Download Loans Classified by Special Provision

Principles of Real Estate
Chapter 11-Loan Classifications
This chapter will describe the different classifications and types of loans, and the types of mortgages.
Overview
Objectives
At the end of this chapter, the student will be able to:
Describe the VA, FHA, RHS, and conventional loans
and compare the specific differences, as well as list the
advantages of each
Name the programs affiliated with a third-party backer
List the different types of loans classified by special
provisions
Describe the structure of each loan classified by special provisions
Discuss the advantages of each loan classified by special provisions
Describe a "subject to" purchase
11.1 | P a g e
Describe an "assumption"
Cite the differences between an "assumption" and a "subject to"
purchase
Name the advantages and disadvantages of "subject to" and assuming
a loan
Loans Classified by Lender's Security-VA
Loans
Under the Servicemen's Readjustment Act of 1944 and
subsequent federal legislation, the Veterans
Administration is authorized to guarantee
loans to purchase or construct homes for
eligible veterans - those who have served a
minimum of 181 days of active service since
September 16, 1940 (some specifically
designated wartime periods require as few as
90 days. Two full years are required for those
enlisting for the first time after September 7,
1980). GI loans assist veterans in financing the purchase of homes with no
down payments, at comparatively low interest rates. Rules and regulations
are issued from time to time by the VA, setting forth the qualifications,
limitations, and conditions under which a loan may be guaranteed.
VA loan is something of a misnomer. The VA does not normally
lend money itself; it guarantees loans made by lending
institutions approved by the agency.
The term VA loan refers to a loan that is not made by the agency but
guaranteed by it.
There is no VA limit on the amount of the loan a veteran can
obtain; this is determined by the lender. The VA does, however, set a
limit on the amount of the loan that it will guarantee.
To determine what portion of a mortgage loan the VA will
guarantee, the veteran must apply for a certificate of eligibility.
This certificate does not mean that the veteran will automatically
receive a mortgage. It merely sets forth the maximum guarantee to
which the veteran is entitled.
11.2 | P a g e
VA Loans: Value
The VA will also issue a certificate of reasonable value for the property
being purchased, stating its current market value based on a VAapproved appraisal. The appraiser uses a form called a URAR (Uniform
Residential Appraisal Report) to present the appraisal results to the lender. The
CRV places a ceiling on the amount the VA loan allows for the property; if the
purchase price is greater than the amount cited in the CRV, the veteran must
pay the difference in cash from his/her personal assets in order to purchase
the property. Also, it sets forth in the contract that the veteran does not have
to buy the property if the property does not appraise for the purchase price.
Only in certain situations (such as in isolated rural areas) where
financing is not reasonably available does the VA lend money itself;
otherwise, a veteran obtains a loan from a VA-approved lending institution.
The VA does not require a down payment, although a funding fee is
charged to the borrower. It may be paid at closing or financed for the term
of the loan. Also, all or part of the funding fee can be paid by the seller. The
funding fee is waived for disabled veterans.
Maximum loan terms are 30 years for one-to four-family dwellings
and 40 years for farm loans. Residential property purchased with
a VA loan must be owner-occupied.
If a VA loan is assumed, the original veteran borrower receives a release of
the liability on loans made after 1988. VA loans made prior to March 1,
1988 may be assumed without qualifying, but the seller retains secondary
liability. Under most circumstances, a veteran may only have one VA loan in
force at any given time. If the loan is assumed, the veteran's guarantee
remains with that loan until it is completely eliminated, at which time the
veteran's eligibility can be restored.
The borrower under a VA loan can prepay the debt at any time
without penalty. Also, the veteran may not be required to pay more
than a one percent origination fee.
VA loans are made by approved lending institutions, such as mortgage
companies, and then sold to investors.
Discounts, or discount points, are usually charged by a lending
institution when the VA interest rate is less than the market rate.
In VA, FHA and conventional loans, points are usually negotiated
11.3 | P a g e
between the seller and the buyer. Points are charged for the purpose
of increasing the effective yield.
Loans Classified by Lender's Security-FHA
Loans
The Federal Housing Administration (FHA) was created in 1934 under the National
Housing Act to encourage improvement in housing standards and conditions,
provide an adequate home-financing system through insurance of housing
credit, and exert a stabilizing influence on the mortgage market. The FHA
was the government's response to the lack of housing, excessive
foreclosures, and collapsed building industry that occurred during the
Depression.
The FHA, which operates under the Department of Housing and Urban
Development (HUD), neither builds homes nor lends money itself.
Rather, it insures loans on real property made by approved
lending institutions. It does not insure the property, but it does insure
the lender against loss.
The term FHA loan refers to a loan that is not made by the agency but
insured by it.
FHA Loan: Title II, Section 203(b)
The most popular FHA program is Title II, Section 203(b), which applies to
loans on one-to four-family residences. While interest rates on these
loans are no longer fixed by the FHA, such rates are generally 1/2 percent
less than those charged under conventional loans. These rates are generally
lower because the protection of the FHA mortgage insurance makes them a
lesser risk to the lender. As mentioned previously, discount points are
negotiable.
Technical requirements established under Congressional authority must be
met before the FHA will issue the insurance. These requirements include:
In addition to paying interest, the borrower is charged a fee for the
FHA insurance which is called a mortgage insurance premium.
The mortgaged real estate must be appraised by an approved FHA
appraiser, and the ratio of possible mortgage debt to the
11.4 | P a g e
appraised value of the property decreases as the appraised value
of the property increases. The formula for calculating the required
down payment will vary from state to state depending upon maximum
mortgage limit which FHA has set for various regions of the
country.
The FHA regulations set standards for type and construction of
buildings and credit requirements for borrowers. FHA loans
originated prior to December 1986, generally have no restrictions on
assumption. For loans originated since December 1, 1986, a credit
worthiness review is required. The review is required for the first 12
months for a residential property and 24 months for an investment
property.
When a mortgage or trust deed loan is insured by the FHA and the real
estate given as security is a single-family dwelling or a building with no more
than four units, the borrower retains the privilege of prepaying the debt
without penalty.
For loans originated since December 15, 1989, there are no assumptions
without complete buyer qualification and there are no longer any investor
loans.
Loans Classified by Lender's Security-Other
FHA Programs
In addition to loans made under Title II, Section 203(b), FHA loans are also
granted under the following programs:
Title I: Home improvement loans are covered under this title; such
loans are for relatively low amounts with a repayment term of no longer
than seven years and 32 days.
Title II, Section 234: Loans made to purchase condominiums are
covered under this program, which in most respects is similar to the
basic 203(b) program.
Title II, Section 245: Graduated payment mortgages are allowed
under this program; depending on interest rates, the loan-to-value ratio
of such loans might range from 87 to 93 percent.
11.5 | P a g e
Loans Classified by Lender's SecurityRHS/FmHA
The Rural Housing Service (RHS), formerly FmHA, is a federal agency under the
U.S. Department of Agriculture, originally designed to handle emergency
farm financing that channels credit to farmers and rural residents and
communities.
Loans can be made for housing located in open country and in all
rural communities with populations under 10,000, and in most
towns with populations between 10,000 and 20,000 that are outside
of Standard Metropolitan Statistical Areas and have a serious lack of
mortgage credit.
Loans can be direct loans for low-income borrowers for whom the
RHS originates the loan, sets the interest rate, and services the
loan. The service can also guarantee loans originated by standard
lending institutions. The RHS also sets the interest rates for these
loans.
Conventional Loans
Any loan not government guaranteed or government insured is a
conventional loan.
As lenders began utilizing the fully amortized loan after the Depression,
conventional loans were originated with loan-to-value ratios up to 80%. For
instance, on a home valued at $10,000 a lender would have to make a loan
of $8,000 ($8,000/$10,000 = 80%).
During the 1950s, conventional lenders began to have a difficult time
competing with government-backed loans. Homeowners simply could not
afford the large down payment. They were attracted by the governmentbacked loans which required little or no down payment.
11.6 | P a g e
Conventional Loans and Private Mortgage
Insurance
The solution to the conventional lender's problems was private mortgage
insurance (PMI). The Mortgage Guaranty Insurance Corporation (MGIC)
was the first private insurance company to insure conventional loans.
PMI allows lenders to increase their loan-to-value ratios considerably,
resulting in lower down payments for the borrowers. Today, conventional
loans may be made at loan-to-value ratios as high as 95%, without the lender
incurring any additional risk. In other words, PMI insures the top 20% to 25%
of the loan amount.
For example, on a $50,000 property, a lender would make a $40,000 loan
and not require any private mortgage insurance. With an 80% loan, lenders
feel reasonably protected because the purchaser has made a 20% down
payment. If a lender makes a $45,000 loan on the same $50,000 property,
he will want the additional $5,000 insured.
Loans Classified by Special ProvisionAdjustable Rate Mortgage
An adjustable rate mortgage (ARM) is
generally originated at one rate of
interest, with the rate fluctuating up or
down during the loan term based on a
certain economic indicator called an
index.
Most indexes are tied to U.S. Treasury
securities.
The interest rate is determined by
adding a premium, called the margin, to the index.
Generally, interest rate adjustments are limited to one each year, and
there are limits (called CAPs) to the amount of increase in any one
year and over the life of the loan.
The borrower is usually given the right to prepay the loan in full
without penalty whenever the interest rate is changed.
11.7 | P a g e
Loans Classified by Special ProvisionGraduated Payment Mortgage
The objective of a graduated payment mortgage (GPM) is to help
borrowers qualify for loans by basing repayment schedules on salary
expectations.
With this type of mortgage, the interest rate and maturity are fixed
but the monthly payment gradually rises.
The first such program, FHA-245, came into being in 1978. The FHA-245
program is especially attractive to those just starting their careers and
anticipating increases in their incomes. They are able to obtain a home with
an initial lower monthly installment obligation than would be available under a
level payment plan. This plan helps borrowers qualify for loans by basing
repayment schedules on salary expectations and anticipated home price
appreciation.
Since FHA underwriting guidelines are based on the first year's
monthly requirement for principal and interest amortization, those using
FHA-245 can qualify for larger loan amounts than would ordinarily be
available under other forms of financing.
COMPARISON OF PAYMENT SCHEDULES OF LEVEL PAYMENT
MORTGAGE AND FHA GRADUATED PAYMENT MORTGAGE (PLAN III)
$100,000 loan, 11 1/2% interest, 30-year term (rounded to nearest dollar)
Year
Level
Graduated Payment
Difference
1
$991
$760
-$231
2
$991
$817
-$174
3
$991
$878
-$113
4
$991
$944
-$47
5
$991
$1,014
+$23
6-30
$991
$1,091
+100
11.8 | P a g e
Loans Classified by Special ProvisionBuydown Mortgage
In a buydown mortgage, some of the interest is paid in advance for the
purpose of temporarily lowering the interest rate.
Builders wishing to sell their newly constructed homes often offer this form of
financing as an incentive to buyers.
Loans Classified by Special Provision-Budget
Mortgage Loans
To avoid the potential problem of a borrower not paying property taxes and
hazard insurance when they become due, many lenders offer budget
mortgage loans.
At the time the loan is made, the borrower is required to establish a
reserve fund for the payment of these items. The funds are placed in
an escrow account, and each month, along with the regular principal
and interest payment, the borrower pays 1/12 of the annual tax and
insurance premium, called impounds, which are added to the account.
When the taxes and insurance become due, the lender is assured of having
collected enough to pay them.
This procedure protects the mortgage lien from becoming subordinate
to a tax lien and guarantees the lender that he has adequate protection
in case the property is destroyed. Budget repayment plans are required
on FHA and VA loans and may be used on any type of conventional loan.
Loans Classified by Special ProvisionPackage Mortgage
A package mortgage not only includes the real estate, but also expressly
includes all fixtures and appliances installed on the premises.
Such loans usually include the kitchen range, refrigerator, dishwasher,
garbage disposal unit, washer and dryer, food freezer, and other
11.9 | P a g e
appliances, as part of the real estate in the sales price of the home.
Not all state courts agree that personal property (such as a washer and
dryer) becomes real estate under these circumstances and is subject
to the package mortgage.
You must determine whether the package mortgage is used in your
state.
Loans Classified by Special Provision-Blanket
Mortgage
A blanket mortgage covers more than one parcel or lot, and is usually
used to finance subdivision developments (though it can be used to
finance the purchase of improved properties as well).
These loans usually include a provision, known as a partial release
clause that the borrower may obtain the release of any one lot or
parcel from the lien by repaying a definite amount of the loan.
The lender issues a partial release for each parcel released from the
mortgage lien. This release form includes a provision that the lien will
continue to cover all other, unreleased lots.
Loans Classified by Special ProvisionWraparound Mortgage
A wraparound mortgage, also known as an
all-inclusive mortgage, enables a
borrower who is paying off an existing
mortgage to obtain additional financing
from a second lender.
The new lender assumes payment of
the existing loan and gives the
borrower a new, increased loan as well
as the additional funds needed by the
borrower.
The borrower makes payments to the new lender on the larger
loan, and the new lender makes the payments on the original
loan.
11.10 | P a g e
A wraparound mortgage is frequently used as a method of
refinancing real property or financing the purchase of real
property when an existing mortgage cannot be prepaid.
It is also used to finance the sale of real estate when the buyer wishes
to put up a minimum amount of cash for the sale initially.
The buyer executes a wraparound document to the seller, who will
collect payments on the new loan and continue to make payments on
the old loan. The buyer should require a protective clause in the
document granting him or her the right to make payments directly to
the original lender in the event of a potential default on the old loan by
the seller.
Loans Classified by Special Provision-Reverse
Annuity Mortgage
A reverse annuity mortgage is one in which
regular monthly payments are made to
the borrower, based on the equity the
homeowner has invested in the property
given as security for the loan.
To be eligible, the participant must be at least
62 years old and the reverse mortgage must
be the only loan allowed on the property.
A reverse loan allows senior citizens on fixed incomes to realize the
equity build-up in their homes without having to sell.
The money received by the senior can be monthly payments, a line of
credit, or another agreed upon means.
The borrower is charged a fixed rate of interest, which will be
periodically added to the principal. The loan is eventually paid from the
sale of the property or from the borrower's estate upon his or her
death.
11.11 | P a g e
Loans Classified by Special Provision-Open
End Mortgage
An open-end mortgage, which is being used with increasing frequency,
secures a note executed by the borrower to the lender, as well as any
future advances of funds made by the lender to the borrower or his or
her successors in title.
The mortgage or trust deed usually includes a statement of the
maximum amount to be secured. Any sums the lender may have to
pay to protect his or her security due to the borrower's neglect for such
items as taxes, assessments, or insurance premiums are added to this
maximum amount.
An open-end mortgage is frequently used by borrowers to obtain
additional funds in order to improve their property.
The borrower "opens" the mortgage or trust deed to increase the debt
to its original amount after the debt has been reduced by payments
over a period of time.
The terms of an open-end mortgage usually restrict the increase in
debt to a limit of either the original amount of the debt or a stipulated
amount set forth in the mortgage or trust deed.
The lender is not obligated to advance the additional funds.
Loans Classified by Special Provision-SharedAppreciation Mortgage
A shared-appreciation mortgage is one in which the lender originates a
mortgage or trust deed loan at a favorable interest rate (several points
below the going rate) in return for a guaranteed share of the gain (if
any) the borrower will realize when the property is eventually sold.
This type of loan was originally made to developers of large real estate
projects, but in times of expensive mortgage money it has appeared in
the residential financing market.
The specific details of the shared-appreciation agreement are set forth
in the mortgage or trust deed and note documents.
11.12 | P a g e
The SAM can also be called a participation loan.
Loans Classified by Special ProvisionPurchase-Money Mortgage
A purchase-money mortgage is a note and mortgage or trust deed
created at the time of purchase to facilitate the sale.
It is often given by the purchaser to the seller to finance the
property.
A purchase-money mortgage is usually given to cover a portion of
the purchase price, such as the down payment; it may even be
given to finance the entire purchase price.
It is a form of owner financing in which the seller acts as the
mortgage company.
Loans Classified by Special ProvisionConstruction Loan
A construction loan is made to finance the construction of
improvements on real estate (homes, apartments, office buildings, and so
forth).
Under a construction loan, the lender disburses the loan proceeds
in installments while the building is being constructed.
This loan is generally a term loan and bears a higher interest rate
because of the risks assumed by the lender.
This type of financing is generally short-term, or interim. An end loan
or take-out loan will "take out" the original construction financing
lender when the work is completed. This "take out" loan is usually
obtained from another lender.
Purchasing 'Subject To'
A person who purchases real estate that has an outstanding mortgage
or trust deed on it may take the property subject to the mortgage or
11.13 | P a g e
may assume it and agree to pay the debt. This technical distinction
becomes important if the buyer defaults and the mortgage or trust deed is
foreclosed.
Subject to: When the property is sold subject to the existing mortgage, the
courts frequently hold that the purchaser is not personally obligated to pay
the debt in full.
The purchaser has bought the real estate knowing that he or she
must make the loan payments and that, upon default, the lender
will foreclose and the property will be sold by court order to pay
the debt.
If the sale does not pay off the entire debt, the purchaser is not
liable for the difference.
Assuming a Debt
In contrast to "subject to," when the grantee assumes and agrees to
pay the debt, the grantee becomes personally obligated for the
payment of the entire debt.
If the mortgage is foreclosed in such a case and the court sale does
not bring enough money to pay the debt in full, a deficiency judgment
against both the assumer and the original borrower may be
obtained for the unpaid balance of the note.
The assumer has primary liability while the original borrower is
secondarily liable.
In Review
The Veterans Administration is authorized to guarantee
loans to purchase or construct homes for eligible
veterans. Loans with that guarantee are commonly called
VA loans.
The FHA neither builds homes nor lends money itself.
Rather, it insures loans on real property made by
approved lending institutions. It does not insure the
11.14 | P a g e
property, but it does insure the lender against loss.
Any loan not government-guaranteed or government-insured is a
conventional loan.
An adjustable rate mortgage is generally originated at one rate of
interest, with the rate fluctuating up or down during the loan term based
on a certain economic indicator called an index.
With a graduated payment mortgage, the interest rate and maturity are
fixed but the monthly payment gradually rises.
In a buydown mortgage, some of the interest is paid in advance for the
purpose of temporarily lowering the interest rate.
A package mortgage not only includes the real estate, but also
includes all fixtures and appliances installed on the premises.
A blanket mortgage covers more than one parcel or lot, and is usually
used to finance subdivision developments
An open-end mortgage secures a note executed by the borrower to the
lender, as well as any future advances of funds made by the lender to
the borrower or his or her successors in title
Under a construction loan, the lender disburses the loan proceeds in
installments while the building is being constructed.
11.15 | P a g e