Real Estate Financing Flashcards
secondary mortgage market
Banks don’t have to keep the loans they make on their books; they have the option sell the loans off to investors on the secondary mortgage market. After the loan is sold (either at discount for less than it is worth, or a premium for more than it is worth), the originating lender may receive fees for administering the loan, or the mortgagor may simply forward their payments to the loan’s new owner.
The mortgagor doesn’t need to consent to the sale of the loan, but they must be informed of the sale per the Helping Families Save Their Homes Act (part of the Truth in Lending Act).
Three major entities in the secondary mortgage market:
Federal National Mortgage Association (Fannie Mae) – Founded in 1938, focuses on conventional and FHA/VA loans.
Federal Home Loan Mortgage Corporation (Freddie Mac) – Founded in 1970. Specializes in conventional and FHA/VA loans. Innovates by implementing the securitization of mortgages, which Fannie Mae later begins as well.
Government National Mortgage Association (Ginnie Mae) – Founded in 1968. Specializes in FHA low-income housing.
Fannie and Freddie are presently in government conservatorship after the 2007-2008 housing crash under the Federal Housing Financing Agency (FHFA).
Fully Amortized Loans
Amortization is the payment of debt in equal installments. Fully amortized loans (also known as direct reduction loans) are loans that are completely paid off when the last payment is made. All payments (known as debt service) pay both the principal (debt) and the interest of the loan, as well as any insurance payments and taxes due. This is known as PITI, or the Principal, Interest, Taxes, and Insurance (usually homeowners insurance, which covers physical damage to the house, and might include additional broad-form insurance for extra damages). The amounts going toward principal and interest change over the lifetime of the loan, and are usually recalculated monthly. Home loans and second mortgages typically take this form.
Balloon Mortgages
A balloon mortgage is a loan with an amortization period that is longer than its payment period (e.g. a 10-year loan whose payments are calculated on a 30-year amortization schedule). This means that the monthly payments on the loan are lower than would be necessary to pay off the loan by the end of the payment period, which makes thepayments affordable. However, it also means that there will be unpaid principal that needs to discharged with the final loan payment (a balloon payment). The loan is usually refinanced to pay for the balloon payment.
Second Mortgages
Second Mortgages (or junior liens) work the same as regular mortgages, except that they come second (or third, or fourth, or whatever). They are often used to pay for a portion of the first mortgage’s down payment, or for renovations. In the event of a foreclosure, the first mortgagee has the first claim on the property; junior mortgagees have claims in the order that they placed their lien against the property. Junior mortgagees thus have greater risk of exposure, and often charge more for their loans.
Straight and Simple Interest Loans
Straight Mortgages are interest only loans; the principal is paid in one lump sum on the last payment. Simple interest loans are non-compounding.
Purchase Money Mortgages
Also known as seller financing or seller carry back loans. The seller finances part, or all, of the sale of their own property by receiving a note and a mortgage (along with the right to foreclosure) from the buyer.
Wraparound Mortgages
A way of structuring seller financing that “wraps” the seller financing around the seller’s existing debt. The seller receives their payments on the seller financing, along with a premium on their existing debt. They then pay off their existing debt with the proceeds from the seller financing arrangement on behalf of the buyer. Note that a due on sale clause precludes this sort of financing, and that the original mortgagee still has a right to foreclose on the new owner if they are not paid.
Construction Financing
Financing used to pay for property construction. Rather than getting all of the money at once, the borrower receives the funds from the loan in draws or stages. This protects the lender in the event of foreclosure. Usually the loan must be replaced by a permanent take out lender when the project reaches completion. New construction often comes with a construction warranty that covers faulty construction for some number of years after purchase (stated in the warranty contract).
Package Mortgages
A package mortgage covers both real property and personal property such as dishwashers, stoves, washer/dryer, air conditioners, and refrigerators. They can be used to buy furnishings, etc. at a lower interest rate than traditional financing (but with a longer payment period). A chattel mortgage is secured by personal property only.
Home Equity Line of Credit
Also known as an Equity Loan, Equity Line of Credit, or Open-End Mortgage. It gives the borrower a line of credit against the equity (value in their home) that they can borrower against as they see fit. Usually the HELOC is a junior lien.
Reverse-Annuity Mortgage (RAM)
A way for homeowners aged 62 years or older to access the equity they have in their home. The bank makes payments to the borrower against the equity in their home, and the loan plus interest is repaid when the homeowner passes away, or sells their home.
Fixed Rate Mortgage
A loan whose interest rate is locked in when the loan is originated, and does not change over the lifetime of the loan.
Adjustable Rate Mortgage (ARM)
A loan whose interest rate adjusts, sometimes over an initially low teaser rate or discounted rate. Usually it adjusts based on the prime interest rate, or the lowest interest rate available at a bank (e.g. the prime rate + 2 points). ARMs often have interest rate caps, but any interest above the cap that is not applied can be carried over to the next rate increase as a carryover. If an ARM has a payment cap then any interest not paid by the limited payment is added to the loan principal.
Graduated Payment Mortgage (GPM)
A loan aimed at homebuyers with predictably rising incomes (e.g. doctors). Initially the payments on the loan are adjusted down so as to be affordable, and increase over time as the borrower’s income increases. The payments made at the outset of the loan often fail to cover the interest charged on the loan, resulting in negative amortization of the interest.
