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Unit 13: Key Points

These are the most important points for you to remember in this unit.

Qualifying for a Loan

  • Determining the customer’s real property needs and economic capabilities is called qualifying.
  • FHA, VA, and conventional lenders all use the Uniform Residential Loan Application.
  • Lenders are most interested in the
    • Quantity and quality of a borrower’s incomeThe lender must know how much the borrower makes in order to calculate the appropriate qualifying ratios.
    • Credit ScoreThe lender will order a credit report that will show the borrower’s payment history and credit score. Credit scoring uses statistical samples to predict how likely it is that a borrower will pay back a loan.
      • The most used credit score is the FICO score.
  • Qualifying Ratios—conventional lenders use a debt-to-income ratio to evaluate the borrower’s ability to make the payments. This ratio should be 43% or lower.
  • Prequalification vs. Preapproval
    • Prequalification—a borrower contacts a lender and answers questions posed by the lender relating to income and debt. If the answers seem to meet the loan requirements, the lender will issue a prequalification letter to the borrower.
    • Preapproval—indicates that the lender has not only gotten information from the borrower, but has ordered a credit report and has verified the borrower’s income and assets.

Conventional mortgages

  • A conventional mortgage is not insured (like FHA mortgages) or guaranteed (like VA mortgages).
  • Conventional mortgage lenders usually require larger down payments from borrowers, typically 20% of the purchase price or the appraisal, whichever is lower.
  • If a borrower makes a down payment of 20%, the loan amount will be 80%. 80% would be called the loan-to-value (LTV) ratio.
  • Private Mortgage Insurance (PMI) protects the lender against loss from default.
    • Borrowers who pay at least 20% down don’t pay for mortgage insurance.
    • PMI can be canceled when the home equity reaches 20%.
  • Qualifying Ratios–conventional lenders use a debt-to-income (DTI) to evaluate a borrower’s ability to pay.
    • The debt in the formula is the total of the borrower’s monthly payments of mortgage payment (PITI), the private mortgage insurance (PMI), and other monthly installment debt.
    • The income in the formula is the borrower’s monthly gross income.
  • Generally, the maximum debt-to-income ratio for conventional loans is 36% for high credit score borrowers. Some government-sponsored loan programs may have looser standards for debt-to-income ratios: Fannie Mae accepts debt-to-income ratios of approximately 45% for the mortgages it backs, and Federal Housing Administration loans accepts debt-to-income ratios of approximately 50%.
  • Conventional mortgage loans are not assumable without the lender’s permission.
  • Conventional mortgage loans may be paid off at any time without penalty.

Common Types of Mortgages

  • An amortized mortgage is gradually paid off by equal level payments of principal and interest.
  • Adjustable-rate mortgages are the most widely used alternative to the standard fixed payment loan. The interest rate on the mortgage can go up or down during the loan period.
    • Components of an ARM—the interest on the loan is tied to a published index.
    • The interest is computed by adding a “margin” to the index.
      • Index—There are several indexes that are used for adjustable-rate mortgages. The key is that the index must be beyond the control of the lender and that it be published during the year. 
      • Margin—The margin is a percentage added to the index. While the index changes, the margin stays the same over the life of the loan.
    • Interest rate capsFannie Mae and Freddie Mac require that the lender limit the increases to no more than 2% annually and 6% over the life of the loan.

Custom mortgages

  • A partially amortized mortgage is amortized over a longer period than the term of the loan. At maturity, the remaining balance is due in a balloon payment.
  • A biweekly mortgage is amortized the same way as loans that have monthly payments, except that a payment is made every two weeks. The payment is exactly ½ of the normal loan payment. Because there are 52 weeks in a year, the borrower will make 26 payments, in effect making 13 full payments a year.
  • A package mortgage includes personal property such as a refrigerator. These loans are often made on equipment for factories or restaurants with the personal property being used as additional security.
  • Home equity loans are usually second mortgages to give funds to the homeowner for repairs, college tuition for the kids, or other necessities.
  • A purchase-money mortgage is seller financing.
  • A reverse mortgage allows homeowners who are 62 or older to borrow on the equity of their home, either in a lump sum or by getting monthly payments.
    • The borrowers are not required to make payments while they live in the house.
    • When the borrower dies, or sells the property, the loan must be paid from the proceeds of the sale.

    Government Insured FHA Program

    • The FHA mortgage loan program was established by the National Housing Act of 1934.
    • The FHA is part of the Department of Housing and Urban Development (HUD).
    • To reduce the risk to lenders from the low-down payments, the FHA uses the Mutual Mortgage Insurance fund (MMI).
      • Each borrower pays an up-front fee to purchase the insurance and pays a monthly payment.
      • If a lender forecloses, the mortgage insurance pays the lender for any losses. The program is a win-win.
    • FHA does not make mortgage loans.
    • The FHA calls the down payment the “minimum cash investment.”
      • The minimum down payment for borrowers with a credit score of at least 580 is 3.5% of the purchase price or the appraisal amount, whichever is less.
      • The down payment can be satisfied with the borrower’s own cash, getting a gift from a family member or an employer. The gift cannot come from the seller, builder, or real estate licensee. Closing costs cannot be counted as part of the down payment.
      • FHA has established maximum regional loan amounts. If the down payment, called the initial investment, results in a loan amount higher than FHA maximum loan, the borrower must make up the difference in cash.
    • Borrowers must pay two types or mortgage insurance.
      • The Up-Front Mortgage Insurance Premium (UFMIP) is paid by the borrower when the loan is originated.
      • Borrowers also are required to pay a monthly mortgage insurance premium.
    • Qualifying for an FHA Mortgage Loan—the two qualifying ratios used by lenders are
      • the housing expense ratio, calculated by dividing the borrower’s monthly housing expense by the borrower’s monthly gross income, and
      • the total obligations ratio, calculated by dividing the total month debt payments by the  monthly gross income.
    • Lenders set the interest rates on FHA mortgages based on market rates. The FHA does not set interest rates for mortgages.
    • FHA appraisals have stricter requirements because of HUD-created minimum property standards. These standards include safety, security, and soundness.
    • Sellers or real estate licensees can pay closing costs of up to six percent of the purchase price.
    • FHA mortgages are assumable if the buyer is financially qualified.
    • FHA loans can be paid off early without any type of penalty.
    • Common FHA Loan Programs:
      • Section 203(b), homeownership, fixed rate, the most common mortgage loan insured by the FHA.
      • Section 203(k), homeownership, fixed rate, often called rehabilitation mortgages because they are intended for homes needing significant rehab.
      • Section 234(c) is for condominium units. 
      • Section 251 adjustable-rate mortgages keep the initial mortgage interest rates and payments low.
        • The maximum fluctuation in the rate in any given year cannot be more than 1%.
        • The loan interest rate may not adjust higher than 5% more than the initial rate.

    VA Loan Guarantee Program

    • The only persons who can apply for a VA mortgage guarantee are veterans, active-duty service members, and unmarried surviving spouses.
    • VA mortgages require the veteran to live in the property.
    • A veteran’s first step is to apply to the VA for a certificate of eligibility, which sets the amount of entitlement available to the veteran.
    • A veteran can use the VA guarantee program to purchase, build, or refinance a one-to-four-unit property provided that the veteran lives in one of the units.
    • Veterans may pay reasonable discount points on VA-guaranteed loans.
    • To qualify for a VA loan, a borrower’s total monthly obligations may not exceed 41 percent of the borrower’s gross monthly income.
    • The veteran can borrow as much as the veteran qualifies for and won’t have to make a down payment.
    • The VA guarantees lenders that if the borrower defaults, VA will pay them up to 25% of the loan amount. 
    • A veteran who used his or her full eligibility cannot receive another VA loan until the existing loan is paid off.
    • Homes purchased with a VA loan must be appraised by a VA-certified appraiser. The appraisal is called a certificate of reasonable value.
    • VA does not collect mortgage insurance premiums, but charges a funding fee to help finance the guaranty. The funding fee may be financed into the loan.
    • VA loans can be paid off at any time without penalty.
    • VA loans made after 1988 are not assumable unless the buyer qualifies financially.

    Primary Mortgage Market

    • A depository mortgage lender originates loans for borrowers in the primary market.
      • They are called depository lenders because they accept checking and savings accounts.
      • They are primary lenders because they approve or reject loans, and use their own funds.
    • Non-depository lenders originate loans with their own funds or with borrowed money.
    • Mortgage brokers don’t make loans or service loans. They work as intermediaries between borrowers and lenders and are paid by fee.
    • Mortgage loan originators are persons who solicit or process mortgage loans. The MLO must complete state prelicense courses, pass an exam and take continuing education.
    • Seller Financing–many sellers agree to finance the purchase of their properties. The seller is considered a primary lender.

    Secondary Mortgage Market

    • Most mortgage lenders sell the loans they originate in the secondary mortgage market. The proceeds from the sale of the loans give the lender the funds necessary to originate new loans. 
    • The secondary mortgage market, because it gives lenders a place to sell their loans, provides liquidity to the marketplace.
    • When persons put their funds into a depository, the depository is an intermediary, and the process is called intermediation. When those persons remove their funds to buy property or stocks, the process is called disintermediation.

    Standardized Loan Requirements

    • A conforming loan is one that meets the requirements to be sold to Fannie Mae, Freddie Mac, or other secondary market buyers.
    • A nonconforming loan is a loan that is higher than the allowed limits (jumbo loan) and cannot be sold to Fannie Mae or Freddie Mac.
    • The Federal National Mortgage Association (FNMA), informally known as Fannie Mae, is a government-sponsored enterprise (GSE).
      • Fannie Mae does not make mortgage loans.
      • Fannie Mae buys FHA, VA and conventional mortgages, usually from larger commercial banks, and issues mortgage-backed securities (MBS) to investors.
    • Freddie Mac, short for Federal Home Loan Mortgage Corporation, was created by congress in 1970.
      • Freddie Mac buys FHA, VA, and conventional loans, primarily from small banks and savings associations which helps their liquidity.  
    • Government National Mortgage Association (GNMA) guarantees bonds for packages of VA and FHA loans. It guarantees bonds issued by Fannie Mae and Freddie Mac.

    Common Types of Mortgage Fraud

    • Mortgage fraud refers to an intentional misstatement, misrepresentation, or omission of information to fund, purchase, or insure a loan secured by real property. Some types include:
      • Straw buyers—a person who makes a purchase for another person who is unable to do so is a straw buyer.
      • No-document loans—made by a lender based solely on representations made by the borrower about the borrower’s assets, liabilities, and income.
    • Red flags—common red flags include:
      • Inflated contract prices, 
      • Inflated appraisals,
      • higher than customary commissions and fees paid to brokers and appraisers, and
      • asking a borrower to sign a blank application or blank employee or bank forms.

    Laws Regarding Fair Credit and Lending Procedures

    • The Consumer Credit Protection Act is an “umbrella” law that includes several other important credit laws, including the Equal Credit Opportunity Act and the Truth in Lending Act.
    • The Equal Credit Opportunity Act (ECOA) ensures that lenders make credit available without discriminating against the buyer based on race, color, religion, national origin, sex, marital status, age or receipt of income from public assistance programs.
    • The Truth in Lending Act (TILA) requires lenders to treat consumers fairly and to provide meaningful disclosure about the cost of credit.
    • Federal Reserve Regulation Z requires a Truth in Lending Disclosure of full credit costs.  
      • The Act requires lenders to tell the consumer the amount of the loan, the annual percentage rate (APR), and any finance charges. The annual percentage rate includes the interest rate and other loan costs.  
    • The Real Estate Settlement Procedures Act (RESPA) requires disclosure of the amounts and types of charges buyers must pay. The six principal areas of the RESPA:
      • Loan Estimate.
      • Settlement cost booklet. The booklet was updated to reflect the new disclosure forms.
      • Selection of the closing agent. The lender must disclose the business relation­ship and the charges of any closing agent if the lender requires that the loan be closed by that agent.
      • Purchase of title insurance. A seller may not make it a condition of the sale that the buyer purchase title insurance from a particular company.
      • No kickbacks. Service fees may not be paid unless a service was per­formed by a person licensed to do so, and all parties are informed. Referral fees between brokers are permitted.
      • Closing Disclosure.
    • TILA-RESPA Integrated Disclosure (TRID) consists of two major forms, the Loan Estimate (LE) and the Closing Disclosure (CD).
      • The Loan Estimate and the settlement cost booklet must be given to the applicant within three days after the loan application.
      • Itmakes the lender responsible for the exact loan charges quoted. Certain other costs must be within 10% of the estimate.
      • Helps buyers understand loan costs.
      • Helps buyers compare loan costs from several lenders.
      • The borrower must receive the Closing Disclosure at least three days before closing.
        • The lender must have proof of receipt.
        • If the lender mails the forms, they must be in the mail at least seven days before the closing.
    • The Federal Reserve, also called “The Fed,” is the central bank of the United States. The Fed regulates the money supply, supervises and regulates banks, and maintains the stability of the financial system.