien on it is a first mortgage. When the owner of this land executes another loan for additional funds, the new loan becomes a second mortgage, or a junior mortgage, when recorded. The second lien is subject to the first lien; the first has prior claim to the value of the land pledged as security. Because second loans represent greater risk to lenders, they are usually issued at higher interest rates and for shorter terms.

The normal recordation priority of mortgage liens may be changed by the execution of a subordination agreement, in which the first lender subordinates its lien to that of the second lender. To be valid, such an agreement must be signed by both lenders. Subordination agreements may be contained in the mortgage itself or they may be separate agreements filed for recordation.

Question 68

FHA loans are characterized as no-down payment loans. (T/F)

Answer 68

False

FHA loans are characterized as low-down payment loans. It is VA loans that are typically “no down payment” loans.

Question 69

FHA insures loans; VA guarantees loans. (t/f)

Answer 69

True

The FHA insures loans made by local lenders to qualified FHA borrowers; the VA guarantees loans made to qualified veterans.

Question 70

Rate Lock

Answer 70

is a guarantee from mortgage lenders that they will give mortgage loan applicants a certain interest rate, at a certain price, for a specific time period. Usually borrowers lock in their interest rate a few weeks before settlement. A longer rate lock typically is more expensive for the borrower. The price for a mortgage loan is typically expressed as points paid to obtain a specific interest rate.

If market rates rise after the rate is locked, borrowers will still get the lower rate, to the lender’s detriment. But there’s a downside: if rates fall after the rate is locked, borrowers might not be able to take advantage of that opportunity.

Question 71

Prequalifying Buyers

Answer 71

credit history and score, adequacy of assets and income, stability of income, types of acceptable income, and occupancy of the property.

Note that broker prequalification is not the same as a lender’s loan approval.

The major element of any prequalification procedure is measuring the adequacy of a buyer’s income. A lender will never approve a loan if the applicant does not have enough income to meet the monthly loan payments. Until a broker knows how large a loan payment the buyer can afford, the broker will not be able to effectively assist the buyer in selecting an affordable home

Question 72

Computerized Loan Origination and Automated Underwriting

Answer 72

A computerized loan origination (CLO) system is an electronic network for handling loan applications through remote computer terminals linked to several lenders’ computers. With a CLO system, a buyer can select a lender and apply for a loan right from the brokerage office.

On the lender’s side, new automated underwriting procedures can shorten loan approvals from weeks to minutes. Automated underwriting also tends to lower the cost of loan application and approval by reducing lender’s time spent on the process by as much as 60%. Complex or difficult mortgages can be processed in less than 72 hours. Such speed in the loan approval process can allow a buyer to submit proof of loan approval with offers to purchase; therefore, this strengthens their negotiating position.

Question 73

Conventional conforming loans (measuring the adequacy of a buyer’s income)

Answer 73

-Conventional lenders usually apply two ratios (income ratio and debt ratio) to the buyer’s income to measure adequacy

First, the proposed monthly housing expense can usually be no more than 28% of the borrower’s monthly gross income. Note that the proposed monthly housing expense includes principal and interest payments, plus monthly property taxes, insurance payments, and homeowner association dues, if applicable. Second, the proposed monthly housing expense plus the buyer’s other long-term recurring monthly debts can usually total no more than 36% of the buyer’s monthly gross income

The borrower must qualify on both ratios or they do not qualify for the loan. The larger the down payment the borrower makes, the easier it will be to qualify.

Question 74

FHA Loans (measuring the adequacy of a buyer’s income)

Answer 74

The FHA also uses the same two ratios (income and debt) as in conventional loans to qualify its borrowers; however, the maximum proposed-housing-expense-to-income ratio is 31%, and the maximum proposed-total-monthly-debt-to-income ratio is 43%.

These ratios are calculated in the same manner as the conventional ratios discussed above. The FHA ratios are not dependent on the loan’s LTV ratio, unlike conventional ratios. FHA ratios remain constant, regardless of the amount of the down payment. Note that FHA standards are somewhat easier to meet than conventional standards.

Question 75

VA Loans (measuring the adequacy of a buyer’s income)

Answer 75

The VA uses only the total-monthly-debt-to-income ratio, which the VA has set at 41% of the borrower’s monthly income. Instead of a second ratio, the VA uses the residual-income method. With this qualifying method, buyers must have a certain amount of cash left over after paying their monthly housing expenses and other recurring debts.

The VA publishes a table of how much residual income is required for buyers. The amount varies, depending on the number of dependents the buyer has and the geographic region in which the buyer lives. As with the two ratios used by conventional and FHA lenders, VA borrowers must qualify under both the total-monthly-debt-to-income ratio and the residual-income method before the loan will be approved.

Question 76

Regulation Z (Truth in Lending Act (TILA))

Answer 76

requires that credit institutions inform borrowers of the true cost of obtaining credit so that the borrowers can compare the costs of various lenders and avoid the uninformed use of credit

Regulation Z applies when credit is extended to individuals for personal, family, or household uses and when the amount of credit is $25,000 or less. Regardless of the amount, Regulation Z always applies when a credit transaction is secured by a residence.

Regulation Z requires that the consumer be fully informed of all finance charges as well as the true annual interest rate before a transaction is consummated. The finance charges must include any loan fees, finder’s fees, service charges, and points, as well as interest

Question 77

Annual Percentage Rate (APR)

Answer 77

APR is frequently thought to be the interest rate because both are expressed as percentages. APR is the relationship of all finance charges to the loan amount and will always be higher than the interest rate.

The APR tells the borrower what the true cost of borrowing is because it includes all of the fees directly related to the loan, not just the interest payments. However, there is more than one way to calculate an APR which makes it difficult for borrowers to comparison shop for loans.

Question 78

Equal Credit Opportunity Act (ECOA)

Answer 78

in effect since 1975, prohibits lenders and others who grant or arrange credit to consumers from discriminating against credit applicants on the basis of race, color, religion, national origin, sex, marital status, age (provided the applicant is of legal age), dependence on public assistance, or exercise of the consumer’s rights under this Act.

In addition, lenders and other creditors must inform all rejected credit applicants, in writing, within 30 days, of the principal reasons why credit was denied or terminated.

Question 79

Fair Credit Reporting Act (Regulation B)

Answer 79

effective since 1970, gives individuals the right to check their own credit reports and demand that mistakes be corrected. Credit bureaus are required to limit the credit information they provide to the previous seven years (except for bankruptcies, which can stay on credit records for 10 years). Individuals who have been denied credit based on information found in a credit report can examine their credit report at no charge.

Under the Fair and Accurate Credit Transaction Act (FACT Act), individuals who have not been denied credit but want to examine their credit report may now receive one free credit report per year from each of the national credit bureaus.

At this time, here are the three major credit bureaus where consumers can access their credit report and learn about protecting their credit identity: Equifax, Experian, and TransUnion.

Question 80

Loan Fraud Legislation

Answer 80

Loan fraud involves making any false representations in order to obtain a loan for a larger amount of money than the borrower is entitled to under the lender’s guidelines. Misrepresentations may involve value of the collateral land, amount of down payment, personal information about the borrower, amount of closing expenses, undisclosed rebates or credits to a party, or occupancy.

Federal loan fraud statutes apply to all residential and commercial real estate transactions. Any false statement to a lender is a federal felony crime punishable by fines up to $1,000,000 and/or imprisonment for up to 30 years.

Question 81

Residential Mortgage Fraud Act

Answer 81

In December 2007, North Carolina passed state-specific mortgage fraud legislation that made violation on one mortgage loan a felony. The penalty for commission of a felony includes incarceration, forfeiture of the property, or restitution. A real estate broker should report suspected mortgage fraud to the appropriate regulatory authority.

Question 82

North Carolina Predatory Lending Act

Answer 82

in 1999, North Carolina became the first state to enact comprehensive predatory lending laws. This North Carolina law that applies to lenders and addresses permissible fees that may be charged in connection with home loans secured by the first mortgage or first deed of trust.

The Act’s main provisions include the following:

-To impose restrictions and limitations on high-cost loans

-To revise the permissible fees and charges on certain loans

-To prohibit unfair or deceptive practices by mortgage brokers and lenders

-To provide for public education and counseling about predatory lenders

Question 83

Real Estate Settlement Procedures Act (RESPA)

Answer 83

was created to ensure that the buyer and seller in a residential real estate transaction involving a new first mortgage loan have knowledge of all settlement costs. This important federal law experienced major revisions in 2015 and will be discussed in detail in Unit 21.

RESPA requires that all transaction charges to the parties be clearly itemized on the Closing Disclosure form that makes loan fraud harder to conceal.

Question 84

Regulation X of the Truth in Lending Act provides strict regulation of real estate advertisements that include mortgage finance terms. (T/F)

Answer 84

False

It is Regulation Z, not X, that regulates ads with mortgage finance terms.

Question 85

The Equal Credit Opportunity Act (ECOA) prohibits lenders from discriminating against credit applicants on a number of factors, including marital status and age. (T/F)

Answer 85

True

Question 86

When there is a difference between appraised value and sales price, lenders will lend on the higher amount. (T/F)

Answer 86

False

Lenders will use the lesser of the two