Chapter 13 (Types of Mortgages and Sources of Financing) Flashcards

Question

Land Development Loans

Answer 1

Developers commonly purchase land for development by securing seller financing. The developer usually requests that the seller agree to a subordination clause. This arrangement allows the developer to secure a construction loan from a traditional lending institution. Blanket mortgages cover a number of parcels, usually building lots. The developer uses proceeds from the sale of individual lots to pay off the blanket mortgage. A partial release clause commonly used in blanket mortgages provides for the release of individual parcels from the blanket mortgage upon payment of a specified amount. The partial release clause stipulates the conditions under which the mortgagee will grant a release of lots, free and clear of the mortgage.

Answer 2

The National Housing Act of 1934 created the Federal Housing Administration (FHA). A major focus of FHA is to stimulate homeownership. The FHA is a government agency within the Department of Housing and Urban Development (HUD). The FHA functions as an insurance company, insuring mortgage loans made by approved lenders. The FHA insures mortgages for various types of properties. Common FHA loan programs include a mortgage program for condominium units and an adjustable rate loan program. Section 203(b) is the most popular home mortgage program of the National Housing Act. Section 203(b) fixed-rate mortgage loans require a small down payment for the purchase or construction of one-family to four-family residences.

Answer 3

1. Loan Insurance FHA loans are a type of nonconventional loan because they are insured by the FHA up to certain limits. The FHA insures mortgage loans to protect lenders in the event that borrowers default. The cost of the mortgage insurance is passed on to the borrower. 2. Lending Source FHA loans are made by FHA-approved lenders. The FHA does not make loans to borrowers. The FHA does not process loans or build houses. 3. Discount Points FHA-approved lenders may charge discount points on FHA-insured mortgage loans. Discount points may be paid by either the seller or the buyer. 4. Down Payment A major benefit of FHA-insured loans is that the down payment is much smaller than the amount required for conventional mortgage loans. A borrower can obtain an FHA-insured loan with a down payment as low as 3.5% of the purchase price or the appraised value, whichever is less. FHA refers to the required down payment as the minimum cash investment. Closing costs may not be used to meet the minimum 3.5% down payment requirement. Borrowers must have a good credit history to qualify for maximum financing. 5. Loan Limit FHA sets limits on the amount that can be borrowed. The limits vary significantly, depending on the average cost of housing in different regions of the country. For example, the maximum FHA loan for a one unit residence is greater in Fort Lauderdale and Miami than in Gainesville or Tallahassee, Florida, because the average cost of housing is greater in the Fort Lauderdale and Miami markets. Lenders make FHA-insured loans in even $50 increments. 6. Insurance Premium Borrowers are charged a one-time mortgage insurance fee at closing. This fee is called the up-front mortgage insurance premium (UFMIP). (A one-time mortgage insurance premium on FHA mortgage loans that is paid at closing) The percentage of the UFMIP is based on the type (new or refinance) and term (15-year or 30-year) of the mortgage. The UFMIP is paid at closing and can be financed into the mortgage amount. In addition to the UFMIP, the borrower is also charged an annual mortgage insurance premium (MIP). "Fee paid by FHA borrowers to obtain a loan (up-front and annual)." The annual MIP is paid monthly (annual premium divided by 12) as part of the monthly mortgage payment. The MIP must be included in the proposed monthly expenses when calculating the buyer's qualifying ratios. The monthly MIP is paid for the life of the FHA loan when the borrower receives maximum financing. UFMIP and MIP go into an FHA fund for repaying lenders if borrowers default. 7. Qualifying Ratios FHA lenders use gross monthly income to calculate two qualifying ratios for loan applicants. a. The housing expense ratio (HER) is calculated by taking monthly housing expenses for principal, interest, property taxes, and hazard insurance (PITI) and the monthly mortgage insurance premium (MIP) and dividing by the applicant's monthly gross income. monthly housing expenses (PITI and MIP) ÷ monthly gross income = HER b. Lenders also use the total obligations ratio (TOR) to qualify applicants for FHA-insured mortgage loans. The TOR cannot exceed 43%. Total obligations includes PITI, MIP, and recurring expenses (also see Qualifying for a conventional mortgage). total monthly obligations ÷ monthly gross income = TOR 8. Assumption FHA mortgage loans do not have a due-on-sale clause in the mortgage. The FHA requires complete qualification of the buyer assuming the loan. All assumed loans (and new FHA loans) are for owner-occupied use only (no investor loans). The lender must release the original mortgagor from liability if the assuming mortgagor is found creditworthy and executes an agreement to assume and pay the mortgage debt. By law, FHA loans cannot charge prepayment penalties; the loan may be paid off early without penalty. 9. Interest Rate The interest rate on FHA mortgages is not set by the FHA or HUD. The interest rate is allowed to fluctuate with the market and is negotiable between the lender and the borrower. 10. Appraisal The home must be appraised by an FHA-approved appraiser. HUD requires the appraiser to confirm the property meets HUD's minimum property standards. However, the FHA does not warrant the condition of the property. The FHA encourages buyers to have a home inspection conducted.

Answer 4

The Servicemen's Readjustment Act (GI Bill of Rights) was passed to aid returning World War II veterans. This act and subsequent acts gave the Department of Veterans Affairs (VA) the authority to partially guarantee mortgage loans made to veterans by private lenders. The partial guarantee covers the top portion of the loan. The VA issues rules and regulations that set the qualifications, limitations, and conditions under which a loan may be guaranteed. The VA loan guarantee differs from the FHA program that insures loans (see below).

Answer 5

1. Qualifications for Program Only veterans, unremarried surviving spouses of veterans, and active military personnel may apply for a VA loan. 2. Eligibility Requirements Specific eligibility requirements are based on the period of active duty or the period of continuous service, as applicable. Real estate licensees should rely on a VA lender to determine an applicant's eligibility for a VA loan. 3. Lending Source VA loans are made by VA-approved lenders. However, the VA does have the power to make direct loans to veterans in areas where VA loans are not available. The VA loan program may be used to purchase, refinance, or construct one to four-unit properties provided the veteran resides in one of the units. The maximum loan term is 30 years. The interest rate on VA loans varies based on market conditions and is negotiated between the borrower and the lender. 4. Loan Guarantee The VA establishes loan guarantee limits called the VA loan guarantee or the maximum "entitlement". The 2014 maximum entitlement (guarantee) is $104,250. A veteran's entitlement is the maximum amount the government guarantees the lender will be paid in the event the borrower defaults. A veteran begins by applying to the VA for a certificate of eligibility. The certificate of eligibility states the amount of entitlement available to the veteran borrower. The VA loan guarantee program uses a scale that establishes each veteran's entitlement based on the loan amount. A veteran who has used the entitlement in the past may only now be eligible for a portion of the entitlement. The unused portion is available to the veteran borrower up to the maximum guarantee. When a VA loan is paid off, the veteran's maximum entitlement is reinstated. 5. Loan Limits The VA does not set loan limits. The amount that a veteran may borrow depends on the value of the real estate. The loan may not exceed the amount stated in the certificate of reasonable value (CRV). The CRV is based on the property value estimated by a VA-approved appraiser. The other limiting factor is the veteran's income and ability to make the monthly mortgage payments. 6. VA Funding Fee The VA requires a funding fee or user's fee to help the government defray the cost of foreclosures. Currently, the funding fee is 2.15% of the loan amount, with no down payment for first-time users. Funding fee expenses may be added to the maximum loan amount and financed over the life of the loan. If a veteran has a service-connected disability, the funding fee is waived. VA loans do not require mortgage insurance premiums (MIP). 7. Discount Points Lenders may charge discount points on VA guaranteed loans. The veteran buyer or the seller may pay the points. 8. Qualifying Ratio To qualify loan applicants, the VA uses a total obligations ratio (TOR) and a table of residual incomes calculated for different regions in the United States. The veteran borrower's total monthly obligations may not exceed 41% of the total monthly gross income. 9. Closing Costs The lender may charge reasonable closing costs. However, these costs may not be included in the VA loan. Closing costs vary among lenders. The veteran borrower or the seller may pay the following closing costs or the closing costs may be shared: ``` VA appraisal Credit report Loan origination fee (usually 1% of the loan) Discount points Title search and title insurance Recording fees State transfer fees Survey ``` 10. Assumption Because they do not have due-on-sale clauses, VA loans are assumable (even by nonveterans). VA loans made prior to March 1, 1988, are assumable without a credit check of the new mortgagor. However, both seller and buyer will be liable in case of default, unless the buyer qualifies and completes all substitution documents. For VA loans made on or after March 1, 1988, the buyer must qualify. The buyer must pay an assumption or transfer fee to the lender plus an assumption fee to the VA. The seller is then released from liability for the VA loan. 11. Prepayment VA mortgage loans do not contain a prepayment penalty clause. Therefore, veterans may prepay all or a portion of the mortgage loan ahead of schedule without penalty.

Answer 6

The constantly changing real estate financing market requires that licensees keep up with the various mortgage types and formats available in their local areas. Before attempting to qualify a buyer, licensees should make sure that required written brokerage relationship disclosures have been made. Brokerage relationship disclosure is important because licensees need to obtain confidential information to help determine appropriate loan amounts, financing plans, and affordable income-expense ratios. Qualifying a buyer involves two separate but important processes: 1. Determining the potential buyer's real property needs (housing objectives) 2. Determining the potential buyer's economic capability to satisfy those needs (financial abilities)

Answer 7

Licensees must listen carefully to potential buyers to separate wishes from actual needs. Then, licensees must help buyers set goals and priorities regarding housing features, neighborhoods, and prices. Licensees should encourage buyers to focus on needs first and then add "wants" as economic conditions permit. A licensee should spend the time necessary to learn a potential buyer's family size, hobbies, ages of family members, distances family members are willing to drive to and from work, plus anything else that might contribute to understanding the potential buyer's needs. If breadwinners regularly bring work home from the office, they may need a quiet, controllable home workspace. Only after housing objectives have been discussed is a licensee prepared to examine financial ability.

Answer 8

For some licensees, gauging economic capability is the more difficult part of the qualifying process. It need not be. Recognize that this is a sensitive area, one that is regarded as private information and no one else's business. However, if licensees are up to date on the financial options currently available to buyers, they find it easier to begin this portion of the qualifying process by reviewing the options available to buyers. Talking about loan options, demonstrates professionalism, introduces buyers to consideration of a down payment and monthly payments, and helps to develop confidence in the licensee. One proven technique for economic qualification is the explain-and-request technique. After a brief summary of available financial options, a licensee explains the need to ask the prospective buyer some general questions and then requests permission to ask the questions. Work with reasonably general questions: "Have you a fairly good idea of how much you plan to invest as a down payment?" "Have you thought about the approximate amount you would feel comfortable with as a monthly mortgage payment?" Amounts the buyer provides may or may not be realistic. However, the buyer responses will confirm such information or bring to the surface any misconceptions about the market value of real estate and how much home the buyer can afford.

Answer 9

The reasons for qualifying potential buyers fall into four areas: - Saves time - Increases confidence in sales associate - Fits buyers to properties - Retains buyers Begin to qualify buyers with questions related to general information (name, address, and so forth), then gradually work into items of a more specific, personal nature (income, expenses, etc.).

Answer 10

Property purchased with any type of mortgage first must be qualified by the lender. After the property has been appraised, surveyed, and the title searched, the loan underwriter will make a decision about the property. The purchaser also must be qualified. Lenders generally use five major qualifying guidelines in borrower qualification and risk analysis: 1. The quantity and quality of the borrower's income (Does the borrower have the ability to repay the debt?) 2. Other assets of value (What is the proposed mortgagor's net worth, and what is the ratio of total liabilities to total assets?) 3. Past credit history (Is the borrower willing to repay the debt?) 4. Loan-to-value ratio (How much equity is the borrower investing?) 5. The borrower's credit score (In today's marketplace, an applicant's credit score is an important component of all loan decisions. The strength of the credit score determines the interest rate offered to the applicant and also dictates the amount of supporting documentation required for the loan application.) Loan underwriting (borrower qualification and property qualification) should not be confused with buyer qualification, which has to do with what the buyer wants and can afford. The loan underwriting process begins with the FNMA/FHLMC Uniform Residential Loan Application for all one-family to four-family homes.

Answer 11

Prospective borrowers must provide information to lenders about their present employment, financial history, and present obligations. In addition, federal regulations require lenders to obtain documented proof, such as tax returns and financial statements. Lenders use this information to make a decision about loan approval or rejection. The lender is interested in the borrower's debt-paying ability and the risk involved. The quantity of the borrower's income is the amount earned. However, amount alone is not sufficient, because the probable duration of income is also important when the debt obligation may extend up to 30 years. So, the quality of the income is also evaluated—the length of time of the applicant's present employment and probable continuation of that employment. Lenders also evaluate demands on a prospective borrower's income; that is, income taxes, installment credit amounts, proposed mortgage payments, and property taxes.

Answer 12

The second area of concern in analyzing a loan application is the total value of the mortgaged property plus other assets belonging to the applicant. Other real estate, savings accounts, stocks, bonds, and equity in personal property are examples of assets that could act as sources of funds for mortgage payments if the applicant's income is interrupted.

Answer 13

The third area of concern is the applicant's willingness to repay debts, based on credit history, obtainable from a local credit bureau. The existing national network of credit bureaus permits a comparatively rapid check of buyers, even of new residents from other states.

Answer 14

A credit score is a number that assists lenders with predicting whether a borrower is likely to make timely credit payments. Lenders use credit scores to measure potential risk of making a loan. Higher credit scores mean that an applicant is more likely to be approved and pay a lower interest rate on new credit. FICO® scores are the most widely used credit scores. Credit scores are based on information found in a consumer's credit report. Scores reflect a consumer’s payment history, amount owed, how much available credit is being used, length of credit history, and whether the consumer has recently applied for or opened new credit accounts. FICO scores range from 300 to 850. FICO scores above 700 are a sign of good financial health. FICO scores below 600 indicate high risk to lenders and could result in denial of a credit application. Lenders buy FICO scores from three national credit reporting agencies. The Fair and Accurate Credit Transaction Act (FACT Act) makes it possible for consumers to monitor their credit reports at no cost. The government allows consumers to request a free copy of their credit report every 12 months from each of the three credit bureaus—Equifax, Experian, and TransUnion. Consumers can request all three reports at once or spread out their requests over the 12-month period. To request your report, go to the centralized source, a combined effort by the three national bureaus, at www.annualcreditreport.com. This is the only site that participates with the government program, so don't be fooled by "free credit report" gimmicks from other sites. You can download and print your credit report online or request your credit report by mail. You can also order by telephone at 877-322-8228.

Answer 15

Title 1 of the Credit Protection Act and implemented by the Federal Reserve Board's Regulation Z. The main purpose of the act is to ensure that borrowers and customers of consumer credit are given meaningful information with respect to the cost of credit so that consumers can compare the various credit terms available. Most of the requirements imposed by TILA are contained in Federal Regulation Z; therefore, the terms Truth in Lending Act and Regulation Z are often used interchangeably. The law became effective in 1969 and has been amended as recently as 2009. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act created the Consumer Financial Protection Bureau, consolidating most federal consumer financial protection authority under a single bureau. The Consumer Financial Protection Bureau supervises banks and credit unions and also enforces federal consumer financial laws, including the Truth in Lending Act.

Answer 16

TILA is intended to inform borrowers of the true cost of obtaining a loan. The law ensures that credit terms are disclosed in a meaningful and uniform way so consumers can compare credit terms more readily and knowledgeably. Before its enactment, consumers were faced with various credit terms and rates. It was difficult to compare loans because they were seldom presented in the same format. Under TILA, all creditors must use the same credit terminology and expressions of rates. In addition to providing a consistent system for disclosures, TILA includes substantive protections. It gives consumers the right to cancel certain credit transactions, regulates certain credit card practices, and provides a means for fair and timely resolution of credit billing disputes. TILA and Regulation Z do not, however, mandate how much interest banks may charge or whether they must grant loans to consumers. The law does not attempt to regulate interest rates. TILA applies to consumer loans only; it does not apply to business, commercial, or agricultural credit, or to credit extended to governmental agencies.

Answer 17

Regulation Z generally applies when a loan is secured by a residence (residential real estate loans intended for the purchase or construction of a consumer dwelling are considered consumer loans under TILA). Specifically, TILA applies to loans to purchase or construct any consumer dwelling (prior to 2009 applied to a principal residence only), refinanced home loans, and home equity loans (including home equity lines of credit).

Answer 18

Regulation Z requires four important disclosures regarding the cost of credit. 1. Annual percentage rate. The finance charge must be stated as an annual percentage rate (APR). The APR includes the interest rate and other loan costs and represents the true annual cost of credit. The APR is expressed as an effective yearly interest rate. The disclosure of the APR is central to the uniform credit cost disclosure. It is common to see an ad that states "mortgage interest rates at 6%" followed by a parenthetical statement such as "(annual percentage rate 6.25%)" or "(APR 6.25%)." APR is a function of the amount financed, the finance charge, and the payment scheduled. The APR is rounded to the nearest 1/8%. 2. Finance charge. The finance charge is the total dollar amount the loan will cost over its entire life. Charges that must be disclosed include interest charges, discount points or buydown fees, loan finder's fees, servicing fees, notary fees, and required life insurance. Not included in finance charges are title insurance, legal fees, appraisal fees, survey fees, notary fees, credit reports, and deed preparation. 3. Amount financed. This is expressed as the total amount of credit provided by the lender. 4. Total payments. The total amount the borrower will have paid after making all scheduled payments.

Answer 19

All required disclosures must be made in writing and either given to the borrower at the time of loan application or sent within three business days of application, and at least seven business days before consummation (a timing waiver is available for a bona fide emergency). The lender may not charge an application fee until after the disclosures have been provided (the applicant may be charged a credit report fee). Lenders must deliver to the borrower a copy of the appraisal report three business days before closing the loan.

Answer 20

TILA makes "bait and switch" advertising a federal offense. For example, if a subdivision developer advertises homes for sale with a down payment of $1,000, the seller must accept $1,000 as the complete down payment or be in violation of the law. TILA is also concerned that consumers may be misled by being given truthful but inadequate information in advertising. While it does not require creditors to advertise credit terms, it does provide that if they advertise certain credit terms, called triggering terms, they must include additional disclosures. Trigger terms include the: amount or percentage of any down payment, number of payments, period (term) of repayment, amount of any payment, and amount of any finance charge. Advertisements containing any of the triggering terms must also disclose the following: Amount or percentage of down payment Terms of repayment Annual percentage rate, using that term; and if the rate may be increased in the future, that fact must also be disclosed TILA allows general phrases such as "owner will finance" and "favorable financing terms available." Such expressions are too general to trigger additional disclosure requirements.

Answer 21

The borrower has the right to rescind (cancel) the loan contract up to midnight of the third business day following the signing of the loan documents. The right of rescission can be waived by the borrower for financial reasons. The right of rescission applies to most consumer loans but does not apply to loans to purchase or construct a home. If the refinance is with a new lender, the right of rescission applies. If the refinance is with the same lender, only additional money added to the original loan (if any) may be rescinded (see below). The three-business-day right of rescission applies to: home equity lines of credit, second mortgages, and refinance loans.

Answer 22

The Equal Credit Opportunity Act (ECOA) is enforced by the Federal Trade Commission. The ECOA is a federal law that requires financial institutions and firms engaged in extending credit to make credit available with fairness and without discrimination on the basis of race, color, religion, national origin, sex, marital status, age, or receipt of income from public assistance programs.

Answer 23

RESPA is a consumer protection law, administered by the Consumer Financial Protection Bureau, intended to ensure that buyers are informed regarding the amount and type of charges they will pay at closing. RESPA also attempts to eliminate kickbacks and referral fees that increase closing costs. RESPA applies to federally related residential loans. RESPA covers loans secured with a mortgage on a one-family to four-family residential property. These include most purchase loans, assumptions, refinances, property improvement loans, and equity lines of credit. Transactions exempt from RESPA include: - loans to finance the purchase of 25 acres or more; - loans for home improvement or to refinance or any other type of loan if its purpose is not to purchase or transfer title; - loans to finance the purchase of a vacant lot if none of the loan proceeds will be used to place a residential structure or mobile home on the lot; - sale or transfer of property involving only an assumption of an existing loan (if the lender does not have to approve the assumption) or sale subject to an existing loan; - construction loans, except those intended for conversion into permanent loans; - permanent loans to finance construction of a one-family to four-family structure when the lot is owned by the borrower; and - loans to finance the purchase of property when the primary purpose is resale of the property.

Answer 24

When borrowers apply for a mortgage loan, they must be given the following disclosures: 1. HUD's settlement cost booklet, published by the Department of Housing and Urban Development (HUD), which contains consumer information regarding closing services (required for purchase transactions only) the borrower may be charged for at closing, describes the homebuying process, and explains both the Good Faith Estimate (GFE) and the Settlement Statement (HUD-1) * A booklet containing consumer information regarding closing costs the borrower may incur at closing. RESPA requires lenders to give the booklet to loan applicants. 2. Good Faith Estimate (GFE) of closing (settlement) costs, listing the charges the buyer is likely to pay at closing. The standardized GFE facilitates shopping among settlement service providers. If the lender allows the borrower to shop for third-party settlement services, the lender must provide the borrower a list of acceptable service providers. 3. Servicing disclosure statement, which discloses to the borrower whether the lender intends to service the loan or transfer it to another lender or servicing company If the borrower did not receive the disclosures at the time of loan application, the lender must mail them within three business days of receiving the loan application

Answer 25

Sometimes, several businesses that offer settlement (closing) services are owned or controlled by a common corporate parent. These businesses are called affiliates. When a lender, real estate broker, or other closing participant refers a borrower to an affiliate for a settlement service (for example, when a real estate broker refers a buyer to a mortgage broker affiliate), RESPA requires the referring party to give the borrower an Affiliated Business Arrangement (AFBA) Disclosure. This form explains to borrowers that they are not required, with certain exceptions, to use the affiliate and are free to shop for other providers. The AFBA must include an estimate of the affiliated business provider's charges. Except in cases where a lender refers a borrower to an attorney, credit reporting agency, or real estate appraiser to represent the lender's interest in the transaction, the referring party may not require the consumer to use the affiliated business.

Answer 26

RESPA prohibits a seller from requiring the homebuyer to use a particular title insurance company as a condition of sale. Generally, the lender will require title insurance. The borrower can shop for and choose a company. However, if the seller is paying for the owner's title insurance policy, the law does not prohibit the seller from choosing the title company.

Answer 27

The closing agent must provide borrowers with the Settlement Statement at closing. The Settlement Statement shows all the charges imposed on the borrower and the seller and any credits due the borrower and the seller. It itemizes the actual closing costs of the loan transaction. The statement was revised to help consumers determine whether their actual closing costs were within established tolerance requirements. The statement includes a chart that compares the charges quoted in the GFE with the actual charges applied at closing. Some of the charges may not increase; others may not increase more than 10%. If requested by the borrower, the closing agent must provide a copy of the Settlement Statement one business day before the actual settlement. The statement must include all information the closing agent has at that time.

Answer 28

RESPA limits the amount that lenders can require borrowers to place in escrow for property taxes and hazard insurance. The lender must perform an annual escrow account analysis. An excess of $50 or more must be returned to the borrower.

Answer 29

It is illegal under RESPA for anyone to pay or receive a fee, kickback, or anything of value because they agree to refer settlement service business to a particular person or organization. For example, a mortgage lender may not pay a real estate broker a fee for referring a buyer to the lender. It is also illegal for anyone to accept a fee or part of a fee for services if that person has not actually performed settlement services for the fee. For example, a lender may not add to a third party's fee, such as an appraisal fee, and keep the difference. RESPA does not prevent title companies, mortgage loan originators, appraisers, attorneys, closing agents, and others, who actually perform a service in connection with the mortgage loan or the closing, from being paid for the reasonable value of their work. It is a crime for someone to pay or receive an illegal referral fee. The penalty can be a fine, imprisonment, or both. The borrower may also be entitled to recover three times the cost of settlement service charges that were illegally referred or charged with no actual service provided by bringing a private lawsuit (also called triple or treble damages).

Answer 30

Like other markets, the mortgage market is tied irrevocably to the law of supply and demand. An economic fact of life is the inverse relationship between available mortgage money and mortgage interest rates. When the amount of available mortgage money goes down, mortgage interest rates go up, and vice versa. The supply of mortgage money available at any given time depends (1) on the continuous and orderly flow of money into various types of financial institutions, and (2) on the amount borrowed by the federal government. All lenders in the mortgage market are tied together by long-term credit lending with real property as security. Also, despite their different locations and operating policies, all lenders are mutually dependent on the overall supply of money existing in the nation. For this reason, price movements of money in different areas are related. When a corporation in San Francisco borrows $50 million from a mutual savings bank in Boston, the money available in the mortgage market is depleted by that amount. The result could be higher interest rates for loans made in Orlando, for example. Thus, each geographical area is a component of the entire mortgage market. The entire mortgage market is, in turn, only one component of the vast financial system called the overall capital market. As interrelated parts, each is responsive to changes affecting the whole system. In fact, it is the total demand for money interacting with the total available supply of money that determines the interest rate, or cost, of mortgages. At any given time, a number of businesses or institutions are renting mortgage money to other businesses or individuals. The rent paid for the use of money is called interest. When money is plentiful and available from many sources, the supply of money exceeds the demand, creating an easy money market situation. The interest charged for money loaned during an easy money market is less than in a tight money market. A tight money market exists when demand for funds exceeds the available supply, resulting in an increase in the interest charged for money. The demand for mortgage money is increased or decreased by the following six major influences: 1. Changes in the number and size of households 2. Shifts in geographic preference for households 3. Existing inventory of structures 4. Changes in employment rates and income 5. Changes in costs of real property services, taxes, and maintenance 6. Changes in construction costs Influences on the supply side of the mortgage money market also are varied. Because they are considered long-term loans, mortgages do not compete directly with the short-term demand for funds. Mortgages must compete directly with other long-term claims for money. The long-term claims are corporate stocks and bonds and long-term bonds issued by the various federal, state, and local governments. As a consequence, the mortgage, stock, and bond markets are all in competition for the overall supply of funds in what is called the nation's capital market. Another important influence on the mortgage market is the refinancing of the national debt. The U.S. government owes the owners of short-term and long-term securities trillions of dollars. At the present time, this debt is refinanced periodically by the sale of new securities on the open market. When the U.S. Treasury sells enough securities to pay interest on $500 billion, for example, it drains a large amount of money from the capital market. This drainage results in less funds available for the mortgage market and higher interest rates.

Answer 31

The Federal Reserve (commonly called the Fed) is the central bank of the United States. It was established by Congress in 1913 to provide the nation with a safer and more stable monetary system. The Federal Reserve System (FRS) consists of a 7-member Board of Governors and 12 Reserve Banks located in major cities across the nation. The members of the Board of Governors are appointed by the President and confirmed by the U.S. Senate. Today, the Federal Reserve's duties include (1) conducting the nation's monetary policy, (2) supervising and regulating banking institutions and protecting the credit rights of consumers, and (3) maintaining the stability of the financial system. Monetary policy refers to the actions undertaken by the Fed to influence the availability and cost of money and credit to promote national economic goals. The Federal Reserve is charged with the responsibility for setting monetary policy. The Federal Reserve also has regulatory and supervisory responsibilities over banks that are members of the FRS. Additionally, the Board is responsible for the development and administration of regulations that implement major federal laws governing consumer credit, such as the Truth in Lending Act and the Equal Credit Opportunity Act.

Answer 32

1. Open-market operations. * Purchase and sale of U.S. Treasury and federal agency securities. The Fed's principal and most effective tool for implementing monetary policy is open-market operations. 1. Open-market operations involve the purchase and sale of U.S. Treasury and federal agency securities. The purchase or sale of these securities results in an increase or decrease of money in circulation. For example, when the Fed decides to sell securities through open-market bulk trading, the FRS holds the funds received from the sale. This reduces the supply of money in circulation, which, in turn, causes a drop in loanable funds and causes interest rates to rise. Higher interest rates cause some business and individuals to postpone borrowing. As borrowing drops off, the economy slows down and inflation (if any) is reduced. When an increase in economic activity seems needed, the Fed buys securities, thereby releasing money back into normal circulation and increasing loanable funds. 2. Discount rate. * The amount of interest the Federal Reserve charges to lend money to its eligible banks. The second most commonly used method of controlling the supply of money is changing the discount rate. The discount rate is the interest rate charged member banks for borrowing money from the Fed (do not confuse discount rate with discount points discussed later in this unit). If the discount rate is increased, member banks have to pay a higher interest rate for money borrowed from their district bank. The higher interest rate is passed on in the form of higher interest to consumers. This reduces the number of loans made because consumers become reluctant to borrow. Because increasing or decreasing the discount rate has the greatest impact on the cost of short-term credit, the discount rate is considered the least effective economic tool for influencing the interest rates of long-term real estate loans. 3. Reserve requirements. * The amount of funds that an institution must hold in reserve against deposit liabilities. The third method the Fed uses to influence the supply of money is the change in reserve requirements. The reserve requirements are the amount of funds that an institution must hold in reserve against deposit liabilities. Institutions must hold reserves in the form of vault cash or deposits with Federal Reserve Banks. Changing the reserve requirement is regarded as perhaps the most abrupt or drastic way to influence the supply of money. Because most member banks have large amounts of time deposits and demand deposits, a very small increase in percentage of reserve requirements has an immediate impact on the amount of funds taken out of circulation.

Answer 33

The actions undertaken by the Fed to influence the availability and cost of money and credit.

Answer 34

The Federal Home Loan Bank System (FHLBS) was created to provide the same regulatory and administrative services for the nation's savings associations that the FRS provides for commercial banks. Patterned after the Fed, the FHLBS includes 12 district Federal Home Loan Banks (FHLBs). They constitute a permanent pool of reserve credit for savings association member institutions and ensure a source of mortgage funds when local funds are insufficient. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) created the Office of Thrift Supervision (OTS) to charter and regulate member federal savings associations. FIRREA also created the Federal Housing Finance Board (FHFB) to supervise mortgage lending by the 12 regional FHLBs. All federally chartered savings associations are required to be members of their district FHLB. While membership is optional for state-chartered savings associations, mutual savings banks, and insurance companies, many of these—that meet federal standards and can qualify—elect to join because only member institutions are allowed to borrow from their district FHLB for up to one year without collateral. Longer-term loans, such as real estate loans, must be secured by collateral.

Answer 35

A branch of the U.S. Treasury Department that replaced the Federal Home Loan Bank Board as regulator of the thrift industry.

Answer 36

The Federal Deposit Insurance Corporation (FDIC) insures deposits in banks and savings associations. The FDIC is an independent agency of the federal government. It is funded by premiums that banks and savings associations pay for deposit insurance coverage and from earnings on investments in U.S. Treasury securities. Deposit accounts are insured to $250,000 per depositor in each bank or thrift that the FDIC insures. Savings, checking, and certain retirement accounts including IRAs are insured to $250,000. The Federal Deposit Insurance Reform Act merged the Bank Insurance Fund (which formerly insured federally chartered banks) and the Savings Association Insurance Fund (which formerly insured federally chartered savings associations) into the Deposit Insurance Fund (DIF) that insures both banks and savings associations.

Answer 37

The primary mortgage market is made up of primary lenders that originate new mortgage loans for borrowers. A primary market is the market where securities or goods are actually created. *A source for the purchase of a mortgage loan by a borrower. For example, if a commercial bank lends a homebuyer the money to buy a house via the use of a mortgage loan, that would be a primary market activity. The dominant primary lenders are commercial banks (CBs), savings associations (SAs), mutual savings banks, selected credit unions, and mortgage companies. Together, these lenders originate more than 95% of all residential mortgage loans.

Answer 38

A source for the purchase of a mortgage loan by a borrower.

Answer 39

The SAFE Act sets a minimum standard for licensing and registering mortgage loan originators. (MLOs were previously licensed as mortgage brokers.) The SAFE Act requires employees of banks, savings associations, credit unions, and farm credit institutions, that are regulated by a Federal banking agency and who engage in residential mortgage loan origination, to register with the Nationwide Mortgage Licensing System (NMLS). Mortgage loan originators must submit fingerprints for a criminal background check. MLOs who are not employed by agency-regulated institutions are licensed by the states. Employees of bank holding companies and their nonbank subsidiaries who act as MLOs are subject to state licensure and associated state regulation, in addition to registration with the NMLS. The SAFE Act requires state-licensed MLOs to complete pre-licensure education courses, pass a written qualification exam, and take annual continuing education courses. The SAFE Act also requires all MLOs to submit fingerprints to the NMLS for submission to the FBI for a criminal background check. State-licensed MLOs must also provide authorization for the NMLS to obtain an independent credit report.

Answer 40

*One who finds a lender for a potential borrower, and vice versa. A mortgage loan originator (MLO) is a person who solicits or offers to solicit mortgage loans, accepts or offers to accept mortgage loan applications, negotiates the terms or conditions of new or existing mortgage loans on behalf of a borrower or a lender, processes mortgage loan applications, or negotiates the sale of existing mortgage loans to noninstitutional investors for compensation. The SAFE Mortgage Licensing Act requires MLOs who are not employed by a institution regulated by a federal agency to obtain a Florida loan originator license. If a loan application is approved, the loan originator earns a negotiated loan origination fee.

Answer 41

*A business entity that conducts loan originator activities. Mortgage brokers can employ mortgage loan originators. Mortgage brokers do not make loans or service loans they arrange loans. Instead, mortgage brokers arrange loans for prospective borrowers with various mortgage lenders.

Answer 42

*A business entity that originates, sells, and then services mortgage loans. Mortgage lenders are not depository institutions. They originate loans and then package the loans together and sell the entire package. Mortgage lenders primarily make VA and FHA loans and then sell the loans in the secondary mortgage market. Mortgage loan originators who are employed by a mortgage broker or mortgage lender must be registered with the NMLS. MLOs employed by a mortgage broker or a mortgage lender must also be state-licensed if the mortgage broker or mortgage lender is not a federal agency–regulated institution. Mortgage lenders secure short-term funds from other lenders (for example, commercial banks) that enable them to originate mortgage loans until they are sold on the secondary market or to large financial institutions. This process is called warehousing, because the mortgage lenders use the loans as security for the short-term financing, and the loans are "stored" for a short period of time until they are sold as a package. Mortgage lenders often serve as loan correspondents (local representatives) for life insurance companies (LICs), enabling LICs to use their insurance policy funds and pension funds to invest in mortgage instruments. Mortgage lenders typically earn loan origination fees plus servicing fees. Today, mortgage lenders are the largest originators of residential real estate loans.

Answer 43

1. Intermediation is a process practiced by financial thrift institutions that serve as financial intermediaries (middlemen) between depositors and borrowers. Intermediation occurs when thrift institutions accept depositors' savings. Thrift institutions are financial institutions that hold savings deposits. Savers deposit funds into commercial banks, savings associations, and mutual savings banks, which then lend the funds to homebuyers and other borrowers. Intermediation results in the availability of mortgage money. 2. Disintermediation occurs when funds are withdrawn from intermediary financial institutions, such as banks and savings associations, and are invested in instruments yielding a higher return. Disintermediation is the process of bypassing the intermediary financial institutions (or middlemen).

Answer 44

Commercial banks (CBs) are the primary reservoirs of commercial credit in this country and the largest group of financial institutions in both assets and numbers. The amount invested in real property mortgages by CBs has been increasing over the past few years. CBs hold demand deposits (checking accounts ; payable on demand by holder), as do federally chartered SAs and credit unions. CBs are chartered by either a state or the federal government (called national banks). National banks are supervised by the Office of the Comptroller of the Currency and are members of the FRS. The chartering agency prescribes the rules and regulations that govern the business operations of a bank. If chartered by the federal government, a CB must display the word National or the initials NA (National Association) somewhere in their name. State-chartered CBs are regulated by state agencies, and membership in the FRS is optional; however, as a practical matter, almost all state banks are members of the FRS. Commercial banks make conventional, FHA, and VA mortgage loans, and they have long been recognized as specialists in construction loans for both residential and commercial projects. Most banks also have concentrated on equity loans (lines of credit)—that is, loans to homeowners based on the amount of equity in their homes.

Answer 45

Savings associations (SAs), formerly called savings and loan associations (S&Ls), are also called thrifts and savings banks. S&Ls, before deregulation, were the major source of residential real estate loans. Today, most SAs invest the bulk of their assets in residential mortgages and home equity loans. They adhere to strict underwriting guidelines established by the secondary mortgage market. SAs are chartered by either the state or the federal government. If a savings association is federally chartered, either Federal or FA (Federal Association) must appear in the name of the association. The experience of SAs with residential mortgages makes them expert in underwriting and making mortgage loans on single-family houses. Practically all SAs prefer to make conventional mortgage loans, although they may make both FHA and VA loans.

Answer 46

Mutual savings banks (MSBs) are state chartered and are similar to SAs. They are mutually owned (no stockholders). While CBs are located in all 50 states, most of the approximately 470 MSBs are concentrated in the Northeast. MSBs are active investors in FHA and VA loans all over the nation. By using mortgage bankers and other representation in fast-growing capital-deficit areas, MSBs are able to extend their lending activities into such areas whenever they choose to do so.

Answer 47

Since the 1980s, the volume of loan originations has shifted from savings associations to mortgage companies. Mortgage companies originate loans with either their own funds or borrowed capital. They package the loans and sell them to institutional investors and secondary market participants. Mortgage companies, also called mortgage lenders, are not financial intermediaries because they do not accept savings deposits. The principal activity of mortgage companies is to originate and service loans on residential and income properties. Mortgage companies charge interest and earn fees on the loans that they originate. From these fees, mortgage companies pay interest on any interim funds borrowed, cover operating expenses, and earn a profit. Today, mortgage companies account for more than half of all single-family loan originations.

Answer 48

Life insurance companies (LICs) are regulated by the laws of the states in which they operate. LICs are not thrift institutions, nor are they organized for the primary purpose of financing real property. As insurance companies, they generate enormous amounts of funds that represent huge amounts of the public's savings, mostly in the form of policyholders' reserves. LICs, through mortgage lenders or other loan correspondents, invest in loans secured by large-scale commercial and industrial real estate. LICs also contribute to the availability of residential mortgage funds by buying residential mortgages in bulk as a part of the secondary mortgage market. LICs have invested billions of dollars in mortgage loans.

Answer 49

The Rural Housing Service (formerly called the Farmers Home Administration) is an agency of the U.S. Department of Agriculture. It offers direct loans and other services to farmers, rural residents, and rural communities, enabling them to purchase and operate farms, homes, and businesses. Loan programs fall into three categories: 1. Originate new loans 2. Insure loans (in much the same way as FHA) 3. Guarantee loans (in much the same way as VA)

Answer 50

*A source for the purchase and sale of existing mortgages. Portfolio lenders hold mortgage loans in their portfolios and service the loans. However, most lenders sell the loans in the secondary mortgage market. The secondary mortgage market is an investor market that buys and sells existing mortgages. The existence of a secondary mortgage market makes the primary mortgage market more efficient, because mortgage originators are able to sell their loans more quickly and obtain funds to originate additional loans. The secondary market is the principal source of mortgage capital in the United States. Lenders sell some of the loans on the secondary market to private mortgage investors. Private investors include banks, life insurance companies, and pension funds. However, most of the loans are sold to government-sponsored enterprises. Fannie Mae, Freddie Mac, and Ginnie Mae are the three major enterprises that purchase mortgages on the secondary market. Mortgage originators package loans they make with other loans and either sell the package as a whole or keep the package and sell securities that are backed by the loans in the package. Ginnie Mae provides liquidity to the mortgage market by guaranteeing mortgage-backed securities. Approximately two-thirds of all residential mortgage loans originated in the United States are now sold in the secondary mortgage market and used as collateral for the issuance of mortgage-backed securities.

Answer 51

Fannie Mae (Federal National Mortgage Association, or FNMA) was established by Congress in 1938. Fannie Mae's initial goal was to stimulate the housing industry after the Great Depression. Fannie Mae also created the first secondary market for mortgage loans. In 2008, Fannie Mae came under federal government conservatorship. Although Fannie Mae remains a privately owned corporation with its own stock, the Federal Housing Finance Agency (FHFA) assumed supervisory responsibility. Fannie Mae keeps low-cost capital flowing to mortgage lenders across the nation. Fannie Mae does not lend money directly to homebuyers. Instead, it works with lenders to make sure they don't run out of mortgage funds. Fannie Mae provides large builders and real estate companies master commitments in amounts of $25 million and more for funds for up to 12 months in advance. In this way, Fannie Mae assures the mortgage lenders of available funds. Fannie Mae operates exclusively in the secondary mortgage market by providing two important functions: Fannie Mae purchases FHA, VA, and conventional mortgages from lenders and holds the mortgages in its portfolio. For loans to be sold to Fannie Mae, they must be written in accordance with Fannie Mae's requirements (guidelines). For example, the mortgages must be uniform mortgage instruments approved by Fannie Mae and Freddie Mac. Fannie Mae also sets limitations on the size and kind of loans it will buy. Loans that meet Fannie Mae guidelines are called conforming loans. Fannie Mae issues mortgage-backed securities (MBSs) in exchange for pools of mortgages from lenders. MBSs are securities guaranteed by pools of mortgages. By pledging large blocks of mortgage loans as collateral, Fannie Mae can issue mortgage-backed securities that are sold to a broad market of investors. The MBSs provide the lenders with a more liquid asset to hold or sell. Fannie Mae MBSs are highly liquid investments and are traded through securities dealers and brokers.

Answer 52

Freddie Mac (Federal Home Loan Mortgage Corporation, or FHLMC) was created by Congress in 1970. Freddie Mac is also under federal government conservatorship. Freddie Mac is subject to supervisory regulatory oversight by the FHFA. Freddie Mac provides a secondary market for loans originated by SAs. Most of the loans Freddie Mac handles are conventional loans. Savings associations can sell qualified mortgages to Freddie Mac for cash, then use the cash to make new mortgage loans.

Answer 53

Ginnie Mae (Government National Mortgage Association, or GNMA) has always been a government-owned-and-financed corporation. Ginnie Mae is part of the Department of Housing and Urban Development (HUD). Ginnie Mae's mission statement is "to expand affordable housing in America by linking global capital markets to the nation's markets." Ginnie Mae accomplishes its mission by guaranteeing securities that are backed by pools of mortgages. The mortgages in the MBSs are mostly FHA and VA mortgages (and some mortgages originated through the Rural Housing Service). Ginnie Mae's guaranty allows mortgage lenders to obtain a better price for their mortgage loans in the secondary market. Ginnie Mae serves as a guarantor of mortgage-backed securities (MBSs). Ginnie Mae MBSs are often called Ginnie Mae pass-through securities. A pass-through security refers to the payments of the underlying mortgages (principal and interest) that are passed through to the investor. MBSs are created by pooling a group of similar (same interest rate and maturity date) mortgages. The mortgage pool is then used as collateral for the issuance of the MBS. Ginnie Mae does not issue, sell, or buy mortgage-backed securities, or purchase mortgage loans. Ginnie Mae–approved private institutions issue the MBSs. In exchange for a fee, Ginnie Mae guarantees the timely payment of principal and interest to the investors. Ginnie Mae mortgage-backed securities are the only MBSs to carry the full faith and credit guarantee of the U.S. government.