FHA and VA Mortgage

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The mortgage market is now dominated by non-bank
lenders: But rising interest rates and anticipated
deregulation under Trump could change things.
Lerner, Michele
ProQuest document link
ABSTRACT (ENGLISH)
Yet the landscape of the lending market has shifted dramatically over the past few years from domination by big
banks to a market where more loans are made by non-banks — financial institutions that only make loans and do not
offer deposit accounts such as a savings account or checking account. The withdrawal of banks from the mortgage
business is the result of the fundamental shift in regulations that took place in response to the housing crisis, says
Meg Burns, managing director of the Collingwood Group, an adviser for financial services companies in Washington.
The cost of complying with new regulations and the risk of making mistakes drove many banks to reduce their
mortgage business, says Rick Sharga, chief marketing officer of Ten-X, an online real estate marketplace in Irvine,
Calif. In the initial aftermath of the housing crisis and the debacle of loan defaults, banks began to add their own
overlays, which are loan-approval guidelines and fees that go beyond the requirements of Fannie Mae and Freddie
Mac, says Susan Wachter, a professor of real estate and finance at the Wharton School at the University of
Pennsylvania in Philadelphia. “Prior to the financial meltdown, loan-guarantee fees charged by Fannie Mae and
Freddie Mac were substantially lower for banks compared to non-banks, but as part of the financial reform, those
fees are now similar for all types of lenders,” Norris says. “Generation Xers and baby boomers have more loyalty to
their financial institutions and tend to look first for a…
FULL TEXT
Most borrowers, whether they are purchasing property or refinancing their home, focus on their mortgage rate and
loan terms rather than the type of lender they choose.
Yet the landscape of the lending market has shifted dramatically over the past few years from domination by big
banks to a market where more loans are made by non-banks — financial institutions that only make loans and do not
offer deposit accounts such as a savings account or checking account.
“For consumers, it doesn’t really matter whether you get your loan through a bank or a non-bank, although in some
ways non-banks are a little more nimble and can offer more loan products,” says Paul Noring, a managing director
of the financial-risk-management practice of Navigant Consulting in Washington. “The impact is bigger on the
housing market overall, because without the non-banks we would be even further behind where we should be in
terms of the number of transactions.”
In 2011, 50 percent of all new mortgage money was loaned by the three biggest banks in the United States:
JPMorgan Chase, Bank of America and Wells Fargo. But by September 2016, the share of loans by these three big
banks dropped to 21 percent.
At the same time, six of the top 10 largest lenders by volume were non-banks, such as Quicken Loans, loanDepot
and PHH Mortgage, compared with just two of the top 10 in 2011.
Why big banks exited the market
Before the financial crisis, mortgages were the last thing a consumer would default on, Noring says.
“That flipped in 2009, when people started defaulting on their mortgages first,” he says. “That was a tsunami for
everyone in the mortgage business, and we’re still seeing the fallout. Lenders were not prepared to deal with it and
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didn’t do a great job, plus new rules were coming out that they needed to follow.”
The withdrawal of banks from the mortgage business is the result of the fundamental shift in regulations that took
place in response to the housing crisis, says Meg Burns, managing director of the Collingwood Group, an adviser for
financial services companies in Washington.
“The regulatory atmosphere changed from a risk-management regime to a zero-tolerance and 100-percentcompliance regime,” Burns says. “Not only were new regulations implemented, but new regulators like the
Consumer Financial Protection Bureau were created. At the same time, the CFPB and other agencies became more
assertive in their enforcement practices.”
Burns says that stepped-up regulations from the CFPB include prescriptive rules that pinpoint exactly how lenders
are to make loan decisions.
“The intent should be to broadly make sure borrowers can repay their loans and sustain homeownership instead of
this narrow approach,” Burns says. “In the face of stiff penalties and aggressive scrutiny, banks were left with a
tremendous uncertainty and risk that made it hard to keep lending.”
Jeffrey Taylor, managing partner of Digital Risk, a provider of mortgage-processing services and risk analytics in
Maitland, Fla., says that while the post-crisis regulations were well-intentioned, the result was to make banks more
cautious.
“Now banks only approve ‘perfect’ loans, not ‘good-enough’ loans,” Taylor says. “This created an opportunity for
non-banks that focus entirely on mortgages and are less regulated than big banks.”
The cost of complying with new regulations and the risk of making mistakes drove many banks to reduce their
mortgage business, says Rick Sharga, chief marketing officer of Ten-X, an online real estate marketplace in Irvine,
Calif.
“Headline risk is another element of this, because if the media perceives you’re doing something incorrectly, it can
really hurt your entire business,” he says.
In the initial aftermath of the housing crisis and the debacle of loan defaults, banks began to add their own overlays,
which are loan-approval guidelines and fees that go beyond the requirements of Fannie Mae and Freddie Mac, says
Susan Wachter, a professor of real estate and finance at the Wharton School at the University of Pennsylvania in
Philadelphia.
Not only have banks reduced their mortgage loan volume, but the entire private market of investors in mortgages
disappeared in 2007 and 2008 and, unlike other financial markets, has yet to come back, Wachter says.
“The aftermath of the crisis was lots of litigation and a decline in trust across the board,” Wachter says.
Banks were forced to pay fines and to take back loans that were considered flawed. At the same time, they were
required to meet stress tests and have more capital on their books in case they have to handle more defaults,
Wachter says.
“Non-banks don’t have to have capital, which could mean that taxpayers are more exposed than in 2009 if numerous
defaults take place among loans made by non-banks,” Wachter says.
Noring says that non-banks were more lightly regulated in the initial aftermath of the housing crisis, although in the
past two years, regulators have stepped up their scrutiny of these lenders.
Non-banks are regulated in every state where they are licensed to provide loans, says David Norris, chief revenue
officer for loanDepot in Foothill Ranch, Calif.
“Prior to the financial meltdown, loan-guarantee fees charged by Fannie Mae and Freddie Mac were substantially
lower for banks compared to non-banks, but as part of the financial reform, those fees are now similar for all types of
lenders,” Norris says. “Now banks and non-banks are competing on a level playing field, which encouraged more
non-banks to increase their business.”
Many large banks have reduced their FHA loan business. Burns says FHA loans were created to serve people with
a riskier profile, but she says the recent zero-tolerance policy of the Justice Department has undermined this loan
program.
“Lenders were supposed to use good judgment on FHA loan approvals, such as looking at the continuity and
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stability of the borrower’s income,” Burns says. “The DOJ has used the False Claims Act to target banks in particular
to fine them for defects in loan files. But a ‘perfect’ loan is pretty much impossible, particularly for borrowers applying
for FHA loans.”
FHA loans appeal to first-time buyers and lower-income borrowers, who are perceived to be more likely to default on
a loan, Norris says. He says non-banks are originating more FHA loans to make up for the lack of banks offering the
loans.
Consumer impact of market changes
Many banks now limit their loans to conventional 30-year fixed-rate loans for borrowers who neatly fit into the
approval box, says Sharga of Ten-X.
“Banks are also approving jumbo loans for high-net-worth individuals that they keep as portfolio loans,” Sharga says.
“They are offering these loans so they can sell other banking services to those customers.”
During the last housing boom, many non-bank lenders targeted subprime borrowers, he says.
“This time around, the non-bank lenders are not being reckless,” Sharga says. “Some offer loans to borrowers with
lower FICO scores, but they are still not making risky loans. Consumers are benefiting from non-banks because they
offer more opportunities to borrowers who are not perfect.”
On the negative side, though, Sharga says that competition from non-banks has contributed to the closing of many
community banks, which particularly hurts communities that are geographically underserved.
The entire ecosystem of the mortgage markets is fragile, says Burns, which has a chilling effect on the economy.
“The lack of access to credit not only hurts consumers, but it hurts builders and therefore contributes to the lack of
affordable housing,” Burns says. “That, in turn, has an impact on the broader economy, because housing
construction impacts a lot of segments such as banking, construction workers, home-improvement businesses and
more.”
The pullback in lending from banks contributes to the overall decline in homeownership, says Burns, because
people with a slightly risky credit profile are underserved.
“The expansion of non-banks in response is a good thing, but we’re still missing a million or more homeowners, in
part because many millennials are still not able to get credit through traditional means,” Wachter says. “For good or
bad, consumers with marginal credit scores and unverifiable income are out of the market now.”
Choosing a lender
Rather than decide on a bank or non-bank, many borrowers focus primarily on the price of their loan or opt for a
lender that provides them with other financial services or one recommended by a real estate company or builder
they are using for a purchase. According to the J.D. Power 2016 U.S. Primary Mortgage Origination Satisfaction
Study, 27 percent of first-time buyers regret their choice of a lender and 21 percent of all borrowers regret their
choice. The most common reasons for dissatisfaction include lack of communication, unmet promises or feeling
pressured to choose a particular loan. But choosing one type of lender over another is no guarantee of satisfaction.
The top 10 most highly rated mortgage providers in the survey are evenly split between banks and non-banks.
Digital Risk’s Taylor says banks and non-banks are aware that customers who don’t feel as if they are well-served
will find another provider, which is why so many financial institutions are investing heavily in technology.
“It’s a race to improve the customer experience,” he says. “Borrowers realize that there’s not a lot of difference
between loan providers on pricing, so they focus on the ease of the loan process and the service they receive.”
Taylor says there are generational differences in the way consumers approach borrowing money.
“Generation Xers and baby boomers have more loyalty to their financial institutions and tend to look first for a credit
card, a car loan or a mortgage to their bank,” he says. “Millennials don’t feel the same way and prefer to start with an
Internet search for their best mortgage options.”
How the market may shift next
Rising interest rates and anticipated deregulation under the Trump administration could change the mortgagelending business again and impact the volume of loans.
“We’re likely to see more banks come back into the mortgage market as interest rates rise, because there’s more
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profit to be made,” Wachter says. “But demand will be down because fewer people will refinance and because
affordability issues will mean that first-time buyers are still missing from the market.”
Sharga says that rising rates increase profitability but also reduce refinancing, which forces lenders to compete
harder for purchase-loan business, so even borrowers with few minor issues with their loan application may qualify
for a loan.
“Higher interest rates will cause funding costs to rise for non-banks, since they have to borrow money from capital
markets to make their loans,” says Navigant Consulting’s Noring. “That could mean a rebalancing among lenders
because banks fund their loans with deposits.”
Burns, however, thinks addressing regulatory issues will have a bigger impact on the lending atmosphere than rising
rates.
“The mortgage industry is overregulated now, so the goal should be to align important safeguards and yet get more
investors and lenders back into the market,” Taylor says. “I expect we’ll see some right-setting of regulations so that
different products can come into the mortgage market.”
In particular, Taylor anticipates the use of different metrics to evaluate borrowers rather than focusing tightly on
FICO scores as lenders do now. “There are already opportunities to make smart decisions based on other data,
such as Fannie Mae’s Day 1 Certainty program that uses independent tools to validate a borrower’s income, assets
and employment and make it simpler and faster for lenders to approve loans,” Taylor says. “The ultimate winner will
be customers, because the more clarity a lender has on what it takes to get a loan, the less risk the lender has to
take.”
Both bank and non-bank lenders are impacted by regulations and guidelines from Fannie Mae and Freddie Mac.
“If the Trump administration is successful in relaxing regulations, then the headwinds lenders face could be slowing
down,” Sharga says. “That would be good for consumers and for the housing market, as long as it doesn’t lead to
the laxity and craziness of the previous housing boom.”
realestate@washpost.com
DETAILS
Subject:
Fines &penalties; Financial institutions; Loans; Housing; Interest rates; Baby boomers;
Default; Consumers; Refinancing
Company / organization:
Name: Fannie Mae; NAICS: 522294; Name: loanDepot; NAICS: 522292
Publication title:
The Washington Post (Online); Washington, D.C.
Publication year:
2017
Publication date:
Feb 22, 2017
Section:
REALESTATE
Publisher:
WP Company LLC d/b/a The Washington Post
Place of publication:
Washington, D.C.
Country of publication:
United States, Washington, D.C.
Publication subject:
General Interest Periodicals–United States
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ProQuest document ID:
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Last updated:
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Chapter 54: Conventional financing on a sale, and the buyer’s agent
359
Chapter
54
Conventional financing
on a sale, and the
buyer’s agent
After reading this chapter, you will be able to:
• undertake the duties of a transaction agent (TA) to police all facets
of their buyer’s mortgage process;
• understand the adversarial relationship between a lender and
buyer; and
• advise buyers of the financial advantage gained by submitting
mortgage applications to multiple lenders.
Loan Estimate
mortgage shopping
worksheet
transaction agent (TA)
Uniform Residential Loan
Application
Learning
Objectives
Key Terms
For a further study of this discussion, see Chapter 37 of Real Estate
Finance.
The ability of a buyer or an owner to obtain financing is an integral
component of most real estate transactions.
The submission of a mortgage application to a private or institutional
lender is the catalyst which sets the machinery of the mortgage industry in
motion.
The buyer’s agent owes their buyer the duty to ensure their buyer negotiates
the best financial advantage available among mortgage lenders. As viewed
and identified by lenders, the buyer’s agent is called a transaction agent
(TA).
Role of the
transaction
agent (TA)
transaction agent
(TA)
The term lenders
use to identify the
buyer’s agent in a
sales transaction, its
closing contingent on
the buyer obtaining a
mortgage to fund the
purchase price.
360
Real Estate Principles, Second Edition
Sources of
conventional
financing
When applying for a conventional mortgage, a buyer has several types of lenders to
choose from, including:
• portfolio lenders, such as banks, thrifts and credit unions;
• institutional lenders, such as insurance companies and trade association
pensions; and
• warehousing lenders, such as mortgage bankers who resell the mortgage in the
secondary mortgage market.
While portfolio and institutional lenders typically service their own mortgages, they
often originate mortgages for immediate sale in a process called warehousing.
Warehoused mortgages are sold on the secondary mortgage market to investment
pools, such as the Federal National Mortgage Association (Fannie Mae), the Federal
Home Mortgage Corporation (Freddie Mac), the Government National Mortgage
Association (Ginnie Mae) and Wall Street bankers.
The business of servicing mortgages is also bought and sold. This causes the mortgage
to appear to be changing hands. Typically, the originating lender continues to service
the mortgage when they sell the mortgage to an investor.
The TA neither arranges nor makes a mortgage. Further, they are barred from
receiving any compensation for referring the buyer to service providers or
policing lender activity. Events related to the transaction serviced by the TA
are covered solely by the broker fee negotiated on the sales transaction.
The TA’s
duties
The duties imposed by agency law on the TA include:
•
helping the buyer locate the most advantageous mortgage terms
available in the market;
•
oversight of the mortgage application submission; and
•
policing the lender’s mortgage packaging process and funding
conditions.
These TA activities ensure all documents needed to comply with the lender’s
requests and closing instructions are in order. If not, funding cannot take
place and closing the sales escrow is jeopardized.
Diametrically
opposed
interests
A lender’s objectives and goals are diametrically opposed to those of the
buyer – a debtor versus creditor relationship.
On the advice from their agents, buyers need to understand that the lender’s
product – money – is always unpriced until the closing has taken place. This
truth exists in spite of the Loan Estimate and interest rate disclosures that
are given to the buyer within three business days following the lender’s
receipt of the mortgage application. [See RPI Form 204-5]
Chapter 54: Conventional financing on a sale, and the buyer’s agent
The buyer needs to understand the Loan Estimate is not a commitment to
lend and is not a guarantee a mortgage on substantially the same terms will
be funded. A lender at any time may change the mortgage terms then simply
provide another, refreshed Loan Estimate. [See RPI Form 204-5]
Editor’s note — The new Loan Estimate and Closing Disclosure forms
published by the Consumer Financial Protection Bureau (CFPB), which
apply to all consumer mortgages, went into effect October 3, 2015. The new
forms significantly simplify and streamline the mortgage lending process
for homebuyers. [See RPI Form 204-5 and 402]
361
Loan Estimate
An estimate of a
buyer’s settlement
charges and mortgage
terms handed to the
buyer on a standard
form within three
business days
following the lender’s
receipt of the mortgage
application. [See RPI
Form 204-5]
The Loan Estimate replaces both the initial Truth-in-Lending statement and
the good faith estimate of costs (GFE). The Loan Estimate is provided within
three business days of the lender’s receipt of the application, and provides
the mortgage terms and details quoted by the lender. [See RPI Form 204-5]
The Closing Disclosure replaces both the old final Truth-in-Lending
statement and the HUD-1 Settlement Statement. This form is provided
within three business days of mortgage closing. It summarizes the “final”
mortgage terms and details.1 [See RPI Form 402]
After their buyer’s offer has been accepted, it’s time for the buyer’s agent
to assist their buyer with submitting a Uniform Residential Loan
Application to multiple lenders. [See Chapter 55; see RPI Form 202 (FNMA
1003)]
Editor’s note – Instructions for the accurate completion of the Uniform
Residential Loan Application are provided in Chapter 55.
As part of the TA’s advice and guidance in the mortgage application process,
the TA instructs the buyer regarding:
•
the expectations held and the role of each servicer or affiliate
involved in the mortgage transaction, such as the lender’s mortgage
representative, an appraiser, any mortgage broker involved, credit
agencies, creditors of the buyer, etc.;
• what is going to take place during the application process, such as
lender disclosures, payment of lender costs, funding requirements, etc.;
and
• what to guard against, such as excuses and claims usually made by the
lender to justify an increase in rates at the time of closing.
Documents the buyer needs to gather and submit to the lender to process the
mortgage include:
• W-2s or other tax documents for the self-employed;
• recent bank statements; and
1
12 Code of Federal Regulations §§1026.19 et seq.
Before
meeting with
a lender
Uniform Residential
Loan Application
A standardized
mortgage application
completed by the
buyer with the
assistance of the
transaction agent and
the mortgage lender’s
representative. [See
RPI Form 202]
362
Real Estate Principles, Second Edition
Government
financing
programs at a
glance
A variety of state and federal loan programs exist, offering down payment assistance
for low- to moderate-income buyers and first-time buyers, mortgage refinance or
modification programs to distressed owners, and special programs for veterans.
Federal programs:
Federal Housing Administration (FHA)-insured mortgage: The FHA insures lenders
against loss for the full amount of a mortgage. FHA-insured mortgages permit small
cash down payments and higher loan-to-value ratio (LTV) requirements than mortgages
originated by conventional lenders. [See Chapter 56]
U.S. Department of Veterans Affairs (VA) mortgage guarantee: The VA mortgage
guarantee program assists qualified veterans or their surviving spouses to buy a home
with zero down payment.
Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage
Corporation (Freddie Mac) and Government National Mortgage Association (Ginnie
Mae): Fannie Mae, Freddie Mac and Ginnie Mae are government-sponsored enterprises
(GSEs) designed to help facilitate home purchases for low- to moderate-income buyers.
Fannie Mae and Freddie Mac do not provide home mortgages directly. Instead, they
purchase and package pools (tranches) of qualifying single family residence (SFR)
mortgages originated by mortgage bankers, known as conforming mortgages, as
mortgage-backed bonds (MBBs). They then sell the MBBs to Wall Street Bankers on the
secondary mortgage market.
State programs:
California Housing Finance Agency (CalHFA): CalHFA administers several first-time
homebuyer assistance programs, offering 30-year fixed rate mortgages with interest
rates and fees typically lower than conventional financing.
California Department of Veterans Affairs (CalVet): CalVet provides a veteran with an
ARM mortgage at a rate generally below market, low monthly payments and flexible
credit standards, as compared to conventional financing or mortgages insured by the
FHA or guaranteed by the VA.
California Department of Housing and Community Development (HCD): HCD
programs fund local public agencies and private entities which produce affordable
housing for rental or ownership.
•
recent pay-stubs to evidence the employment information represented
by the buyer in section four of the mortgage application. [See Chapter
55; see RPI Form 202 (FNMA 1003)]
Lenders also verify other information in the application by requesting and
reviewing:
•
an appraisal report to establish the value of the property serving as
security;
• verification of deposit or tax returns to establish the buyer’s income
and assets; and
•
a credit report to establish the buyer’s liabilities and propensity to
repay the mortgage. [See Chapter 55; see RPI Form 202 (FNMA 1003)]
Chapter 54: Conventional financing on a sale, and the buyer’s agent
363
Form 312
Mortgage
Shopping
Worksheet
To best protect the buyer, applications are to be submitted to at least two
lenders. The second application is insurance against lenders’ last minute
changes to the rates and terms at the time of closing.
Without a backup application processed by another lender, the buyer is left
with no opportunity to reject the lender’s changes.
Multiple government agencies promote the practice of submitting multiple
applications. To assist the buyer with the task of comparing the products of two
Government
supports
multiple
applications
364
Real Estate Principles, Second Edition
Mortgage Shopping
Worksheet
A worksheet designed
for use by buyers
when submitting
applications for a
consumer mortgage
to compare mortgages
offered by different
lenders based on a list
of all the variables
commonly occurring
as costs at the time
of origination and
over the life of the
mortgage. [See RPI
Form 312]
Chapter 54
Summary
or more lenders, entities such as the California Department of Corporations,
Freddie Mac, the Federal Reserve, and the Federal Trade Commission publish
Mortgage Shopping Worksheets.
The Mortgage Shopping Worksheet published by Realty Publications,
Inc. (RPI) is designed to be completed by the buyer with the assistance of
the TA. The worksheet contains a list of all the mortgage variables commonly
occurring on origination and during the life of the mortgage. [See Form 312
accompanying this chapter]
After submitting mortgage applications to two lenders and receiving the
corresponding Loan Estimates, the buyer will possess all the information
needed to fill out a Mortgage Shopping Worksheet for each lender. Once
complete, the buyer and TA can clearly compare the terms offered by the
competing lenders and if that lender remains competitive, close with that
lender. [See Form 312]
It is the duty of the buyer’s transaction agent (TA) to ensure their buyer
negotiates the best financial advantage available to them. Further, the
TA ensures all documents needed to comply with the lender’s closing
instructions are timely delivered and in order. The TA neither arranges
nor makes a mortgage, but polices all facets of the mortgage process.
A buyer’s first step toward obtaining a mortgage is the submission of
a standardized Uniform Residential Loan Application to a lender as a
prospective borrower. The Uniform Residential Loan Application is
designed to be completed by the buyer with the assistance of the TA and
the lender’s mortgage representative.
To ensure competitive mortgage rates and terms, the TA needs to advise
their buyer to submit separate mortgage applications to multiple
lenders. By having mortgage applications with two or more lenders, the
TA is able to direct the buyer to the lender who offers the superior set of
mortgage costs, terms for payment and interest rates, and keep it that
way through closing.
Chapter 54
Key Terms
Loan Estimate…………………………………………………………………….. pg. 361
mortgage shopping worksheet…………………………………………. pg. 364
transaction agent (TA)……………………………………………………….. pg. 359
Uniform Residential Loan Application…………………………… pg. 361
Quiz 10 Covering Chapters 49-54 is located on page 615.
Chapter 55: The Uniform Residential Loan Application and post-submission activities
365
Chapter
55
The Uniform Residential
Loan Application and
post-submission activities
After reading this chapter, you will be able to:
• understand the components of the Uniform Residential Loan
Application;
• guide your buyer on how to prepare the mortgage application;
and
• advise on the lender disclosures required under the Real Estate
Settlement Procedures Act (RESPA).
balance sheet
buyer mortgage capacity
creditworthiness
debt-to-income ratio (DTI)
loan-to-value ratio (LTV)
mortgage package
Real Estate Settlement
Procedures Act (RESPA)
transaction agent (TA)
Uniform Residential Loan
Application
Learning
Objectives
Key Terms
For a further study of this discussion, see Chapter 38 of Real Estate
Finance.
The Uniform Residential Loan Application prepared by the buyer with
the assistance of their transaction agent (TA) provides the lender with
necessary information about the buyer and the property which will secure
the mortgage. It also gives the lender authorization to start the mortgage
packaging process. [See Figure 1, RPI Form 202 (FNMA 1003)]
Fundamentals
of the Uniform
Residential Loan
Application
366
Real Estate Principles, Second Edition
Uniform Residential
Loan Application
A standardized
mortgage application
completed by the
buyer with the
assistance of the
transaction agent and
the mortgage lender’s
representative. [See
RPI Form 202]
transaction agent
(TA)
The term lenders
use to identify the
buyer’s agent in a
sales transaction, its
closing contingent on
the buyer obtaining a
mortgage to fund the
purchase price.
Components
of the Uniform
Residential
Loan
Application
Generally, a mortgage is sought in a home sales transaction which is
contingent on the buyer obtaining a mortgage to fund the purchase of the
property, known as purchase-assist financing. However, a mortgage may
also be needed for funding by:
•
an owner of vacant land to construct a dwelling;
•
a property owner to improve or renovate a property they currently
own;
•
a property owner to refinance an existing mortgage; or
•
a tenant on a long-term lease who has agreed to make tenant
improvements (TIs) to the property they rent.
As implied by its title, the Uniform Residential Loan Application is intended
primarily for use on mortgages secured by residential properties.
However, as a generic mortgage application, it is used by mortgage brokers
as an application for a mortgage funding any purpose and secured by any
type of property. The Uniform Residential Loan Application contains all
the information required for arranging all types of real estate mortgages.
In practice, the type of property intended to be purchased by use of the
mortgage funds is provided by the description of the property in the mortgage
application.
The first section of the Uniform Residential Loan Application calls for the
type of mortgage sought, such as conventional, VA or FHA-insured. The
buyer also indicates:
•
the total dollar amount of the mortgage requested;
•
the anticipated interest rate, and whether it is to be fixed or adjustable;
•
the periodic payment schedule (constant or graduated); and
•
the amortization period (positive or negative). [See Figure 1, RPI Form
202 (FNMA 1003)]
The property under contract to secure the mortgage is identified and its
intended use set forth in section two. Section two also states the purpose to be
funded by the mortgage, such as purchase-assist or refinance. Also disclosed
is the source of down payment funds and closing costs. [See Figure 1, RPI
Form 202 (FNMA 1003)]
Buyer
information
Information identifying the buyer, such as their name and social security
number, is entered in section three. Space is left to insert any co-borrower
information if the income, assets and liabilities of a co-borrower are to be
considered for mortgage qualification purposes.
A separate form is used to disclose to the lender the applicant’s assets and
liabilities if:
•
the assets and liabilities result from separate property owned by a coborrower;
Chapter 55: The Uniform Residential Loan Application and post-submission activities
367
Figure 1
Form 202
Uniform
Residential Loan
Application
For a full-size, fillable copy of this or
any other form in this book that may be
used in your professional practice, go to
realtypublications.com/forms
• the co-borrower is a necessary party to the transaction as the property
encumbered is considered community property; or
• the co-borrower is a co-signer of the note as a primary borrower. [See
Figure 2, RPI Form 209-3]
The buyer and co-borrower need to prepare a balance sheet if their assets
and liabilities are sufficiently joined to make one combined statement viable.
If not, each co-borrower is to prepare a separate asset and liabilities statement
for individual consideration by the lender. [See Figure 2, RPI Form 209-3]
balance sheet
An itemized, dollarvalue presentation
for setting an
individual’s net worth
by subtracting debt
obligations (liabilities)
from asset values. [See
RPI Form 209-3]
368
Real Estate Principles, Second Edition
Figure 1
Form 202 Cont’d
Uniform
Residential Loan
Application
For a full-size, fillable copy of this or any
other form in this book that may be used
in your professional practice, go to
realtypublications.com/forms
Employment
information
The buyer’s (and co-borrower’s) employment information necessary to
identify their source of income is entered in section four of the Uniform
Residential Loan Application.
Employment information includes:
•
the employment currently held by the buyer;
•
the buyer’s job title; and
Chapter 55: The Uniform Residential Loan Application and post-submission activities
369
• years spent at that specific job and within that profession. [See Figure 1,
RPI Form 202 (FNMA 1003)]
If the buyer is self-employed, they indicate this by checking the self-employed
box. [See Figure 1, RPI Form 202 (FNMA 1003)]
Next, the buyer reports their monthly income and housing expenses in
section five. [See Figure 1, RPI Form 202 (FNMA 1003)]
The buyer’s assets and liabilities are entered into section six. This discloses
the buyer’s net worth. The information is pertinent since the buyer’s
liabilities affect their ability to repay the mortgage. However, the buyer
may not want to disclose all their assets. Thus, a balance needs to be struck
between maintaining financial privacy and disclosing enough assets to get
creditworthiness clearance so the mortgage will be funded. [See Figure 1,
RPI Form 202 (FNMA 1003)]
Since the mortgage funds the acquisition of property, the buyer enters
pricing details about the transaction in section seven, including the cost
of repairs, alterations and improvements made to the property. [See Figure 1,
RPI Form 202 (FNMA 1003)]
The buyer (and any co-borrower) declares any relevant miscellaneous
creditworthiness issues in section eight of the mortgage application. This
includes debt enforcement or debt avoidance the buyer has experienced. [See
Figure 1, RPI Form 202 (FNMA 1003)]
Additional
components of
the application
The buyer signs the application (with any co-borrower) to acknowledge and
agree to the numerous conditions, some of which are:
• the property will be occupied as represented in the application;
•
the buyer will amend the application and resubmit it to the lender if
the facts originally stated substantially change;
•
the lender may sell/assign the mortgage to others, though the buyer
will not be able to sell the property and delegate the mortgage
responsibility to another person who acquires the property; and
•
the lender is authorized to verify all aspects of the mortgage application
as represented by the buyer. [See Figure 1, RPI Form 202 (FNMA 1003)]
A lender evaluating a mortgage package considers a buyer’s willingness and
capacity to pay. To comply, borrowers applying for a consumer mortgage are
evaluated by the lender for their ability-to-repay (ATR), part of Regulation
Z (Reg Z), which implements TILA.1
“Willing and
able” to pay
Generally, the debt-to-income ratio (DTI) for conventional mortgages, also
called the debt-to-income standard, limits the buyer’s:
debt-to-income ratio
(DTI)
Percentage of monthly
gross income that goes
towards paying debt.
• monthly payments for the maximum purchase-assist mortgage,
including impounds for hazard insurance premiums and property
taxes, to approximately 31% of the buyer’s monthly gross income; and
1
12 CFR 1026.43 et seq.
370
Real Estate Principles, Second Edition
Types of
mortgages
The typical conventional mortgage is a 30-year amortized mortgage with a fixed rate
of interest.
The buyer’s monthly payment remains the same during the life of the fixed-rate
mortgage. Fixed-rate mortgages offer greater long-term stability for the buyer than
adjustable rate mortgages (ARMs) with their varying interest rates and payment
schedules.
Financing options include:
buyer mortgage
capacity
A buyer’s ability
to make mortgage
payments based on
their debt-to-income
ratios (DTI).
creditworthiness
An individual’s ability
to borrow money,
determined by their
present income,
wealth and previous
debt payment history.
•
•
ARMs where the interest rate changes periodically based on an index for shortterm consumer rates, plus a profit margin. ARMs cause the buyer’s monthly
payment to periodically adjust;
•
rate buy-downs where the buyer receives an initial interest rate which is
periodically increased, along with the monthly payment, to a fixed rate within a
few years, called a graduated payment mortgage (GPM);
•
the length of the mortgage, which is typically 15 or 30 years, although some
lenders offer mortgages with irregular terms;
•
assumable mortgages allowing resale to a creditworthy buyer, with or without
a rate adjustment [See Chapter 57];
•
bi-weekly mortgages with payments made every two weeks to reduce the total
amount of interest paid on the mortgage; and
•
private mortgage insurance (PMI) where a qualifying buyer obtains a mortgage
with less than a 20% down payment while paying a premium for insurance
to cover the lender’s risk of loss created by the smaller down payment. [See
Chapter 60]
long-term debt, plus the monthly payments, to approximately 41% of
the buyer’s gross monthly income. [See RPI Form 229-1, 229-2 and 230]
Lenders use the DTI ratio to evaluate the buyer’s ability to make timely
mortgage payments. This is referred to as buyer mortgage capacity. [See
RPI Form 230]
The buyer’s willingness to make mortgage payments is evidenced by the
credit report. The credit history demonstrates to the lender whether or not
the buyer has a propensity to pay, called creditworthiness.
The DTIs can be adjusted depending on one or more compensating factors,
such as if the buyer has:
• ample cash reserves;
RESPA
disclosures
•
a low LTV; and
•
spent more than five years at the same place of employment.
The Real Estate Settlement Procedures Act (RESPA) mandates lenders
active in the secondary mortgage market to disclose all mortgage related
charges on mortgages used to purchase, refinance or improve one-to-four
unit residential properties.
Chapter 55: The Uniform Residential Loan Application and post-submission activities
371
Mortgage related charges include:
• origination fees;
•
credit report fees;
•
insurance costs; and
•
prepaid interest.
RESPA is now administered and enforced by the Consumer Financial
Protection Bureau (CFPB) — not the U.S. Department of Housing and
Urban Development (HUD).
A RESPA-controlled lender provides the buyer with:
• a Loan Estimate of all mortgage terms quoted by the lender within
three business days of the lender’s receipt of the buyer’s mortgage
application [See RPI Form 204-5; see Chapter 54];2
• a special information booklet published by the CFPB to help the
buyer understand the nature and scope of real estate settlement costs
within three business days after the lender’s receipt of the buyer’s
application;3
• a Closing Disclosure, which summarizes the “final” mortgage terms
and details, provided by the lender at least three days before the
consumer closes on the mortgage [See RPI Form 402];4 and
•
Real Estate
Settlement
Procedures Act
(RESPA)
Legislation prohibiting
brokers from giving
or accepting referral
fees if thebroker or
their agent is already
acting as a transaction
agent in the sale of
a one-to-four unit
residential property
which is being funded
by a purchase-assist,
federally-related
consumer mortgage.
a list of homeownership counseling organizations.
Editor’s note: A list of homeownership counseling organizations approved
by HUD can be found at the CFPB’s website.
If the buyer is arranging financing through a mortgage broker, the broker, not
the lender, provides a copy of the special information booklet to the buyer.5
However, the booklet does not need to be given to the buyer if the mortgage
funds:
•
the refinance of an existing mortgage;
•
a closed-end mortgage in which the lender takes a subordinate lien;
•
a reverse mortgage; and
•
any federally related mortgage used to fund the purchase of other than
a one-to-four unit residential property.6
Also, on ARMs, the lender informs the buyer not only of the interest rate, but
also the index, margin and payment and interest rate floors and caps. [See
RPI Form 320-1]
On the lender’s receipt of a mortgage application, the property is appraised.
[See RPI Form 223-2 and 207; see Chapter 29]
2
3
4
5
6
12 CFR §1026.37
12 CFR §1026.19(g)
12 CFR §1026.19(f)(ii)
12 CFR §1024.6(a)(1)
12 CFR §1024.6(a)(3)
Property
appraisal
372
Real Estate Principles, Second Edition
Figure 2
Form 209-3
Balance Sheet
Financial
Statement
For a full-size, fillable copy of this or
any other form in this book that may be
used in your professional practice, go to
realtypublications.com/forms
loan-to-value ratio
(LTV)
A ratio stating
the outstanding
mortgage balance as
a percentage of the
mortgaged property’s
fair market value. The
degree of leverage.
The appraisal determines whether the property is of sufficient value to
support the amount of financing the buyer requests. Essentially, the lender
uses the appraisal to gauge whether the loan-to-value ratio (LTV) meets
the lender’s standards. [See Chapter 29]
Generally, an acceptable LTV for conventional mortgages is 80% of the
property’s value, requiring the buyer to make a minimum 20% down
payment. A greater LTV compels the lender to require the buyer to obtain
private mortgage insurance (PMI).
Chapter 55: The Uniform Residential Loan Application and post-submission activities
373
Once a lender approves property based on an appraisal, a mortgage package
is assembled and sent to a mortgage underwriter for review.
A mortgage approval issued by a lender is often conditioned on a buyer
providing more information or taking corrective actions. For example:
• the physical condition of the property may need correction;
•
title may need to be cleared of defects;
•
derogatory entries on the buyer’s credit report may need to be
eliminated; or
•
the buyer’s long- or short-term debt is to be reduced.
Once conditions for funding are met and verified, the mortgage is classified as
approved. Escrow calls for mortgage documents and funds, and on funding,
the sales transaction is closed.
Agents need to remind themselves that the degree of risk each lender finds
acceptable is different. More often than not, a lender exists who will make a
mortgage of some amount and under some conditions to nearly any buyer. It
is the business of lenders to do so.
The Uniform Residential Loan Application prepared by the buyer
with the transaction agent (TA) supplies the lender with necessary
information about the buyer and the property securing the mortgage.
It also gives the lender authorization to start the mortgage packaging
process.
The Uniform Residential Loan Application calls for the buyer, with the
assistance of the mortgage representative and TA, to enter information
such as:
• the type of mortgage sought;
•
the identity of the property used to secure the mortgage;
•
the buyer’s name and employment information;
•
the buyer’s monthly income and housing expenses;
Mortgage
approval
mortgage package
A collection of
documents required
to process a mortgage
application and
sent to a mortgage
underwriting officer
for review after receipt
of the appraisal on the
property offered as
security.
Chapter 55
Summary
374
Real Estate Principles, Second Edition
•
the buyer’s assets and liabilities; and
•
relevant miscellaneous creditworthiness issues to be disclosed to
the lender.
A Real Estate Settlement Procedures Act (RESPA)-controlled lender
needs to provide the buyer with a Loan Estimate of all mortgage related
charges, a copy of the HUD-published special information booklet, a
Closing Disclosure detailing all charges actually incurred and a list of
homeownership counseling organizations.
Once a lender receives a mortgage application and any processing fee,
the property is appraised to determine if it qualifies as security for the
mortgage. If a lender approves the property based on an appraisal, a
mortgage package is assembled and sent to an underwriter for review.
Once mortgage conditions are met and verified, the mortgage is
classified as approved. Escrow calls for mortgage documents and funds.
On funding, the sales transaction is closed.
Chapter 55
Key Terms
balance sheet……………………………………………………………………… pg. 367
buyer mortgage capacity ………………………………………………….. pg. 370
creditworthiness………………………………………………………………… pg. 370
debt-to-income ratio (DTI)…………………………………………………. pg. 369
loan-to-value ratio (LTV) …………………………………………………… pg. 372
mortgage package………………………………………………………………. pg. 373
Real Estate Settlement Procedures Act (RESPA)……………… pg. 371
transaction agent (TA)……………………………………………………….. pg. 366
Uniform Residential Loan Application…………………………… pg. 366
Quiz 11 Covering Chapters 55-61 is located on page 616.
Chapter 56: The FHA-insured home mortgage
375
Chapter
56
The FHA-insured home
mortgage
After reading this chapter, you will be able to:
• understand how purchase-assist mortgages insured by the Federal
Housing Administration (FHA) enable buyers to become owners;
• explain the minimum down payment and loan-to-value ratio
(LTV) for FHA-insured financing;
• determine whether a buyer and property qualify for an FHA
insured mortgage; and
• advise buyers on the use of an FHA Energy Efficient Mortgage to
finance energy efficient improvements.
Energy Efficient Mortgage
(EEM)
Federal Housing
Administration (FHA)insured mortgage
fixed payment ratio
loan-to-value (LTV) ratio
mortgage insurance
premium (MIP)
mortgage payment ratio
Real Estate Settlement
Procedures Act (RESPA)
Learning
Objectives
Key Terms
For a further study of this discussion, see Chapter 41 of Real Estate
Finance.
Consider a residential tenant who is solicited by a real estate agent to buy
a home. The financial and tax aspects together with the social benefits of
home ownership are compared to the corresponding benefits and mobility
provided by renting their shelter.
The tenant indicates they are ready and willing to be owners of a home for
their shelter. However, they have not accumulated enough cash reserves for
the down payment needed to qualify for a mortgage they need to fund the
purchase of a home.
Enabling tenants
to become
homeowners
376
Real Estate Principles, Second Edition
Federal Housing
Administration
(FHA)-insured
mortgage
A mortgage originated
by a lender and
insured by the FHA,
characterized by a
small down payment
requirement, high
loan-to-value (LTV)
ratio and high
mortgage insurance
premiums (MIPs),
typically made to firsttime homebuyers.
The agent assures the tenant that first-time homebuyers with little cash
available for a down payment can buy a home by qualifying for a purchaseassist mortgage insured by the Federal Housing Administration (FHA).
By insuring mortgages made with less demanding cash down payment
requirements, and with high loan-to-value (LTV) ratios of up to 96.5%, the
FHA enables prospective buyers to become homeowners.
The FHA does not lend money to buyers. Rather, the FHA insures mortgages
originated by approved direct endorsement lenders to qualified buyers who
will occupy the property as their principal residence. For issuing insurance
to the lender covering losses on a default, the buyer will pay premiums to
FHA for the coverage.
To qualify for an FHA-insured fixed-rate mortgage, a first-time homebuyer is
required to make a down payment of at least 3.5% of the purchase price. The
interest rate on the underlying mortgage is negotiated between the buyer
and the lender.1
Buyer liability
on a default
If a buyer defaults on an FHA-insured mortgage, the FHA covers the lender
against loss on the entire remaining balance of the mortgage. This is unlike
private mortgage insurance (PMI) and insurance from the Veterans
Administration (VA) which only insures a portion of the total mortgage
amount.
After the lender acquires the property through foreclosure and conveys the
property to the FHA, the FHA pays the lender the amount of the unpaid
principal balance remaining on the mortgage.2
Before accepting a conveyance from the lender, the FHA requires the lender
to confirm the property is in a marketable condition and has not suffered any
waste. The FHA then sells the property to recoup the amount it paid to the
lender.
Unlike conventional home mortgages where only a lender is involved, a
buyer who takes out an FHA-insured mortgage with a lender is personally
liable to the FHA for any loss the FHA suffers as a result of the homebuyer’s
default.
When the FHA suffers a loss, the FHA can obtain a money judgment against
the homebuyer for the difference between:
•
the amount the FHA paid the lender; and
•
the price received from the sale of the property.
California anti-deficiency mortgage laws do not apply to FHA-insurance
coverage for lender claims on insured mortgages.3
1
2
3
24 Code of Federal Regulations §203.20
24 CFR §203.401
24 CFR §203.369
Chapter 56: The FHA-insured home mortgage
The most commonly used FHA-insurance program is the Owner-occupied,
One-to-Four Family Home Mortgage Insurance Program, Section 203(b).
Buyers obtaining a Section 203(b) mortgage need to occupy the property as
their primary residence.
For the privilege of making a small down payment, the buyer needs to
pay a mortgage insurance premium (MIP) to the FHA. This essentially
increases the annual cost of borrowing as the annual rate charged for MIP is
added to interest payments. Together, the MIP and interest are the annual
cost incurred to borrow FHA-insured funds for the purchase of a home.
FHA guidelines include:
• manual underwriting for homebuyers whose debt-to-income ratio
(DTI) exceeds 43% and whose credit scores are below 620;
•
5% minimum down payments on FHA mortgages greater than
$625,000; and
•
MIP to continue through the life of the mortgage (previously it was
cancelled once the homeowner reached a 78% LTV).
377
One-to-four
unit mortgage
default
insurance
mortgage insurance
premium (MIP)
The cost for default
insurance incurred
by a borrower on an
FHA-insured mortgage
set as a percent of the
mortgage amount paid
up front and an annual
rate on the principal
balance paid with
monthly principal and
interest for the life of
the mortgage.
Further, an upfront premium, paid once at the time the mortgage is
originated, is calculated as 1.75% of the funded mortgage amount.
The public policy rationale behind the FHA Section 203(b) program is
based on the proposition homeowners are less of a financial burden on the
government in their later years than life-time tenants.
The maximum FHA-insured mortgage available to assist a buyer in the
purchase of one-to-four unit residential property is determined by:
• the type of residential property; and
•
the county in which the property is located.
FHA-insured
dollar limits by
regions
A list of counties and their specific mortgage ceilings is available from FHA
or an FHA direct endorsement lender, or online from the Department of
Housing and Urban Development (HUD) at http://www.hud.gov.
The FHA sets limitations on the amount of a mortgage it will insure. The
limit is a ceiling set as a percentage of the appraised value of the property,
called the loan-to-value ratio (LTV) .
The LTV ratio on an FHA-insurable mortgage is capped at a ceiling of 96.5% of
the property’s fair market value. Thus, the minimum down payment is 3.5%.4
Additionally, even after including buyer-paid closing costs in the LTV
calculations, the insurable mortgage amount cannot exceed the ceiling of
96.5% of the property’s appraised value.
4
HUD Mortgagee Handbook 4155.1 Rev-5 Ch-2 §A.2.b
Loan-to-value
(LTV) ceilings
and costs
loan-to-value ratio
(LTV)
A ratio stating
the outstanding
mortgage balance as
a percentage of the
mortgaged property’s
fair market value. The
degree of leverage.
378
Real Estate Principles, Second Edition
The maximum mortgage amount the FHA will insure is the LTV ratio’s
percentage amount of the lesser of:
•
the property’s sales price; or
•
the appraised value of the property.5
Closing costs may not be used to help meet the 3.5% minimum down
payment requirement. Also, closing costs are not deducted from the sales
price before setting the maximum mortgage amount.6
The lender’s origination fee included as a closing cost is limited to 1% of the
mortgage amount, excluding any competitive discount points and the 1.75%
upfront MIP.
Either the buyer or seller may pay the buyer’s closing costs, called nonrecurring closing costs. The lender may also advance closing costs on
behalf of the buyer.
Credit
approval
mortgage payment
ratio
A debt-to-income
ratio (DTI) used to
determine eligibility
for an FHA-insured
mortgage limiting
the buyer’s mortgage
payment to 31% of the
buyer’s gross effective
income.
fixed payment ratio
A debt-to-income
ratio (DTI) used to
determine eligibility
for an FHA-insured
mortgage limiting
the buyer’s total fixed
payment on all debts
to 43% of the buyer’s
gross income, also
called the DTI backend ratio.
For a buyer to be creditworthy for an FHA-insured mortgage, the following
debt-to-income (DTI) ratios need to be met:
•
the buyer’s mortgage payment may not exceed 31% of the buyer’s gross
effective income, called the mortgage payment ratio; and
• the buyer’s total fixed payments may not exceed 43% of the buyer’s
gross effective income, called the fixed payment ratio.7
A buyer’s income consists of salary and wages. Social security, alimony, child
support, and government assistance are factored into the buyer’s income
to determine effective income. The buyer’s effective income before any
reduction for the payment of taxes is referred to as gross effective income.
The maximum mortgage payment ratio of 31% of the gross effective income
determines the maximum amount of principal, interest, taxes and insurance
(fire and MIP) the buyer is able to pay on the mortgage. Collectively, this is
called PITI.
Lenders use the maximum fixed payment ratio of 43% of the gross effective
income. Applying this ratio, they determine whether a buyer can afford to
incur the long-term debt of an FHA-insured mortgage in addition to all other
long-term payments the buyer is obligated to pay.
When computing the fixed-payment ratio, the lender adds the buyer’s total
mortgage payment to all the buyer’s recurring monthly obligations. This
includes debts extending ten months or more, such as all installment loans,
alimony and child support payments.8
5
6
7
8
HUD Mortgagee Handbook 4155.1 Rev-5 Ch-2 §A.2.a
HUD Mortgagee Handbook 4155.1 Rev-5 Ch-2 §A.2.d
HUD Handbook 4155.1 Rev-5 Ch-4 §F.2
HUD Handbook 4155.1 Rev-5 Ch-4 §C.4
Chapter 56: The FHA-insured home mortgage
Acceptable sources of cash down payment include:
•
Savings and checking accounts: Lenders need to verify the account balance
is consistent with the buyer’s typical recent balance and no large increase
occurred just prior to the mortgage application. [See RPI Form 211]
•
Gift funds: The donor of the gift needs to have a clearly defined interest in the
buyer and be approved by the lender. Relatives or employer unions typically are
acceptable donors. Gift funds from the seller or broker are kickbacks considered
an inducement to buy and result in a reduction in the mortgage amount.
•
Collateralized mortgages: Any money borrowed to make the down payment
needs to be fully secured by the buyer’s marketable assets (i.e., cash value of
stocks, bonds, or insurance policies), which may not include the home being
financed. Cash advances on a credit card, for example, are not acceptable
sources for down payment funds.
•
Broker fees: If the buyer is also a real estate agent involved in the sales
transaction, the fee received on the sale may be part of the buyer’s down
payment.
•
Exchange of equities: The buyer may trade property they own to the seller as
the down payment. The buyer needs to produce evidence of value and ownership
before the exchange will be approved.
•
Sale of personal property: Proceeds from the sale of the buyer’s personal
property may be part of the down payment if the buyer provides reliable
estimates of the value of the property sold.
•
Undeposited cash is an acceptable source of down payment funds if the buyer
can explain and verify the accumulation of the funds. [HUD Handbook 4155.1
Rev-5 Ch-5 §B.1]
379
Acceptable
source of cash
down payment
However, even if the buyer’s ratios exceed FHA requirements, the mortgage
may be approved if the buyer:
•
makes a large down payment;
•
has a good credit history;
• has substantial cash reserves; and
•
demonstrates potential for increased earnings due to job training or
education.
Taken together, these are referred to as compensating factors.9
The Real Estate Settlement Procedures Act (RESPA) requires any lender
making an FHA-insured mortgage to deliver to the mortgage applicant a
Loan Estimate published by the Consumer Financial Protection Bureau
(CFPB) of costs paid to providers of services on the sale of a one-to-four unit
residential property. [See RPI Form 204-5; see Chapter 54]
9
HUD Handbook 4155.1 Rev-5 Ch-4 §F.3
RESPA
and TILA
disclosures
380
Real Estate Principles, Second Edition
Lenders also deliver a Housing and Urban Development (HUD) information
booklet. Both need to be delivered within three days after receiving the
buyer’s application. [See Chapter 54]
Upon closing a sale, the lender delivers a Closing Disclosure published by
the CFPB detailing all mortgage related charges incurred by the buyer and
seller.10 [See RPI Form 402; see Chapter 54]
Mortgages insured by the FHA under Section 203(b) are subject to both
disclosure requirements since they fund personal use mortgages and are
federally related (RESPA).11
Personal
liability of the
seller
Real Estate
Settlement
Procedures Act
(RESPA)
Legislation prohibiting
brokers from giving
or accepting referral
fees if thebroker or
their agent is already
acting as a transaction
agent in the sale of
a one-to-four unit
residential property
which is being funded
by a purchase-assist,
federally-related
consumer mortgage.
When a home is sold with the buyer taking title subject to an existing FHAinsured mortgage under some arrangement to pay for the seller’s equity, the
seller is released from personal liability, if:
•
they request a release from personal liability;
•
the prospective buyer of the property is creditworthy;
•
the prospective buyer assumes the mortgage; and
•
the lender releases the seller from personal liability by use of an FHAapproved form.12
If the conditions for release from personal liability are not satisfied, the seller
remains liable for any FHA loss on their insurance coverage for five years
after the sale.13
However, if five years pass from the time the property is resold, the seller is
then released from personal liability if:
• the mortgage is not in default by the end of the five-year period;
•
the buyer assumes the mortgage with the lender; and
• the seller requests the release of liability from the lender.14
Energy
efficiency
Energy Efficient
Mortgage (EEM)
An FHA-insured
purchase-assist or
refinance mortgage
which includes the
additional amount
to cover the costs of
constructing energy
improvements on the
mortgaged property.
Homebuyers and homeowners have a way to finance energy efficient
improvements under the FHA’s Energy Efficient Mortgage (EEM)
program.
The underlying idea behind the EEM program is this: reduced utility charges
allow applicants to make higher monthly mortgage payment to fund the
cost of the energy efficient improvements.
Financeable energy efficient improvements funded under FHA’s program
include:
•
purchasing energy efficient appliances or heating and cooling systems;
•
installing solar panels;
10 24 CFR §3500 et seq.
11 12 CFR §226.19
12 HUD Form 92210; 24 CFR §203.510(a); HUD Handbook 4155.1 Rev-5 Ch-7
13 12 USC §1709(r)
14 24 CFR §203.510(b)
Chapter 56: The FHA-insured home mortgage
381
• installing energy efficient windows;
•
installing wall or ceiling installation; and
•
completing repairs of existing systems to improve energy efficiency.
Under the EEM program, the costs of fundable energy improvements
are added to the base FHA maximum mortgage amount on a purchase or
refinance.15
Like most FHA mortgage programs, the EEM is not funded by the FHA. It is
funded by a lender, and insured to guarantee repayment by the FHA.
An EEM may be used in connection with either an FHA-insured purchase or
refinance mortgage (including streamline refinances), under the:
•
“standard” 203(b) program for one-to-four unit residential properties;
•
203(k) rehabilitation program;
•
234(c) program for condominium projects; and
•
203(h) program for mortgages made to victims of presidentially
declared disasters.16
Eligible property types include new and existing:
• one-to-four unit residential properties for the 203(b) and 203(k)
programs;
•
one-unit condominiums; and
•
manufactured housing.17
15 HUD Mortgagee Letter 2009-18
16 HUD Handbook 4155.1 Chapter 6.D.2.a
17 HUD Handbook 4155.1 Chapter 6.D.2.a
The Federal Housing Administration (FHA) insures mortgages
originated by approved direct endorsement lenders to qualified buyers
to fund the purchase of their principle residence.
FHA-insured mortgages provide for a down payment as low as 3.5% and
a higher loan-to-value (LTV) ratio than conventional mortgages. For the
privilege of making a small down payment, the buyer pays a mortgage
insurance premium (MIP) to the FHA, effectively increasing the annual
cost of borrowing as an addition to interest.
If a buyer defaults on an FHA-insured mortgage, the FHA covers the
lender against loss on the entire remaining balance of the mortgage.
The most commonly used FHA-insurance program is the Owneroccupied, One-to-Four Family Home Mortgage Insurance Program,
Section 203(b).
Chapter 56
Summary
382
Real Estate Principles, Second Edition
Before the FHA will insure a mortgage, the lender needs to determine
the buyer’s creditworthiness. For a buyer to be creditworthy for FHA
mortgage insurance, the following debt-to-income ratios (DTI) need to
be met:
•
the buyer’s mortgage payment ratio may not exceed 31% of their
gross effective income; and
• the buyer’s fixed payment ratio for all installment debts may not
exceed 43% gross effective income.
Homebuyers and homeowners may finance energy efficient
improvements under the FHA’s Energy Efficient Mortgage (EEM)
program. With reduced utility charges, buyers and owners may make
higher monthly mortgage payment to fund the cost of the energy
efficient property improvements.
Chapter 56
Key Terms
Energy Efficient Mortgage (EEM)……………………………………… pg. 380
Federal Housing Administration (FHA)-insured
mortgage…………………………………………………………………………….. pg. 376
fixed payment ratio…………………………………………………………… pg. 378
loan-to-value (LTV) ratio……………………………………………………. pg. 377
mortgage insurance premium (MIP)………………………………… pg. 377
mortgage payment ratio……………………………………………………. pg. 378
Real Estate Settlement Procedures Act (RESPA)……………… pg. 380
Quiz 11 Covering Chapters 55-61 is located on page 616.
Chapter 57: Carryback financing in lieu of cash
383
Chapter
57
Carryback financing in
lieu of cash
After reading this chapter, you will be able to:
• comprehend the financial benefits afforded to a seller and a buyer
under seller carryback finance arrangements;
•
identify the seller’s risks involved in carryback financing; and
•
explain the tax advantages available to a seller for carrying back a
portion of the sales price.
all-inclusive trust deed
(AITD)
private mortgage
insurance (PMI)
nonrecourse
seller financing
Learning
Objectives
Key Terms
portfolio category income
For a further discussion of this topic, see Chapter 26 of Real Estate
Finance.
When the availability of real estate mortgages tightens, a seller hoping to
locate a buyer amenable to the seller’s asking price needs to consider seller
financing.
Seller financing is also known as:
• an installment sale;
•
a credit sale;
•
carryback financing; or
•
an owner-will-carry (OWC) sale.
Seller
financing
supports the
price
384
Real Estate Principles, Second Edition
seller financing
A note and trust deed
executed by a buyer
of real estate in favor
of the seller for the
unpaid portion of
the sales price on
closing. Also known
as an installment sale,
credit sale or carryback
financing.
Seller financing occurs when a seller carries back a note executed by the buyer
to evidence a debt owed for purchase of the seller’s property. The amount of
the debt is the remainder of the price due after deducting:
•
the down payment; and
•
the amount of any existing or new mortgage financing used by the
buyer to pay part of the price.
On closing, the rights and obligations of real estate ownership held by the
seller are shifted to the buyer. Concurrently, the seller carries back a note and
trust deed taking on the rights and obligations of a secured creditor.
Editor’s note —California brokers and agents who make, offer or negotiate
residential mortgages for compensation are required to obtain a Mortgage
Loan Originator (MLO) license endorsement on their California Bureau of
Real Estate (CalBRE) license. A residential mortgage is a consumer purpose
loan secured by a one-to-four unit residential property.
Thus, offering or negotiating carryback financing triggers the MLO license
endorsement only if the broker or agent receives additional compensation
for the act of offering or negotiating the carryback, beyond the fee collected
for their role as seller’s agent or buyer’s agent.
Marketing
property: the
seller will
carry
The seller who offers a convenient and flexible financing package to
prospective buyers makes their property more marketable and defers the
tax bite on their profits.
Qualified buyers who are rational are willing to pay a higher price for real
estate when attractive financing is available. This holds regardless of whether
financing is provided by the seller or a mortgage lender. For most buyers, the
primary factors when considering their purchase of a property is the amount
of the down payment and the monthly mortgage payments.
Buyer willingness is especially apparent when the rate of interest on the
carryback financing is in line with or below the rates lenders are charging on
their purchase-assist mortgages. The lower the interest rate, the higher the
price may be.
Flexible sales
terms for the
buyer
For buyers, seller carryback financing generally offers:
• a moderate down payment;
•
competitive interest rates;
•
less stringent terms for qualification and documentation than imposed
by lenders; and
•
no origination (hassle) costs.
In a carryback sale, the amount of the down payment is negotiable between
the buyer and seller without the outside influences a traditional mortgage
broker and borrower has to contend with.
Chapter 57: Carryback financing in lieu of cash
385
Additionally, a price-to-interest rate tradeoff often takes place in the
carryback environment. The buyer is usually able to negotiate a lower-thanmarket interest rate in exchange for agreeing to the seller’s higher-thanmarket asking price.
Taxwise, it is preferable for a seller to carry back a portion of the sales price,
rather than be cashed out when taking a significant taxable profit.
The seller, with a reportable profit on a sale, is able to defer payment of a
substantial portion of their profit taxes until the years in which principal
is received. When the seller avoids the entire profit tax bite in the year of
the sale, the seller earns interest on the amount of the note principal that
represents taxes not yet due and payable.
If the seller does not carry a note payable in future years, they will be cashed
out and pay profit taxes in the year of the sale (unless exempt or excluded).
What funds they have left after taxes are reinvested in some manner. These
after-tax sales proceeds will be smaller in amount than the principal on
the carryback note. Thus, the seller earns interest on the net proceeds of the
carryback sale before they pay taxes on the profit allocated to that principal.
Tax benefits
and flexible
sales terms
portfolio category
income
Unearned income
from interest on
investments in bonds,
savings, income
property, stocks and
trust deed notes.
The tax impact the seller receives on their carryback financing is classified as
portfolio category income.
On closing the sale, the seller financing may be documented in a variety of
ways. Common arrangements include:
• land sales contracts;
•
lease-option sales;
•
sale-leasebacks; and
•
trust deed notes, standard and all-inclusive.
Legally, the note and trust deed provides the most certainty. Further,
they are the most universally understood of the various documents used to
structure seller financing. In this arrangement, carryback documentation
consists of:
•
a promissory note executed by the buyer in favor of the seller as
evidence of the portion of the price remaining to be paid for the real
estate before the seller is cashed-out [See RPI Form 421]; and
• a trust deed lien on the property sold to secure the debt owed by the
buyer as evidenced by the note. [See RPI Form 450]
The note and trust deed are legally coupled, inseparable and function in
tandem. The note provides evidence of the debt owed but is not filed with the
County Recorder. The trust deed creates a lien on property as the source for
repayment of the debt in the event of a default.
The closing
documents
needed for
the carryback
386
Real Estate Principles, Second Edition
Form 303
Foreclosure Cost
Sheet
In addition, when the seller carries back a note executed by the buyer as part
of the sales price for property containing four-or-fewer residential units, a
financial disclosure statement is to be prepared. This statement is prepared
by the broker who represents the person who first offers or counteroffers on
terms calling for a carryback note.1 [See RPI Form 300]
1
Calif. Civil Code §2956
Chapter 57: Carryback financing in lieu of cash
A carryback seller assumes the role of a lender at the close of the sales
escrow. This includes all the risks and obligations of a lender holding a
secured position in real estate – a mortgage. The secured property described
in the trust deed serves as collateral, the seller’s sole source of recovery to
mitigate the risk of loss on a default by the buyer on the note or trust deed.
387
Carryback
risks for the
seller
Another implicit risk of loss for secured creditors arises when the property’s
value declines due to deflationary future market conditions or the buyer
committing waste. The risk of waste, also called impairment of the security,
is often overlooked during boom times.
However, a decline in property value during recessionary periods due to
the buyer’s lack of funds poses serious consequences for the seller when the
buyer defaults on the payment of taxes, assessments, insurance premiums or
maintenance of the property.
Also, the seller needs to understand a carryback note secured solely by a trust
deed lien on the property sold is nonrecourse paper. Thus, the seller will
be barred from obtaining a money judgment against the buyer for any part
of the carryback debt not satisfied by the value of the property at the time of
foreclosure – the unpaid and uncollectible deficiency.2
nonrecourse
A debt secured by real
estate, the creditor’s
source of recovery on
default limited solely
to the value
of their security
interest in the secured
property.
However, as with any mortgage lender, if the risk premium built into the
price, down payment, interest rate and due date on the carryback note is
sufficient, the benefits of carryback financing level out or outweigh the risks
of loss. [See RPI Form 303]
2
Calif. Code of Civil Procedure §580b
Seller financing, also known as carryback financing, occurs when the
seller carries back a note for the unpaid portion of the price remaining
after deducting the down payment and the amount of the mortgage the
buyer is assuming.
Carryback financing offers considerable financial and tax advantages
for both buyers and sellers when properly structured. A carryback seller
is able to defer a meaningful amount of profit taxes, spreading the
payment over a period of years. Further, a seller who offers a convenient
and flexible financing package makes their property more marketable.
For buyers, seller carryback financing generally offers a moderate down
payment, competitive interest rates, less stringent terms for qualification
than those imposed by lenders and no origination costs.
A carryback seller takes on the role of a lender in a carryback sale, with
all the risks and obligations of a lender holding the seller’s secured
Chapter 57
Summary
388
Real Estate Principles, Second Edition
position on title. As with any creditor, if the risk premium built into
the rate and terms of the carryback note is sufficient, the benefits of
carryback financing outweigh the risks of loss.
Chapter 57
Key Terms
all-inclusive trust deed (AITD)………………………………………… pg. 467
nonrecourse………………………………………………………………………. pg. 387
portfolio category income ……………………………………………….. pg. 385
private mortgage insurance (PMI) ………………………………….. pg. 465
seller financing ………………………………………………………………… pg. 384
Quiz 11 Covering Chapters 55-61 is located on page 616.
Chapter 58: Usury and the private lender
389
Chapter
58
Usury and the private
lender
After reading this chapter, you will be able to:
• determine which lending arrangements are subject to or exempt
from usury restrictions on interest rates;
• identify extensions of credit on property sales as excluded from
usury restrictions;
• discern when the usury threshold rate applies; and
• explain the penalties imposed on a non-exempt private lender on
violations of usury law.
exempt debt
excluded debt
restricted real estate loans
treble damages
usury
Learning
Objectives
Key Terms
For a further study of this discussion, see Chapter 43 of Real Estate
Finance.
When a mortgage is made, the lender charges the borrower interest for use
of the money during the period lent.
However, the amount of interest a private, non-exempt lender can charge is
regulated by statute and the California Constitution. Collectively, these are
referred to as usury laws.1
Today, the remaining goal of usury laws is the prevention of loan-sharking
by private lenders. Loan-sharking involves charging interest at a higher rate
than the ceiling-rate established by the usury laws. These mortgages are
categorized as usurious.2
1
2
Calif. Constitution, Article XV; Calif. Civil Code §§1916-1 through 1916-5
CC §1916-3(b)
Broker
arranged
mortgages
avoid usury
usury
A limit on the lender’s
interest rate yield on
nonexempt real estate
mortgages.
390
Real Estate Principles, Second Edition
Usury
exemptions
spur
competition
Adopted in 1918 as a consumer protection referendum, the first California
usury laws set the maximum interest rate at 12% for all lenders — no
exceptions.
During the Great Depression, California legislation exempted certain types
of lenders from usury restrictions. The exemptions were implemented with
the intent to open up the mortgage market.3
These exemptions to usury laws remain in place today and more have been
added. For example, in 1979, mortgages made or arranged in California by
real estate brokers were exempted from usury restrictions.
Other types of lenders exempted from usury law restrictions include:
•
savings and loan associations (S&Ls);
•
state and national banks;
•
industrial mortgage companies;
•
credit unions and pawnbrokers;
•
agricultural cooperatives;
•
corporate insurance companies; and
•
personal property brokers.4
Exemptions successfully opened the market by increasing the availability
of funds. In turn, interest rates were soon driven lower due to increased
competition.
Interest paid
with goods
and services
When a borrower pays interest on a mortgage, they are paying rent to the
lender for use of its money for a period of time. The money lent is fully repaid
during or at the end of the period.
Normally, the amount of interest charged is a fixed or adjustable percentage
of the amount of money loaned.
Though interest is commonly paid with money, interest may also be paid
by the borrower by providing the lender with personal property, goods or
services. The many types of consideration given by the borrower for
the lender making a mortgage become part of the lender’s yield on the
mortgage—interest.5
Thus, interest includes the value of all compensation a lender receives for
lending money, whatever its form, excluding reimbursement or payment for
mortgage origination costs incurred and services rendered by the lender.6
Setting the
interest rate
If the use of the proceeds of a mortgage is earmarked primarily for personal,
family, or household use by the borrower, the maximum annual interest
rate is 10% per annum.7
3
4
5
6
7
Cal. Const. Art. XV
Cal. Const. Art. XV
CC §1916-2
CC §1915
Calif. Const. Art. XV §1(1)
Chapter 58: Usury and the private lender
391
Mortgages made to fund the improvement, construction, or purchase of
real estate when originated by a non-exempt private lender are subject to a
different usury threshold rate, which is the greater of:
• 10% per annum; or
•
the applicable discount rate of the Federal Reserve Bank of San
Francisco (FRBSF), plus 5%.
Two basic classifications of private mortgage transactions exist relating to
interest rates private lenders may charge on real estate mortgages:
• brokered real estate mortgages; and
•
restricted or non-brokered real estate mortgages.
Usury law and
real estate
mortgages
Brokered real estate mortgages are exempt from usury restrictions and fall
into one of two categories:
• mortgages made by a licensed real estate broker acting as a principal
for their own account as the private lender who funds the mortgage; or
• mortgages arranged with private lenders by a licensed real estate broker
acting as an agent in the mortgage transaction for compensation.
Restricted real estate mortgages are all mortgages made by private party
lenders which are neither made nor arranged by a broker.
Editor’s note — Private lenders include corporations, limited liability
companies, partnerships and individuals. These entities are not exempt
from usury limitations unless operating under an exempt classification,
such as a personal property broker or real estate broker.
The most common restricted mortgage involves private party lenders,
unlicensed and unassisted by brokers, who make secured or unsecured
mortgages.
Private party transactions involving the creation of a debt which avoid usury
laws break down into two categories:
•
exempt debts, being debts which involve a mortgage or a forbearance
on a mortgage and are broker-made or arranged; and
• excluded debts, being debts which do not involve a mortgage.
The most familiar of the excluded “non-mortgage” type debts is seller
carryback financing. [See Chapter 57]
Carryback notes executed by the buyer in favor of the seller are not loans of
money. They are credit sales, also called installment sales. A seller may
carry back a note at an interest rate in excess of the usury threshold rate. The
rate exceeding the usury law threshold is enforceable since the debt is not a
mortgage. Thus, carryback notes are not subject to usury laws.
restricted real estate
loans
All mortgages made by
private party lenders
which are neither
made nor arranged by
a real estate broker.
exempt debt
Private party
transactions exempt
from usury laws
involving the
origination of a
mortgage secured by
real estate and made
or arranged by a real
estate broker.
Exceptions
for private
parties
excluded debt
Extensions of credit
by sellers of real
estate creating a debt
obligation in sales
transactions which
avoid usury laws.
392
Real Estate Principles, Second Edition
Penalties for
usury
The most common penalty imposed on a non-exempt private lender in
violation of usury law is the forfeiture of all interest on the mortgage.
Thus, the lender is only entitled to a return of the principal advanced on
the mortgage. All payments made by the borrower are applied entirely to
principal reduction, with nothing applied to interest.8
treble damages
A usury penalty
computed at three
times the total interest
paid by the borrower
during the one year
period immediately
preceding their filing
of an action on a nonexempt private lender
mortgage.
The lender may also have to pay a usury penalty of treble damages.9
Treble damages are computed at three times the total interest paid by the
borrower during the one year period immediately preceding their filing of a
suit and during the period of litigation until the judgment is awarded.
An award of treble damages is typically reserved for a lender the court
believes took grossly unfair advantage of an unwary borrower.10
A borrower who knew at all times a loan interest rate was usurious is not
likely to be awarded treble damages. Also, a lender who sets a usurious rate
in complete ignorance of the illegality of usury would not be additionally
penalized with treble damages.
8 Bayne v. Jolley (1964) 227 CA2d 630
9 CC §1916-3
10 White v. Seitzman (1964) 230 CA2d 756
Chapter 58
Summary
The amount of interest a private, non-exempt lender can charge a
borrower is regulated by the California Constitution and statutes,
collectively called usury laws.
Mortgages made or arranged by a California real estate broker are
exempt from usury restrictions. Further, sales transactions involving
the extension of credit by a seller are not subject to usury laws.
Non-exempt mortgages made to fund the improvement, construction,
or purchase of real estate are subject to an interest restriction of 10%
annually or the current discount rate of the Federal Reserve Bank of San
Francisco plus 5%, whichever is greater.
Penalties for violating usury law include the forfeiture of all interest
on a usurious mortgage. Lenders who are found to have taken grossly
unfair advantage can also be penalized with treble damages.
Chapter 58
Key Terms
exempt debt………………………………………………………………………… pg. 391
excluded debt……………………………………………………………………… pg. 391
restricted real estate loans………………………………………………… pg. 473
treble damages…………………………………………………………………… pg. 392
usury…………………………………………………………………………………… pg. 389
Quiz 11 Covering Chapters 55-61 is located on page 616.
Chapter 59: A lender’s oral promises as commitments
393
Chapter
59
A lender’s oral promises
as commitments
After reading this chapter, you will be able to:
•
identify the unenforceability of a lender’s oral or unsigned mortgage
commitment; and
• better your buyer’s chance of closing with the best rates and terms
possible by submitting mortgage applications to at least two
lenders.
mortgage commitment
Learning
Objectives
Key Terms
For a further study of this discussion, see Chapter 39 of Real Estate Finance.
Consider an owner planning to make improvements to their industrial
property. The owner applies for a mortgage to upgrade the facilities, add
equipment and construct additional improvements. The owner has a longstanding business relationship with a lender, having borrowed from it in the
past.
The mortgage officer processing the mortgage orally assures the owner
it will provide permanent long-term financing to refinance the short-term
financing the owner will use to fund the improvements. Nothing is put to
writing or signed. Relying on the lender’s oral assurances, the owner enters
into a series of short-term mortgages and credit sales arrangements to acquire
equipment and improvements.
The mortgage officer visits the owner’s facilities while improvements are
being installed and constructed. The lender orally assures the owner they
will provide long-term financing again.
No
responsibility
for oral or
conditional
promises
394
Real Estate Principles, Second Edition
On completion of the improvements, the owner makes a demand on the
lender to fund the permanent financing. However, the lender refuses. The
owner is informed the lender no longer considers the owner’s business to
have sufficient value as security to justify the financing.
The owner is unable to obtain permanent financing with another lender.
Without amortized long-term financing, the business fails for lack of capital.
The business and property are eventually lost through foreclosure to the
holders of the short-term financing. The owner seeks to recover money losses
from the lender, claiming the lender breached its commitment to provide
financing.
Can the owner recover for the loss of their business and property from the
lender?
mortgage
commitment
A lender’s
commitment to make a
mortgage, enforceable
only when written,
unconditional and
signed by the lender
for consideration.
No! The lender never entered into an enforceable mortgage commitment.
Nothing was placed in writing or signed by the lender which unconditionally
committed the lender to specific terms of a mortgage.
Even though the lender orally assured the owner multiple times a mortgage
will be funded, and despite the owner’s reliance on their pre-existing
business relationship with the lender, the owner cannot rely on the lender’s
oral commitment.1
The only other course of action the buyer may take is to purchase a written
mortgage commitment, paying for the assurance funds will be provided on
request.
However, these commitments are always conditional, never absolute.
The lender is allowed to deny a mortgage even after delivering a written
mortgage commitment in exchange for a commitment fee without liability
if they refuse to fund.
Escape
from an oral
commitment
Once a lender signs a written agreement, it is bound to follow it. The preceding
scenario is an example of the reason lenders rarely enter into signed written
promises regarding a mortgage application. When they do, they need to do
nothing more than the limited federally mandated nonbinding disclosures
on single family residence (SFR) mortgages under Regulation Z (Reg Z),
also known as the Truth-in-Lending Act (TILA). [See Chapter 54]
Lenders customarily process applications and prepare mortgage documents.
However, these documents are at all points only signed by the buyer. The
lender orally advises the buyer whether the mortgage has been approved,
but signs nothing that binds it.
The first and only act committing the lender is its actual funding of the
mortgage — at the time of closing.
Thus, the lender-borrower relationship is one of power, not one of an open
market arrangement. Lending is an asymmetrical power relationship.
1
Kruse v. Bank of America (1988) 202 CA3d 38
Chapter 59: A lender’s oral promises as commitments
395
Until the lender delivers funds and a closing has occurred, the lender can
back out of its oral or unsigned written commitment at any time without
liability.
When a lender breaches its oral commitment to lend, the buyer’s reliance on
anything less than an unconditional written mortgage commitment is
not legally justified — even though the buyer had no realistic choice other
than to rely on the lender’s oral promises.
In order to prepare a buyer for the mortgage application process, agents
need to advise their buyer of the likely scenarios they will encounter. Thus,
the informed buyer is best able to anticipate and defend themselves when
confronted with unscrupulous eleventh-hour changes.
Always advise buyers seeking a purchase-assist mortgage to “double app”;
that is, submit mortgage applications to a minimum of two lenders as
recommended by the U.S. Department of Housing and Urban Development
(HUD) and the California Bureau of Real Estate (CalBRE). [See RPI Form 312]
Agents
provide
protection for
their buyers
Multiple competitive applications keep lenders vying for your buyer’s
business up to the very last minute – the ultimate moment of funding, when
commitments truly are commitments. [See Chapter 54]
A lender’s oral or unsigned mortgage commitment is unenforceable by
a buyer. A mortgage commitment is only enforceable when it is placed
in writing and signed by the lender, unconditionally committing the
lender to the specific terms of a mortgage for consideration.
Chapter 59
Summary
Lenders customarily process applications and prepare mortgage
documents. However, these documents are signed only by the buyer.
The first and only act committing the lender is its actual funding of the
mortgage which occurs at the time of closing. Thus, until the lender
delivers funds and a closing has occurred, the lender can back out of its
oral commitment at any time without liability.
To better your buyer’s chance of closing with the best rate and terms
possible, counsel them to submit applications for a mortgage to at least
two institutional lenders. A second application with another institution
gives the buyer additional leverage in mortgage negotiations needed at
closing.
mortgage commitment…………………………………………………….. pg. 394
Quiz 11 Covering Chapters 55-61 is located on page 616.
Chapter 59
Key Terms
Notes:
Chapter 60: Private mortgage insurance
397
Chapter
60
Private mortgage
insurance
After reading this chapter, you will be able to:
• advise your buyers who have a down payment less than 20%
about the availability of private mortgage insurance (PMI)
on conventional mortgages with loan-to-value ratios (LTVs)
exceeding 80%; and
• review the qualification and approval process for obtaining PMI
with buyers.
lender-paid mortgage
insurance (LPMI)
loan-to-value ratio (LTV)
private mortgage
insurance (PMI)
Learning
Objectives
Key Terms
For a further study of this discussion, see Chapter 42 of Real Estate
Finance.
Private mortgage insurance (PMI) indemnifies a lender against losses on
a mortgage when a borrower defaults.1
The lender’s recoverable losses include:
•
principal on the debt;
•
any deficiency in the value of the secured property; and
•
foreclosure costs.
PMI insurers are unrelated to government-created insurance agencies, such as
the Federal Housing Administration (FHA) and the Veterans Administration
(VA), which also insure or guarantee mortgages made to qualified borrowers.
[See Chapter 56]
1
Calif. Insurance Code §12640.02
Protecting
the lender
from loss
private mortgage
insurance (PMI)
Default mortgage
insurance coverage
provided by
private insurers for
conventional loans
with loan-to-value
ratios higher than 80%.
398
Real Estate Principles, Second Edition
PMI is not mortgage life insurance, which pays off the insured mortgage in
the event a borrower dies, becomes disabled, or loses their health or income.
Private
mortgage
insurance
coverage
PMI insures the lender for losses incurred up to a percentage of the mortgage
amount. In turn, the mortgage amount represents a percentage of the
property’s value, called the loan-to-value ratio (LTV).
Who pays for
PMI?
The buyer usually pays the PMI premiums, not the lender (although the
lender is the insured and holder of the policy).
loan-to-value ratio
(LTV)
A ratio stating
the outstanding
mortgage balance as
a percentage of the
mortgaged property’s
fair market value. The
degree of leverage.
lender-paid
mortgage insurance
(LPMI)
Default mortgage
insurance provided
by private insurers
in which the lender
pays the mortgage
insurance premium
and recovers the cost
through a higher
interest rate.
Typically, mortgages insured by PMI are covered for losses on amounts
exceeding 67% of the property’s value at the time the mortgage is originated.
However, some lenders and PMI insurers offer a lender-paid mortgage
insurance (LPMI) program. If issued by the PMI insurer, the lender pays
the mortgage insurance premium and charges the borrower a higher interest
rate on their principal payments.
Premium rates are set as a percentage of the mortgage balance and are
calculated in the same manner as interest.
If the buyer is current on PMI payments and has not taken out other mortgages
on their property, the buyer may terminate their PMI coverage when the
equity in their property reaches 20% of its value at the time the mortgage
was originated. Once the buyer reaches 22% equity, PMI is automatically
cancelled (unless the mortgage is a piggyback 80-10-10).
Furthermore, the buyer may cancel PMI two years after the mortgage is
recorded if the LTV for the mortgage balance is 75%. The lender may agree to
a higher LTV for cancellation.
When PMI may be cancelled as agreed, the lender may not charge advance
PMI payments unless the borrower has:
•
incurred more than one late penalty in the past 12 months; or
•
been more than 30 days late on one or more payments on the note.2
Premiums charged by PMI insurers do not include an up-front fee on
origination like FHA, only an annual fee calculated as a percentage of
the mortgage balance and payable monthly with principal and interest
payments.
Buyer and
property
standards
Depending on the policies of the insurer, the buyer needs to meet PMI
qualification standards such as:
2
•
a minimum credit score of upwards of 680;
•
a debt-to-income ratio between 41% and 45%;
Calif. Civil Code §2954.12(a)(3)
Chapter 60: Private mortgage insurance
399
• two months principal, interest, taxes and insurance (PITI) payments in
cash reserves;
• employment full time during the past two years, a current pay
stub, written verification by employer (VOE form), and telephone
confirmation of employment at closing, unless self-employed;
• if self-employed, financial statements for the two prior years and yearto-date, plus IRS tax returns;
• all documents and title vestings to be in the name of the buyer as an
individual;
• limit to three mortgages under PMI coverage in the name of the buyer;
• completion of a homeowners’ course of education on mortgage debt
obligations;
• no bankruptcy within four years, unless excused by extenuating
circumstances; and
• no prior foreclosure under a mortgage.
The PMI investigation and documentation takes place after submission of a
mortgage application. It is generally limited to verification of all the buyer’s
representations on the application. The availability of PMI coverage for
different types of California real estate is limited. Only properties classified as
single family residences (SFRs) may receive PMI.
Most PMI contracts do not authorize the insurer to seek indemnity from the
borrower for claims made on the policy by the lender. This is distinct from
FHA or VA insurance programs which place homeowners at a risk of loss for
a greater amount than their down payment.
Defaulting
borrower and
PMI recourse
Most insured mortgages are purchase-money mortgages made to buyeroccupants to acquire their principal residence. Purchase money mortgages
are nonrecourse obligations, with recovery on the mortgage limited to
the value of the real estate.3
However, if the mortgage is recourse, as is the case of a refinance, the lender’s
right to seek a deficiency judgment may be assigned to the PMI insurer.
Pursuing a money judgment to collect from the borrower for a deficiency in
the value of the property requires a judicial foreclosure action. [See Chapter
70]
In the case of fraud on recourse or nonrecourse mortgages, the PMI insurer is
not barred by anti-deficiency statutes from recovering losses. Thus, they may
enforce collection of their losses against the borrower for misrepresentations,
such as the property’s value, job status, etc.
To qualify for PMI, the buyer needs to be a natural person and take title as the
vested owner of the property.
3
Calif. Code of Civil Procedure §580b
The PMI
credit check
400
Real Estate Principles, Second Edition
The lender, when qualifying the buyer for a mortgage to be covered by PMI,
relies on the more restrictive PMI insurer’s requirements regarding the
buyer’s:
•
liquid assets after closing;
•
debt-to-asset ratio;
•
debt-to-income ratio; and
•
regard for financial obligations.
A buyer required to qualify for PMI before a lender funds a mortgage
undergoes an in-depth risk analysis based on the PMI insurer’s eligibility
requirements.
At a minimum, the buyer is required to submit documents for review by the
PMI insurer, including:
• a copy of the mortgage application;
•
a credit report current with…