Financing Flashcards
Title Theory
In title theory states, the borrower must give legal title to the lender
Lien Theory
In lien theory states, the mortgagor retains title and give the mortgagee a lien as a security for the debt
Promissory Note
Promise to repay; can include a prepayment clause & an acceleration clause; secured by a mortgage or deed of trust
Prepayment Clause
Privilege to pre-pay
Acceleration Clause
Speeds up the note when the borrower is in default
Mortgage and deed of trust (security instruments)
Contract that pledges property as security for repayment without giving up possession
Causes of Foreclosure & Default
- Nonpayment of principal & interest
- Nonpayment of taxes
- Inadequate or no insurance
- Waste
- Due on sale clause/alienation
Due on Sale Clause/Alienation
Stops assumption without the lender’s consent; allows the lender to accelerate the loan if the borrower sells the property without paying off the loan
Mortagor
Borrower
Mortgagee
Lender
Deed of Trust as a 3 Party Instrument
Trustor = borrower, beneficiary = lender, trustee = third party
Satisfaction (Defeasance)
- when a mortgage note is paid, mortgagee gives satisfaction to release lien
- when dee of trust is paid, trustee gives deed of reconveyance to release lien
Foreclosure
A legal procedure whereby property used as security for a debt is taken by a creditor is sold to pay off the debt
Insufficient proceeds from a foreclosure sale could result in a deficiency or personal judgment
A foreclosure removes all liens from the property
Deed in Lieu of Foreclosure
An alternative to foreclosure (mortgagor deeds to mortgagee); DOES NOT wipe secondary liens, if a lender accepts a deed in lieu of foreclosure, then the lender would take title subject to any junior liens
Short Sales
Occurs when a seller is in default prior to foreclosure; a broker sells the property for a price lower than what is on the loan and the lender may require the seller to pay the deficiency
Term/straight/interest-only loan
Only interest is paid until maturity at the end of the term, this loan has a SMALL monthly payment but a LARGE balloon payment; the full amount of the principal (balloon) is due at the end
Partially Amortized
Repaid in equal payments of principal and interest; LARGER payment than a term loan but SMALLER than a fully amortized loan; has a balloon payment at the end of the term that will be smaller than the original loan amount
Fully Amortized
Loan is repaid in equal payments of principal and interest with the balance paid in the last payment so there is no balloon; payments are large than a term or partially amortized and are made at regular intervals; interest is paid in arrears
Adjustable-Rate Mortgage (ARM)
- Rate subject to change based on changes in an economic index
- May include interest and/or payment caps;
- Interest rate = Index + Margin (e.g., 5% index + 2% margin = 7% interest)
Budget (PITI)
The borrower pays P&I plus 1/12 taxes and 1/12 insurance into the lender’s impounded escrow account (interest & taxes are deductible)
Reverse Mortgage
- Mortgagee makes payments to mortgagor over a specific term;
- Used to obtain money from the equity in the home when a senior does not want to sell but needs cash (MUST be 62 or older);
- Is due upon sale of the property (death of the mortgagor(s), or at the end of the term
Line of Credit
Allows the borrower to obtain further advances at a later date (future advance limited to the difference between original loan amount and current amount owed)
Subprime Loans
Borrower is at higher risk, so the loan is more likely to default; a higher-than-prime rate is charged because the borrower and/or the property is used as security is a higher risk than a prime borrower (e.g., prime rate might be 6% and the subprime would be 8%)
Contract for Deed/Land Contract/Installment Contract
- Seller (vendor) who retains legal title holds the deed; buyer (vendee) has equitable title;
- Buyer takes possession when the contract is signed;
- Seller transfers title via a deed when the buyer makes the final payment
Seller Carry-Back Purchase Money
- Owner financing where title transfers to the buyer;
- Seller takes back a mortgage as partial payment; seller has lien
LTV (loan-to-value ratio)
- Maximum percentage of value the lender will loan;
- Used to determine loan amount and if the borrower will have to pay PMI;
- Based on price or appraisal, whichever is less
Equity
Market Value Today - Total Debt Today = Equity
Points and Loan Origination Fee
- Discount points are charged by the lender to increase lender’s yield (1 point = 1% of loan amount);
- Loan origination fee is charged by the lender to process and issue the loan;
- Both are tax deductible
Leverage
- Borrowed money is used to increase investment return;
- It does not give more equity and requires a small down payment;
- The advantage is that the borrower can control a large asset and very little cash;
- The disadvantage is the higher risk created by less equity
Subordination Clause
Allows a change in the order/priority of mortgages
Usury
The charging of an interest rate in excess of what is permitted by state law (STATE LAW determines the maximum rate limits and the type of loans affected by usury law)
Private Mortgage Insurance (PMI)
Loans over 80% loan-to-value (LTV) requires PMI; the advantage to the borrower is the smaller down payment
FHA Loans
Insures lenders against loss due to foreclosure
VA Loans
Guarantees lenders against loss on loans to veterans (up to 100% of the LTV ratio is allowed); individuals must be veterans, active National Guard members, or retired military service members
Miscellaneous Aspects of FHA/VA
- Rules regarding assumption depend on the date of the original loan;
- NO prepayment penalty is allowed, no matter when or how the loan was originated;
- Nonveterans may assume VA loans;
- Borrowers must have an appraisal to be approved for the first loan;
- Both offer higher LTV ratios than conventional mortgages
Primary Mortgage Market
Mortgage bankers and mortgage brokers
- Mortgage brokers act as an intermediary between borrowers and lenders but don’t usually service loans;
- Mortgage bankers originate and service loans with their company’s money
Predatory Lending
- Often occurred in the subprime market;
- Many states now have predatory lending laws that require lenders and originators to be licensed;
- Subprime loans were often coupled with down payment assistance (second mortgage) in which borrowers made no down payment and borrowed 100%, this made loans more likely to default
Secondary Mortgage Market
- Buys mortgages from primary lenders, which are banks, not retirement or insurance funds, to supplement the mortgage and lending process;
- Borrowers may needs to send monthly payments to a new address if their mortgage is sold
Organizations that Sell Mortgage-Backed Securities to Investors
- Federal National Mortgage Association/Fannie Mae (FNMA) - buys all types of mortgages;
- Government National Mortgage Association/Ginnie Maw (GNMA) - an agency of HU; backs FHA/VA mortgages;
- Federal Home Loan Mortgage Corporation/Freddie Mae (FHLMC) - buys from S&L’s and commercial banks
Truth in Lending Act
Promotes the informed use of consumer credit by requiring disclosures about its terms and costs (regulated by Federal Reserve Board)
Truth in Lending Act Disclosure Requirements
- Lender finance charges (loan origination fees, interest, discount points, and assumption fees) must be disclosed;
- Annual percentage rate (APR) is the effective rate that includes the note rate plus the total cost of credit; APR will be higher than the note rate;
Three-day right to rescission allows the borrower to withdraw from loans on home improvements and refinances (it is NOT used when purchasing a first home or a vacation home, or when using a construction loan)
Loan Advertising Requirement
General terms OK
- Price and/or APR are the only specific finance terms allowed in advertising without disclosing all terms;
- Down payment, interest rates, monthly payments, or number of payments trigger full disclosure
Real Estate Settlement Procedures Act (RESPA)
Lender must give “Guide to Settlement Costs” booklet and a good-faith estimate of all closing costs at time of application or no later than 3 days after
Closing expenses, legal fees, and title insurance premiums are not finance charges but are disclosed under RESPA
Broker’s commission is not included
Borrower has right to inspect Uniform Settlement Statement (HUD-1) 1 day before closing
Restricts amount of advance escrow payments for taxes and insurance – no more than 3 months plus what is owed
Term Loan Details
PAYMENT: small, interest only
BALLOON: large, full principal
TERM: short, 6m-2y
Partially Amortized Loan Details
PAYMENT: bigger, principal & interest
BALLOON: medium, balance of principal
TERM: relatively short, 1-5y
Fully Amortized Loan Details
PAYMENT: large, enough to pay in full
BALLOON: none
