chapter 10: Financing Home Ownership Flashcards
steps to the loan process
- source the loan
- assess risk/creditworthiness
- advise borrower of loan conditions
- confirm approval an d loan price
- close and fund the loan
- complete legal documents/recording
what do all lenders want
to be paid back according to terms
what is the underwriter’s role
- to ensure the loan meets the guidelines
- identify fraud
- proper disclosures
saleable loans
-most loans are sold into a secondary market
firewall
between underwriter and borrowers/loan officer/seller
-the underwriter must not approve loan for the wrong reasons
mortgage menu
the many types of residential loans offered by originating lenders to residential borrowers. the menu includes the cost of the various mortgage items, including the contract interest rate and number of upfront discount points and origination fees.
primary mortgage market
the loan origination market in which borrowers and lenders come together
-numerous institutions supply money to borrowers on either the internet or retail/street market
Players: bankers, brokers, banks, thrifts, credit unions
secondary mortgage market
the market where mortgage originators can divest their holdings and existing mortgages are resold
- Fannie Mae and Freddie Mac
- where existing home loans are sold regardless of who the originations the loans
Fannie Mae and Freddie Mac
one of the largest purchasers of residential mortgages in the secondary market
government sponsored enterprises (GSEs)
refers to Fannie Mae and Freddie Mac and other entities created by Congress to promote an active secondary market for home mortgages
conventional mortgage loan
oldest form, most common, any standard home loan that is not insured or guaranteed by an agency of the US government
- all standard home loans except FHA and VA
- prime, subprime,Alt-A
types of mortgages
conventional
FHA
VA
home equity loans
loan guidelines for all loan
evaluate:
- credit
- capacity
- collateral
conforming conventional home loan
meets the requirements for purchase by freddie mac or fannie mae
- standard note
- standard mortgage
- standard appraisal
- size limit (417,000)
nonconforming loan
does not meet GSE requirements in some respect
- jumbo
- non-qualified mortgages
forms of prime conventional mortgages
-(fixed-rate) level payment mortgage (LPM)
-
jumbo loans
loans that generally conform, but exceed the dollar limit
-18% of total single family mortgage originiations since 1990
maturity imbalance problem
created by funding long term LPMs with short-term deposits and savings because their assets are long term but the liabilities are short term
how they solved the maturity imbalance problem
by using adjustable rate mortgages instead
private mortgage insurance
protects lender against losses due to default
- does NOT protect borrower, against legal threats to lender’s claim, or against physical hazards
- generally required for loans over 80% of value
- protects lender for losses up to 25-35%
premiums on PMI can be paid
by the borrower in a lump sum at the time or loan origination or in monthly installments added to the mortgage interest rate
insurer may allow termination of PMI if
loan falls below 80% of current value and borrower is in good standing
insurer must allow termination of PMI when
loan falls to 80% of original value
insurer must terminate PMI when
loan falls to 78% of original value and borrower is in good standing
federal housing administration (FHA)
a gov sponsored housing finance agency that operates in the primary market by providing a default insurance program as well as other housing programs and initiatives
Goals of the National Housing Act of 1949
- decent home and suitable living environment
- implemented mainly through mortgage markets
- more efficient and allowed government agencies to concentrate on extreme needs
FHA is strictly a loan insurance program
- Loans are from private lenders
- FHA has had a positive cash flow in most years
- Through 2012, never needed gov funding
- set the precedent for PMI
FHA mortgage insurance
covers any lender loss after conveyance of title of the property to the US Department of Housing and Urban development
FHA loans are less restrictive than conforming loans
- lower credit scores
- lower down payment (3.5%) “gift funds”
- higher debt to income ratios
- targets borrowers in weaker financial circumstances (first time buyers, moderate income)
- requires less time to pass before forgiving bankruptcy, foreclosure
how FHA insurance works
- insures 100% of loan
- after foreclosure, title is transferred to HUD
- requires 2 premiums: upfront MIP and annual MIP
- upfront premium of 1.75% which can be included in the loan
- annual premiums based on average balance 1.20%, 1.25%, 0.60%, or 0.55%
- see slide 21 for details
mortgage insurance premium
upfront insurance premium required by FHA insured loans
when are premiums automatically cancelled
when the loan-to-original value reaches 78% provided that MIP payments have been made for at least 5 years
- ( but for loans of 15 years or less this cancelation is irrespective of how long the MIP is paid)
- automatic cancellation of the MIP does not mean cancellation of insurance coverage
section 203b
insures single family home mortgages, standards level payment mortgage insurace
importance of FHA
- encourages owner occupied housing
- created the LPM
- influenced housing and subdivision standards
- continues to innovate HECM program
- created a fully amortized loan
FHA loan example
page 253 and slide 23
VA guaranteed loan
a government guaranteed loan designed to help veterans obtain home mortgage loans for which they might not otherwise qualify for
- NOT mortgage insurance
- loans under 45k: 50%
- loans over 144k: 25%
- maximum guarantee: 1/4 of GSE loan limit
- loan can be up to 100% of value
- fee is based on loan to value ratio and service (see slide for detail)
- loan covers funding fee but not closing cost
purchase money mortgage
mortgage given by a property buyer simultaneous with receipt of title
- among brokers: refers to a second mortgage loan from a seller to reduce the buyers down payment
- amounts to installment payments with interest
- among gov agencies: any loan that finances a purchase
piggyback loan
a second mortgage paired with an underlying first mortgage to keep the first below 80% LTV, this avoiding required mortgage insurance
-(bc conventional loans exceeding 80% value require PMI so they wanna keep it under the limit)
home equity loan
second mortgages, used to finance home improvements and other purchases, where homeowners can borrow against the accumulated equity in the home
- closed end or open end
- tax deductible interest
- usually limited to total mortgage debt of 75% to 80%
closed end loan
a fixed amount is borrowed all at once and is repaid in monthly installments over a set period
open end line of credit
money is borrowed as it is needed, drawn against a maximum amount that is established when the account is opened.
-interest is paid on the balance due, just like a credit card
reverse mortgage
an arrangement where the lender agrees to pay money to an elderly homeowner and to be repaid from the homeowners equity when he or she sells the home or obtains other financing
- offers additional monthly income to homeowners using the home as security for the accumulating loan
- allows homeowners to liquify a portion of their housing equity without having to sell the house and move
- requires no payment (regular annuity disbursement, lump sum disbursement, credit line)
- example of page 257
mortality risk
risk that loan will grow beyond value of mortgaged property
traditional mortgage vs. reverse mortgage
TM: building equity through amortization, principal payments reduce loan balance
RM: liquidating equity through regular disbursements, periodic loan draws plus accruing interest increase the loan, and reduce the owner’s equity
interest only balloon mortgage
interest only payments for 5-7 years ending with full repayment of principal
-can have fixed or adjustable rate
interest only amortizing
interest only payments for up to 15 years then coverts to fully amortizing payment for the remainder of the term
hybrid ARM
- interest rate is fixed for some years, then becomes adjustable
- payment is set to be fully amortizing
- fixed rate period ranges from two to ten years
- fixed rate is higher as its term is longer
- successfully blends need of borrowers for predictable payments and need of lenders for market level interest rates
- expected term of loan like VA
- become tainted in recent years due to association with subprime lending
option arm
- most radical and controversial
- allows borrower to switch from fully amortizing to interest only to minimum payment
- minimum payment based on very low rate (1.5)
- minimum payment increases 7.5% per year
- interest rate was adjustable, deeply reduced at first
- with min. payment the loan balance grew to “negative amortization”
- at end of 5 years or when balance reaches 125% the payment is recast to fully amortize the loan over its remaining term
- final payment increase was typically severe and often unmanageable for the buyer
subprime loans
loans made to homeowners who do not qualify for standard home loans. can have high fees and costly prepayment penalties that “lock in” the borrower to a high interest rate
- most 2-28 hybrid, I-O, or option ARM
- adjustable rate
-low initial payment, large negative amortization
-very high loan-to-value ratio
-designed to require refinancing
-
Alt-A loans
a home loan for borrowers who fall short of qualifying for a standard home loan. better than subprime loan but below standard (prime) in borrower qualification and loan terms.
- absence of complete documentation of borrower’s income assets
- low or no cash down payment
- weak credit score
- “no doc” or “low doc” loans
comparing cost of loans using APR
- APR converts regular interest expense and upfront loan fees into a single equivalent interest expense
- APR assumes that upfront fees are spread over the full maturity of the loan
- APR will tend to understate the true cost of borrowing when upfront fees are charged
refinancing decision equation
net benefit = benefit of payment reductions - cost of refinancing
first approximation of benefits:
sum of all future monthly payment reductions where
- new loan is at current market rate
- new loan has the same remaining life as the old loan
- page 265 or slide 44-45
after tax net benefit equation
after tax net benefit = benefit of loan payment reductions x tax adjustment
the effects of refinancing-
- time and stress cost
- income taxes (mortgage interest can be deductible for taxes)
refinancing rule of thumb
- the borrower should refinance when the interest rate spread between the existing loan and a new loan reaches 2 percentage points or some other level
- payback period: divide the total cost of refinancing by the monthly payment reduction to see when the sum of payment reductions will exceed the cost of refinancing
conditions that borrowers usually default in
- monthly value of occupancy is less than its cost
- equity is zero or negative
- trigger event like divorce, death in family, or loss o f job
