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Conventional Loans/Financing

Conventional Loans/Financing. Chapter 13. Chapter Objectives. Identify the characteristics of a conventional loan. Define amortization. Identify different types of conventional loans. Recognize the use of private mortgage insurance. Contrast conforming and nonconforming loans.

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Conventional Loans/Financing

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  1. Chapter 13: Conventional Loans/Financing Conventional Loans/Financing Chapter 13

  2. Chapter 13: Conventional Loans/Financing Chapter Objectives • Identify the characteristics of a conventional loan. • Define amortization. • Identify different types of conventional loans. • Recognize the use of private mortgage insurance. • Contrast conforming and nonconforming loans. • Describe methods of secondary financing. Refer to page 265

  3. Chapter 13: Conventional Loans/Financing Conventional Loans • Made by a bank or institutional lender • Not insured or guaranteed by a government entity or agency • Written to guidelines set by government-sponsored entities (GSEs) so they may be sold on secondary market • Conforming loan – meets the criteria necessary to be sold in the secondary market. Refer to page 266

  4. Chapter 13: Conventional Loans/Financing Traditional Conventional Loans • Long-term , fully amortizing, fixed rate real estate loans • Long-term loans • Limit borrowers to terms involving a maximum of 30 years Refer to page 266

  5. Chapter 13: Conventional Loans/Financing Traditional Conventional Loans (cont.) • Amortization • Reduction of the balance of the loan by paying back some principal owed on a regular basis • Payments applied to principal and interest • Negative amortization • Monthly payment is not sufficient to cover the accrued interest from previous month • Fully amortizing loan • Total payments over life of loan pay off entire balance of principal and interest due at the end of the term (self-liquidating) • Regular periodic payments reduce loan by end of the term, although different amounts applied to interest and principal out of payment Refer to page 266

  6. Chapter 13: Conventional Loans/Financing Traditional Conventional Loans (cont.) • Fixed rate • Haveinterest rates, but not necessarily payments, that remain constant • Interest only payment mortgage • Period of reduced payments, for a specified time, then payment increases to fully amortize by end of term • Now prohibited by regulations implemented by the CFPB Refer to page 266-267

  7. Chapter 13: Conventional Loans/Financing 15-Year Mortgage Loans Advantages • Lenders give better interest rate • Shorter term = less risk • Total interest paid about one-third less than 30-year at the same interest rate • Borrower: Full ownership in half the time Disadvantages • Payments higher • Higher payments consume financial resources that might be invested/earn higher rate of return • Borrower’s income tax deduction declines more quickly Refer to page 267

  8. Chapter 13: Conventional Loans/Financing Bi-Weekly Payment Plan • Fixed rate mortgage set up like 30-year conventional loan • Regular monthly payments: Monthly amortization schedule • Payments every two weeks • Loans with bi-weekly payment structures are usually paid off in about 22 to 26 years, instead of 30 years, depending on the interest rate charged. Refer to page 267

  9. Chapter 13: Conventional Loans/Financing 13.1 Knowledge Check 1.A conforming loan is a loan that can be sold in the secondary market to FNMA or FHLMC. • true • false Refer to page 268

  10. Chapter 13: Conventional Loans/Financing 13.1 Knowledge Check (cont.) 2. A self-liquidating loan requires a balloon payment be made at the end of the loan term. • true • false Refer to page 268

  11. Chapter 13: Conventional Loans/Financing Conforming Loans • Conforming loans meet Fannie Mae / Freddie Mac standards – Can be sold on the secondary market • Qualifying guidelines • 28% total housing expense ratio • 36% total debt-to-income ratio • Borrowers must qualify under both ratios • Borrowers should have 5% of their own funds for a down payment • Borrowers should have 2 months of reserves on deposit Refer to page 268

  12. Chapter 13: Conventional Loans/Financing Nonconforming Loans • Cannot be sold to Fannie Mae or Freddie Mac, can be sold in other secondary markets • Loan classified as nonconforming due to: • Size of the loan: Jumbo loans exceed the maximum loan amount established by Fannie Mae and Freddie Mac for conforming mortgage loans • Credit quality of borrower: B or C borrower Refer to page 268

  13. Chapter 13: Conventional Loans/Financing A-Minus Conventional Loans • Allows borrower with less than perfect credit history, limited money for down payments, higher debt-to-income ratio to get a loan that could be sold on secondary market • Final interest rate and fees determined on risk factors present in loan • Rare in today’s mortgage market Refer to page 268

  14. Chapter 13: Conventional Loans/Financing Conventional Loan Products • Fixed rate – 8 to 30 years; max loan-to-value 95% • Adjustable rate – 8 to 30 years; max loan-to-value 90% for owner-occupied home loans • My Community or Home Possible – Relaxed guidelines for down payment; require homebuyer education • Homepath and Homesteps (financing GSE’s REO’s)– No appraisal, no MI, 5% down (Homesteps only in certain states) • Home Affordable Refinance Programs / Relief Refinance Mortgages – Loans for borrowers with consistent repayment history, but property with negative equity • Construction-to-Permanent – Retire construction loan; provide permanent, long-term takeout financing Refer to page 268-269

  15. Chapter 13: Conventional Loans/Financing Conventional Loan Programs • Classified by percentage of down payment borrower pays to acquire loan • Loan-to-value ratio: Amount of money borrowed compared to value of the property • Use the lower appraised value or sale price to protect its interest • Lower the LTV, the higher the borrower’s down payment • 80% LTV Example $200,000 x .08 = $160,000 loan amount Refer to page 269

  16. Chapter 13: Conventional Loans/Financing 13.2 Apply Your Knowledge Bill wants to buy a house that is selling for $160,000, and the lender has approved him for an 80% conventional loan. • How much can Bill borrow? • What would be the required down payment? • If the house appraises for $150,000, how much can Bill borrow? • What other options does he have? Refer to page 269

  17. Chapter 13: Conventional Loans/Financing Higher LTV Loans • Possible because of PMI and secondary financing • Qualifying standards and lender adherence more stringent • May have higher interest rate • Call for higher loan origination fees • Impose additional conditions and standards • Lender and agency requirements determine if property must be owner-occupied as condition for loan Refer to page 270

  18. Chapter 13: Conventional Loans/Financing 90% Versus 95% Conventional Loans • 90% LTV • Half of required down payment must be made from personal cash reserves • Remainder of down payment may be gift, equity in other property traded to the seller, or credit for rent already paid under lease/purchase • 95% LTV • Owner occupancy of property and down payment made from personal cash reserves, without secondary financing or gifts • 97% LTV • Require a “first time homebuyer” • MyCommunity Mortgage properties may add requirements Refer to page 270

  19. Chapter 13: Conventional Loans/Financing Private Mortgage Insurance (PMI) • Insures a lender against default on loan by a borrower where loss of collateral value at time of default. • Fannie Mae and Freddie Mac require on home loans with less than 20% down • Mortgage insurer shares lender’s risk, but only part of risk • Insures upper portion of loan that exceeds standard 80% LTV • Amount of coverage can vary; typically, 20% to 25% of loan amount Refer to page 270

  20. Chapter 13: Conventional Loans/Financing PMI Premiums • One-time, non-refundable fee at closing, and • Recurring fee, called renewal premium • Added to borrower’s monthly mortgage payment • Insurer provides PMI rate cards used to determine monthly premium Refer to page 271

  21. Chapter 13: Conventional Loans/Financing 13.3 Apply Your Knowledge If the sale price of a home is $100,000, on a 90% LTV 30-year fixed mortgage, calculate the PMI using the sample rate card. Use the Fannie Mae/Freddie Mac required 25% coverage, at a rate of 0.62%. • What is the loan amount? • What is the fee due at closing? • How much will be added to the borrower’s monthly mortgage payment? Refer to page 272

  22. Chapter 13: Conventional Loans/Financing One-Time PMI Premium • Offered by some PMI insurers • No renewal fee • Combine initial premium and renewal premiums into one payment • Allows borrower to finance PMI premium • Monthly payments may be lower than when renewal premiums added to regular mortgage payment Refer to page 272

  23. Chapter 13: Conventional Loans/Financing PMI Cancellation • Homeowners Protection Act of 1998 (HPA) requires lenders to automatically cancel PMI when home paid down to 78% of original value. • Exceptions: Multi-family units, non-owner-occupied homes, mortgages on second homes, second mortgages Refer to page 272

  24. Chapter 13: Conventional Loans/Financing PMI Cancellation (cont.) • Loans closed after July 29, 1999, lenders drop PMI coverage at borrower’s request if: • New lender-approved appraisal shows loan paid down to 80% or less of home’s value • Borrower shows history of timely repayment over past 12 months • Certification that equity of mortgagor is unencumbered by subordinate lien Refer to page 272

  25. Chapter 13: Conventional Loans/Financing Secondary Financing When buyer borrows money from another source to pay part of purchase price or closing • Allows conventional loan without a 20% down payment • Secondary financing – Seller may carry the extra • Primary lender – Includes payment as part of the borrower’s monthly housing expense and considers total amount borrowed when determining combined LTV • Borrower – Must still make 5% minimum investment from his own funds Refer to page 273

  26. Chapter 13: Conventional Loans/Financing Subordinate Financing • Debt financing in which the lender is not the first party due to be repaid by the borrower • Can be more than simply a second mortgage. • Borrowers may have additional junior liens • Secondary financing may be: • Fully amortized • Partially amortized • Interest only Refer to page 273

  27. Chapter 13: Conventional Loans/Financing Combined Loan-to-Value (CLTV) • Percentage of property value borrowed through a combination of more than one loan • Calculated by adding loan amounts and dividing home’s appraised value or purchase price, whichever is lower • Both LTV and CLTVused to determine amount of home equity Refer to page 273

  28. Chapter 13: Conventional Loans/Financing Secondary Financing Conditions • Down Payment • Borrower make 5% down payment. First mortgage cannot exceed 80% LTV • Loan Terms • Term of second loan cannot exceed 30 years, or be less than 5 years • Interest Rate • Interest rate on second mortgage could be fixed or adjustable • No Prepayment Penalty • Second mortgage payable in full or in part without penalizing borrower for paying debt early Refer to page 274

  29. Chapter 13: Conventional Loans/Financing Secondary Financing Conditions (cont.) • Regularly Scheduled Payments: Payments due on regular basis – do not have to be monthly • Secondary finance payments can be any regular schedule • Payments fully or partially amortize the debt, or pay interest only • No Negative Amortization • Payments on second mortgage must equal interest on loan • Loan balances cannot grow because of deferred interest • Ability to Qualify • Borrower must afford payments on first and second mortgages • Primary lender on first mortgage counts on both mortgages • Subordination Clause • Primary lenders require secondary financing to have subordination clause: Insure primary lender’s lien takes priority, even if second mortgage recorded first Refer to page 274

  30. Chapter 13: Conventional Loans/Financing 13.4 Apply Your Knowledge Review the example below of secondary financing for a $120,000 home: $90,000 75% First Mortgage (primary lender) $18,000 15% Second Mortgage (from seller) + $12,000 10% Down Payment (from borrower) $120,000 100% Total Sales Price • What is the loan-to-value (LTV)? • What is the combined loan-to-value (CLTV)? Refer to page 274

  31. Chapter 13: Conventional Loans/Financing Summary • Conventional loans are not insured or guaranteed by government agency. Traditional conventional loans are long-term, fully amortizing, have fixed rate. Amortizing loan has payments that are applied to principal and interest. Fixed rate, fully amortizing loan has regular payments that are equal in amount that fully retires debt at end of term. • Conventional loans: 15- or 30-year, conforming or nonconforming. 15-year retires sooner and saves interest, higher payments. Bi-weekly payment structure = one extra monthly payment per year. • Conforming loans meet Fannie Mae/Freddie Mac standards: 28% for housing expense and 36% for total debt-to-income. Nonconforming loans do not; may be sold on secondary market. Refer to page 275

  32. Chapter 13: Conventional Loans/Financing Summary • 80% conventional loan: LTV = 80% appraised value or sale price of property, whichever is less. Interest rates and fees higher, require PMI. Generally require owner-occupancy. • PMI insures lenders against borrower default. PMI can be fee paid at closing and as a renewal premium, one-time PMI premium, or no PMI premium, but with a higher interest rate. Loans after July 1999 must drop PMI when LTV is 78% of original property value and borrower not delinquent or if borrower requests and appraisal is 80% of original property value. Fannie Mae/Freddie Mac rules require drop of PMI if LTV is 78% (or borrower-paid appraisal is 80%) of property’s current value. Refer to page 275

  33. Chapter 13: Conventional Loans/Financing Summary • Secondary financing: When a buyer borrows money for part of purchase price or closing costs. To calculate CLTV ratio: Add loan amounts and divide by home’s appraised value or purchase price, whichever is lower. Conditions for secondary financing: • Borrower must make 5% down payment • Term of second loan: 5 to 30 years • No prepayment penalty • Scheduled payments due on regular basis • No negative amortization • Borrower must be able to afford payments on first and second mortgages • Required subordination clause Refer to page 275

  34. Chapter 13: Conventional Loans/Financing Summary • Second mortgage: Fully amortizing, partially amortizing with a balloon payment, interest only with a balloon payment. Partial amortization: Payments scheduled as if loan term is longer, balance is due sooner. Partially amortizing and interest only loans: Smaller payments that are regular and equal (if fixed) or recomputed regularly (if adjustable) with final, larger balloon payment at end of term. One lender can provide both loans at different interest rates. • Assumption: Buyer takes over primary liability for loan of seller. Always consult original lender or a lawyer concerning assumptions. Refer to page 275

  35. Chapter 13: Conventional Loans/Financing Chapter 13 Quiz 1. A loan that is repaid with periodic payments of both principal and interest so that the entire loan amount is paid in full at the end of the loan term is a(n) • annualized loan. • conventional loan. • fully amortizing loan. • partially amortizing loan. Refer to page 276

  36. Chapter 13: Conventional Loans/Financing Chapter 13 Quiz 2. Which statement about 15-year mortgages is FALSE? • Higher interest rates are usually charged. • There is an earlier loss of interest deduction for income tax purposes. • They have higher monthly payments. • They result in less interest owed. Refer to page 276

  37. Chapter 13: Conventional Loans/Financing Chapter 13 Quiz 3. You are pre-qualifying a buyer for a conventional loan on a house with the purchase price of $160,000. She states she does not want to pay PMI on the loan. In that case, what is the maximum loan amount she can receive (assuming no lender-paid PMI)? • $32,000 • $128,000 • $136,000 • $144,000 Refer to page 276

  38. Chapter 13: Conventional Loans/Financing Chapter 13 Quiz 4. Which type of mortgage is NOT insured or guaranteed by the government? • conventional mortgage • FHA mortgage • rural home mortgage • VA mortgage Refer to page 276

  39. Chapter 13: Conventional Loans/Financing Chapter 13 Quiz 5. When seeking an 80% conventional loan with the seller taking back a second mortgage, the buyer • can expect to pay a higher interest rate than with a 90% loan. • may choose which mortgage (first or second) will have lien priority. • must make at least a 5% down payment from personal funds. • must make at least a 20% down payment from personal funds. Refer to page 276

  40. Chapter 13: Conventional Loans/Financing Chapter 13 Quiz 6. PMI must be canceled • any time the borrower requests it. • only if the lender is satisfied that the borrower is no longer a credit risk. • when a home has been paid down to 78% of its original value and the borrower is current. • whenever a new appraisal is ordered, regardless of the value. Refer to page 276

  41. Chapter 13: Conventional Loans/Financing Chapter 13 Quiz 7. Lenders are often willing to charge lower interest rates for 15-year mortgages because the • borrower is always a better risk. • interest rate is fixed for a longer period of time. • loan funds will be repaid more quickly. • loan qualifications are much more stringent. Refer to page 276

  42. Chapter 13: Conventional Loans/Financing Chapter 13 Quiz • A buyer is paying $200,000 for a house. He makes a $30,000 down payment, gets a first mortgage for $160,000, and a second mortgage to cover the balance. What is his CLTV? • 70% • 75% • 80% • 85% Refer to page 276

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