Nontraditional Mortgage Products

(1)

1

Nontraditional

Mortgage Products

Chapter 8

Mortgage Principles and Practices 4th Edition (02/21/2012)

Chapter 8: Nontraditional Mortgage Products

2

Nontraditional Mortgage Products

• SAFE Act

–

Anything other than a 30-year fixed

rate mortgage

• Interagency Guidance on Nontraditional

Mortgage Product Risks

–

Mortgage products that allow

borrowers to defer principal and,

sometimes, interest

Chapter Objectives

•

Describe the advantages and disadvantages of

buydown plans.

•

Identify the elements that make up an adjustable

rate mortgage.

•

Identify characteristics of a reverse mortgage.

•

Identify factors that define a subprime loan.

•

Discuss agency guidelines on lending and subprime

loans.

(2)

4

Deferring Higher Interest Rate/Payment

•

Growth Equity Mortgage (GEM)

–

Fixed rate mortgage set up like a 30-year conventional loan

–

Payments increase over time with predictable and scheduled

escalation

–

Good for borrower with expected increases in income

–

100% of scheduled payment increases reduce principal balance

•

Reduction Option Mortgage

–

Fixed rate loan with limited opportunity to reduce interest rate

–

Avoids certain refinancing costs, such as for an appraisal

•

Shared Appreciation Mortgage (SAM)

–

Lender charges below-market interest in exchange for a share of

the gains the borrower realizes when the property is eventually

sold

–

Shared risks/rewards, especially on commercial projects

5

Buydown Plans

•

Point = 1% loan amount

•

Discount points: Paid upfront to lower interest rate

•

Buydown may be paid by:

–

Borrower

–

Seller

–

Interested third party

•

If borrower, appears on GFE as borrower charge

•

Advantages:

–

Lower monthly payment

–

May allow qualification on reduced payment

Case in Point

•

Borrower financing $180,000

•

Quoted 6.5% interest rate for 30-year conventional

loan

•

Payments would be $1,137.72 per month

•

At 6.25% for the same $180,000 30-year loan,

payments would be only $1,108.29

•

Paying discount points up front to buy down the

interest rate 1/4%, buyer saves $29.43 / month

•

May help borrower qualify for the home loan

•

Makes mortgage payments more attractive

•

2 points cost approximately $3,600

(3)

7

Buydown Plans: Paid by Seller

•

Less money to seller

•

May help close the deal

•

Buydown amount subtracted from loan proceeds

•

Reflected on HUD-1 as charge to seller

•

Buyer signs note for full amount

8

Permanent Buydown

•

Points paid to lender to reduce the interest

rate and loan payments for the entire life of

the loan

•

Interest rate written into promissory note

•

Nominal rate (or coupon rate) stated in the

note will be the actual reduced interest rate

Temporary Buydown

•

Funds deposited at closing to supplement monthly

payment

•

Short-term discount

•

Lender receives full payment

–

Borrower’s discounted payment

–

Supplemented by “deposited” funds

•

When “deposited” funds run out, borrower makes

full payment

•

Underwriters generally consider payments using fully

indexed rate, not starting rate

(4)

10

Temporary Buydown: Level

•

Level payment reduction plan: Constant throughout

buydown period

11

Temporary Buydown: Graduated

•

Payments increase every year, as per note, until

sufficient to amortize loan

–

2-1 buydown

: Subsidized for 2 years

–

3-2-1 buydown

: Subsidized for 3 years

Buydowns: Fannie / Freddie Limits

•

Limits interested party contributions (IPCs) to % of sale price or

appraised value, whichever is less

•

Excessive contributions deducted from maximum loan amount

•

Contributions from employers or immediate family members

usually not subject to limits

Property Type

LTV/CLTV

Max. IPC

Investment

All CLTV ratios

2%

Principal residence

or second home

Greater than 90%

75.01% to 90%

Less than 75%

3%

6%

9%

(5)

13

Buydowns: FHA / VA Limits

•

FHA:

–

Will not underwrite at temporary buydown rate

–

Unless permanent, borrower must qualify at note rate

–

Reduction limited to 2% below note rate

–

Allows maximum interest party contribution of

6%

–

Excess contribution deducted from maximum loan

amount

–

Excludes family and employer contributions

•

VA has no set limits

14

Mortgage Exercise 8-1

A borrower wants to buy a $150,000

home, and is going to make a $15,000

down payment. The borrower is seeking

a conventional loan, but doesn’t want to

pay more than 6 1/2% interest. The

lender agrees to 6 1/2% interest if the

loan has three discount points and the

loan origination fee is 2%.

Mortgage Exercise 8-1

1.

What’s the total amount of points (in dollars and

percentage) that the lender will receive for making this

loan?

–

Points are based on the loan amount, in this case, $135,000

($150,000 - $15,000 down).

–

The lender is charging a total of 5 points, or 5% of the loan.

–

Discount points total $4,050 ($135,000 x .03) and the loan

origination fee is $2,700 ($135,000 x .02).

–

The total the lender will receive in points is $6,750 ($4,050 +

$2,700).

(6)

16

2. If the seller agrees to pay the discount

points, how much will the seller net from the

transaction? (Assume the seller pays no

other costs.)

–

The seller net is the sale price minus any

seller-paid points, so the seller will net $145,950

($150,000 - $4,050).

17

3. What will the borrower’s note state as the

interest rate on the loan? What dollar

amount will the note say was borrowed?

–

The loan note rate will be 6.500% since this is

not a temporary buydown.

–

The amount on the note equals the loan

amount, not the sale price, so it’s $135,000

($150,000 - $15,000).

–

The note amount does not reflect the

seller-paid points.

Mortgage Exercise 8-1

4. Can the lender sell this loan to Fannie Mae

or Freddie Mac on the secondary market?

Why or why not?

–

Yes, the lender should be able to sell this loan

to Fannie Mae/Freddie Mac on the secondary

market because it has less than the 6% seller

assistance limit that the programs allow with a

90% LTV.

(7)

19

Adjustable Rate Mortgages (ARMs)

•

Frees lender from being locked into fixed rate

•

Interest rates may adjust to reflect fluctuations

in cost of money

•

May allow borrower to qualify more easily

•

Allows lenders to pass risk on to borrowers

•

Lenders may charge lower starting interest rate

than for fixed

•

Must adhere to guidelines of appropriate

regulatory agency, Fannie Mae/Freddie Mac,

FHA, and private mortgage insurers

20

ARM Elements

•

Index

•

Margin

•

Rate adjustment period

•

Mortgage payment adjustment period

•

Interest rate cap/floor (if any)

•

Mortgage payment cap (if any)

•

Negative amortization cap (if any)

•

Conversion option (if any)

ARM Elements: Index

•

Statistic consumer can examine

•

Generally reliable indicator of cost of money, e.g.:

–

Average One-Year Treasury Constant Maturity Index (TCM)

–

Cost of Funds Index (COFI) (used by Fannie Mae)

–

London Interbank Offered Rate (LIBOR)

•

Interest rate adjustments based on up / down

movement of index

•

Index must be:

–

Independent of lender

–

Affected by market conditions

–

Regularly listed in major publication

(8)

22

ARM Elements: Margin

•

Difference between index value and interest rate

charged (margin + index = interest rate)

•

Generally remains fixed; negotiated with lender

23

ARM Elements: Adjustment Periods

•

Rate adjustment period: Length of time between at

which interest rate changes

–

Often every six months or 1 year

•

Payment adjustment period: Length of time between

payment adjustments

–

Can range from months to several years

•

May be adjusted parallel to rate adjustment

•

May be adjusted less frequently than rate

adjustment

–

Negative amortization: Interest paid insufficient to

pay interest accrued from previous month

–

Excess interest paid may be applied to principal

Mortgage Principles and

Practices 4th Edition (02/21/2012)

ARM Elements: Interest Rate Cap

•

Discounted indexed rate or teaser rate

–

Start rate lower than fully indexed rate

–

Makes ARMs more attractive to borrowers

–

Could result in significant payment shock

•

Interest rate caps limit % points rate can increase

•

May be shown as 2 numbers, such as 2/6:

–

1st number: Max. increase at adjustment

–

2nd number: Max. lifetime increase

•

May be shown as 3 numbers, such as 5/2/6:

–

1st number: Max. increase at 1st adjustment

–

2nd number: Max. increase at subsequent adjustments

–

3rd number: Max. lifetime increase

(9)

25

ARM Interest Rates

•

1-year ARM loan for $100,000 for 30 years

•

5/2/6 interest rate cap

•

Current index rate is 4.5%; margin is 3%; discounted

start rate is 4%.

9%

7%

9%

10%

26

ARM Elements: Interest Rate Caps

•

Fannie Mae:

2%

per year /

6%

lifetime

•

Freddie Mac:

2%

per year /

5%

lifetime

•

FHA:

1%

per year /

5%

lifetime

•

VA:

–

1%

per year / 5

%

lifetime on traditional

ARMs (adjusts annually)

–

2%

per year /

6%

lifetime on hybrid ARM

(fixed for at least five years)

ARM Elements: Payment Cap

•

Protects a borrower from large payment

increases

•

Limits magnitude of payment changes with

interest rate adjustments

•

Some lenders only use interest rate caps;

others use both rate and payment caps

•

Could allow for negative amortization if

(10)

28

ARM Elements: Negative Amortization Cap

•

Negative amortization:

Loan balance grows

because payments don’t cover the accrued

interest due on the loan

–

Most likely to occur with frequent rate changes

and less frequent payment adjustments

•

Cap limits growth of loan balance beyond a

certain point

•

Maintains manageable LTV

•

May require readjustment (

recast

) of monthly

payments

29

ARM Elements: Conversion Option

•

Gives the borrower the right to convert from

an adjustable rate loan to a fixed rate loan

•

Conversion option note normally includes:

–

Higher interest rate

–

Limited time to convert

–

Conversion fee

•

If sold to the secondary market, terms would

have to be honored by purchaser

ARM Standardization

•

Most lenders follow secondary market guidelines

•

Loan-to-value a consideration

–

May not make higher LTV if chance of negative

amortization

–

Higher LTV generally requires occupancy

•

Fannie Mae / Freddie Mac require occupancy

for all ARM loans

–

Credit scores may be considered

•

Appraisal must not be influenced by financing

concessions

•

May use smaller housing expense and

debt-to-income ratios for qualifying

(11)

31

ARM Disclosures

•

Index / where to find it

•

How interest rate and payment

are determined

•

Suggestion to ask about current

margin / interest rate

•

Initial discount rate and

suggestion to ask about amount

of discount

•

Rate / payment adjustment

periods

•

Rate and payment caps

•

Statement payment caps may result in

negative amortization

•

Statement if loan has demand provision

•

Description / time of adjustment notice

•

Availability of other ARM loan

disclosures

•

Maximum interest rate / payment

•

Initial interest rate / payment

•

Conversion option details

•

Example based on $10,000 loan

• Disclose APR to comply with TILA (Reg Z)

• CHARM Handbook discloses (as appropriate):

• Advance notice of change in payment / interest rate

32

ARM: Annual Percentage Rate

•

Annual percentage rate

(APR):

Relationship between

the cost of borrowing money and the total amount

financed, represented as a percentage

•

Disclosure cannot be made based solely on ARM’s

initial rate

•

Must reflect the finance charges and fees as well as

the

composite annual percentage rate

–

Based on initial payment rate and fully indexed

rate that could exist for the remaining loan term

–

Lets consumers comparison shop for rates among

lenders

ARM: Payment Option

•

Allows borrowers to pick a payment option each

month

–

Traditional payment of principal and interest

•

Reduces the amount owed

–

Interest only payment

•

Pays interest due but does not reduce principal

–

Minimum (or limited) payment

•

May be less than the amount of interest due

•

Balloon payment may be required

•

Built-in recalculation period, e.g., every 5 years

–

New minimum payment amortizes loan

•

Uncommon today; could result in negative

amortization

(12)

34

ARM: Hybrid ARM

•

Loan has a fixed rate for a specified number of years,

then interest rate adjusts regularly for remainder of

loan term according to note

•

May be designated by:

–

Number years fixed and adjustable:

•

2/28 or 3/27 ARM – fixed for first 2 or 3 years;

interest rate adjusts at predetermined point

–

Number of years fixed and adjustment period:

•

3/1, 5/1, 7/1, or 10/1 ARM -- fixed for first 3, 5, 7,

or 10 years with annual adjustment after

CAUTION:

Be careful when using the term “fixed”

35

•

A borrower received a 30-year ARM mortgage loan for

$120,000.

•

The start rate was 3.50% and the loan adjusts every 12

months for the life of the mortgage.

•

Rate caps are 3/2/6.

•

The index used for this mortgage is the LIBOR. For this

exercise, let’s say it was:

–

3.00% at the start of the loan

–

5.00% at the end of the first year

–

4.50% at the end of the second year

•

The margin on the loan is 3.00%.

Mortgage Exercise 8-2

1.

What’s the initial rate (start rate) and what is the

interest rate after the first year?

–

The start rate is 3.50%. The fully indexed rate after the

first year is 8.00% (5.00% index + margin of 3.00% =

8.00%).

–

BUT, the periodic maximum rates caps (in this example,

annual) have to be taken in consideration also. In this

mortgage, the maximum rate increase the first year is

3.00% (2.00% in all other years).

–

So 3.50% + 3.00% = 6.50%, which will be the interest

rate after the first adjustment.

(13)

37

2. What is the fully indexed rate after the

second year?

–

The fully indexed rate is 7.50% (LIBOR rate of

4.50% + 3.00% margin).

38

Mortgage Exercise 8-2

3. What is the borrower’s interest rate after the

second adjustment?

–

The borrower’s interest rate after the first

adjustment period was 6.50%.

–

Adding the periodic maximum adjustment cap

of 2.00% = 8.50%.

–

However, the borrower’s interest rate would be

the LOWER of the two interest rates, which is

7.50%.

Mortgage Exercise 8-2

4. What is the maximum interest rate this loan

could have?

–

The maximum interest rate equals the start

rate of 3.50% + the life of the loan cap of

6.00%, so the maximum interest rate this loan

could have is 9.50%.

(14)

40

5. What would the LIBOR have to be to obtain

that interest rate?

–

In order for this loan to get to that rate, the

LIBOR would have to increase 2.00% from its

current rate of 4.50% to 6.50%:

–

9.50% (maximum lifetime rate) – 3.00%

(margin) = 6.50% (LIBOR)

41

ARM: Be Prepared to Answer

1. What will my interest rate be?

2. How often will my interest rate change?

3. How often will my payment change?

4. Is there any limit to how much my interest rate can

be increased?

5. Is there any limit to how much payments can be

increased at any one time?

6. What is the probability of runaway negative

amortization?

7. Can my ARM be converted to a fixed rate loan?

Advantages & Disadvantages

(15)

43

Advantages

Disadvantages

•

Lower initial interest rate and

payments

•

May be easier to qualify for

loan

•

Leverage buyer into a

higher-priced home

•

Payments may decrease over

time

•

May be converted to a

fixed-rate loan

•

Good in times of low inflation

or for short-term ownership

44

Advantages

Disadvantages

•

Lower initial interest rate and

payments

•

May be easier to qualify for

loan

•

Leverage buyer into a

higher-priced home

•

Payments may decrease over

time

•

May be converted to a

fixed-rate loan

•

Good in times of low inflation

or for short-term ownership

•

No interest rate guarantees

•

No payment guarantees

•

Buyer’s financial situation

may change

•

Buyer may over-leverage

•

Possibility of negative

amortization

•

May have to pay a fee to

convert even if you choose

not to convert

Subprime Loans

•

Riskier than conforming loans

–

Less creditworthy borrowers (also called B-C

loans)

–

Less documentation provided

•

Rely on equity in property to offset credit risk, so

may require larger down payment

•

Requires experienced / specialized underwriter

•

Allows lenders to charge higher interest / fees

•

Borrowers showing good credit/payment history may

be able to refinance at more favorable terms

(16)

46

Interagency: Nontraditional Products

•

Interagency Guidance on Nontraditional Mortgage

Product Risks

•

Mortgage products that allow borrowers to defer

principal and, sometimes, interest, for example:

–

Interest only (IO) feature

–

Potential for negative amortization

•

Qualifying standards/guiding principles:

–

Recognize potential impact of payment shock

–

Nontraditional loans may not be appropriate for high

LTV, high DTI, and low credit scores

–

Analysis should consider fully indexed rate

–

Avoid over-reliance on credit scores

47

Interagency: Nontraditional Products

•

Avoid collateral-dependent loans

•

Compensate risk layering with risk mitigating features

•

Reduced documentation – acceptable only if other risk

mitigating features available

•

Simultaneous seconds – minimal equity loans should not

allow delayed / negative amortization

•

Teaser rates – minimize early or disruptive recastings or

extraordinary payment shock

•

I/O feature – should evaluate ability to repay by final

maturity at fully indexed rate

•

Negative amortization – analysis should consider initial

loan amount + balance increases

Interagency:

Statement on Subprime

•

Promote consumer protection standards, particularly

on ARMs offered to subprime borrowers that have:

–

Very high / no limits on payment amount / interest

rate increases

–

Limited / no income documentation

–

Features leading to frequent refinancing

–

Prepayment penalties:

•

Substantial

(17)

49

Interagency: Statement on Subprime

•

Provides consumer protection through

disclosure:

–

Payment shock potential

–

Prepayment penalties and how calculated,

imposed

–

Balloon payments

–

Cost of reduced documentation loans

–

Responsibility for taxes and insurance

50

Interagency: Statement on Subprime

•

Defines predatory lending as:

–

Making loans based on foreclosure /

liquidation value of collateral rather than on

borrower’s ability to repay

–

Inducing borrower to repeatedly refinance in

order to charge high points and fees (“loan

flipping” or “equity skimming”)

–

Engaging in fraud or deception to conceal the

true nature of the obligations from

unsuspecting or unsophisticated borrower

Reverse Mortgages

•

Allows borrower to convert equity in home

without selling or making payments

•

Funds may be used for virtually anything

•

Also called reverse equity mortgage or reverse

annuity mortgage (RAM)

•

FHA’s Home Equity Conversion Mortgage

(HECM) most popular

•

Balance of loan rises as equity shrinks (rising

debt, falling equity)

(18)

52

Reverse Mortgages: Eligibility

•

No income requirements

(must be able to pay

continuing obligations related to property)

•

All individuals with ownership interest must be at

least 62 years old

•

Generally, single-family homes, including condos and

PUDs

–

Mobile homes / co-ops

not

generally eligible

•

Homeowner’s insurance at replacement value

•

Principal residence with little or no mortgage balance

•

Required pre-loan counseling

53

Reverse Mortgages: Amount

•

Many factors:

–

Appraisal of home value

–

Amount of equity

–

Payment options

–

Interest rate

–

Fees

•

Age of borrower

–

Older can borrow more

–

Age of youngest borrower determines

Reverse Mortgages: Payment

•

Payment options:

–

Fixed monthly payments

–

Lump sum

–

Line of credit as needed

–

Combination

•

Spending options: Virtually anything

•

Tax implications:

–

Generally not considered income

–

Interest deducted only at loan conclusion

–

Could affect eligibility for other programs

(19)

55

Reverse Mortgages: Repayment

•

If not in breach, due when last surviving borrower:

–

Dies

–

Sells the home

–

Ceases to live in home for 12 consecutive months

•

Total amount due (interest, insurance, fees, etc.)

•

Any remaining equity belongs to estate

•

Lender generally may not sell home during loan term

•

Non-recourse

–

Cannot claim other assets

–

Borrower cannot owe more than fair market value

•

Repayment could be accelerated under some

circumstances

56

Seller Financing / Purchase Money

•

Seller extends some or all credit to purchase

property

–

Buyer may not be able to get traditional financing

–

Allows seller to enhance marketability

•

Alienation (due on sale) clause gives lender

certain rights upon transfer of some interest in

property

•

Purchase money mortgage - given to seller by

buyer

•

Sellers not bound by institutional policies

–

Can take any form, e.g., fixed, adjustable, etc.

–

Cannot violate laws, e.g., usury laws

Seller Financing

•

Assumption:

One party agrees to take over payments of another

party’s debt, with terms of the note staying unchanged

–

FHA / VA loans require approval of lender

–

Buyer becomes primarily liable but lender may have recourse

against seller upon default without release

•

Wraparound financing:

Seller retains existing loan on the property

while giving the buyer a second loan

–

Buyer pays seller full amount; seller pays original lender, keeps

excess

–

Original mortgage must:

•

Be assumable with lender approval or

•

Not have an alienation clause

(20)

58

Land Contracts

•

Installment agreement where buyer pays seller for right

to occupy and use property

–

Also called land installment contracts, installment sales contracts,

land sales contracts, real estate contracts

•

No deed or title is transferred until all, or a specified

portion, of the payments have been made

•

Seller (

vendor

) holds legal title to property as security

•

Buyer/debtor (

vendee

) may possess and enjoy land, but

is not legal owner (equitable title)

•

No institutional loan qualifying standards

•

Cannot be sold to Fannie Mae / Freddie Mac

•

Generally require vendor to provide annual statement

59

Lease / Option

•

Property lease for specific term with option to buy at a

predetermined price during lease term

–

Lease: Rent in exchange for possession of real estate

–

Option: Contract giving right to do something within a

designated time period, without obligation

–

Optionee: Prospective purchaser

–

Optionor: Property owner

•

May credit any portion of rent that is above established

market for comparable property toward:

–

Down payment

–

Loan amount

–

Sales price

Lease / Purchase

•

Seller leases property for specific term; tenant

agrees to buy property at set price during or

following the lease term

•

Equivalent of a sale where purchase agreement:

–

Locks in a predetermined price

–

Sets date for sale transaction

•

Reasons for lease / purchase include buyer:

–

Needs time to acquire cash

–

Will qualify once circumstances change

(21)

61

Equity Exchanges

•

Value in one property traded for another

•

Also called tax-deferred or tax-free exchange,

like-kind exchange, Section 1031

•

Properties must be:

–

Exchanged, or qualify as delayed exchange

–

Like-kind property (real estate for real estate)

–

Held for use in a trade, business, or investment

•

Seller defers paying tax until profit is realized

from transaction

•

Legal and tax advice should always be consulted

62

Participation Plans

•

Partnership between buyer and another investor

(or seller, lender, etc.)

•

Investor provides cash; receives percentage of

equity in lieu of or in addition to interest

•

Buyer pays principal (or it is deferred)

•

Things to negotiate:

–

Loan application

–

Equity calculation

–

Investor’s equity percentage

–

Investor repayment

–

Handling improvements

–

Responsibility for taxes and insurance

Homebuyer Assistance Programs

•

May provide:

–

Down payment assistance

–

Subsidized mortgage interest rates

–

Help with closing costs

•

Offered by government, non-profits, lenders

•

Program funding usually limited

•

Lender programs developed to provide financing

flexibility

–

First time homebuyer

–

Community homebuyer

•

Positive: Help get people into homes

•

Negative: Potential for default

(22)

64

Key Term Review

•

Adjustable Rate Mortgage

(ARM)

•

Buydown

•

Caps

•

Equity Exchange

•

Estoppel

•

Index

•

Land Contract

•

Lease/Option

•

Lease/Purchase

•

Margin

•

Option

•

Participation Plan

•

Points

•

Rate Adjustment Period

•

Reverse Mortgage

•

Subprime Loan

•

Teaser Rate

65

Summary

1. Nontraditional mortgage products

–

Defined by the SAFE Act as anything

other than

30-year fixed rate loans.

–

Defined by Interagency Guidance on

Nontraditional Mortgage Products as mortgage

products that allow borrowers to defer principal

and, sometimes, interest.

–

Such products can help buyers qualify for larger

loans or help them reach other financial goals.

Summary

2.

Buydowns are additional money (discount points)

paid to the lender at the start of a loan to lower

interest rate and payments.

–

Make up the difference between the market interest rate

and the rate a borrower gets in the note.

–

A permanent buydown (for life of loan) has a reduced

rate stated in the note.

–

A temporary buydown (early in loan) can be level

payment or graduated payment.

–

Buyer can qualify 2% below market rate. FHA requires

buyers to qualify at note rate, not buydown rate.

–

Fannie Mae, Freddie Mac, and FHA limit points and

other interested party contributions (IPCs) that can be

paid.

(23)

67

Summary

3.

Adjustable rate mortgages

(ARMs)

–

Borrowers select

index

(statistical report reflecting cost of money),

lenders add a

margin

(spread) =

fully indexed rate

paid on the loan.

–

Loan documents must state: Rate, index, margin, and payment

adjustment period; caps (if any) on rate, payments or negative

amortization; conversion option (if any).

–

Rates that change more frequently than payments may create

negative amortization

(payments insufficient to cover interest due).

–

Caps

keep loans from growing out of control.

–

Lenders periodically

readjust

or

recast

the loan by recalculating

payments based on the loan balance at specific interval.

–

Conversion options

allow buyers to convert to fixed rate.

–

Lenders/MLOs must provide CHARM booklet to borrower in

addition to other mandated disclosures, including the

annual

percentage rate

(APR). For ARMs, it is a composite rate that reflects

the lower rate for certain number of years and the higher rate for

later years. Lenders cannot disclose only initial low rates.

68

Summary

4. Reverse mortgages

provide monthly income, a lump sum of cash, or a line

of credit to borrowers aged 62 or older, based on the equity in their

homes

–

Loan generally repaid when the borrower dies, moves out of the

house for 12 months, or sells the house (assuming no breach).

5. Structured mortgages

help borrowers reach other financial goals.

–

Growth equity

: Fixed rate, but payments increase to pay off faster.

–

Reduction option

: Buyer can reduce rate one time, with fewer

refinancing costs.

–

Shared appreciation

: Lender shares equity in commercial project.

6. Subprime

loans (B-C loans, low-doc, stated income) have more risk than

what is allowed by the conventional market. Borrower risk factors

determine interest rate and terms. A-minus loans are riskier than prime

loans, less risky than subprime loans.

Summary

7.

Seller financing

is when seller extends credit to buyer to finance

the purchase of property. Seller can extend all or partial credit.

–

Can help buyer who doesn’t have enough cash to buy a property, can’t

qualify for a conventional loan, or wants or needs a lower-than-market

interest rate. Seller gets the benefit of a home that’s easier to sell, and

often a better price by offering terms.

–

A

purchase money mortgage

or

seller-held mortgage

is given by buyer

to the seller to secure part or all of the money borrowed to purchase

property. Unencumbered property with no liens is best for this

transaction; encumbered property with liens needs assumption or

wraparound.

–

Assumption

has the buyer take responsibility for the mortgage, but the

seller must get a release from the lender.

–

A

seller-wraparound mortgage

has the seller retain existing mortgage

(the buyer makes one larger payment; the seller pays the lender and

keeps difference).

(24)

70

Summary

8.

A

land contract

is a real estate installment

agreement.

–

Buyer (vendee) makes payments to seller (vendor) for

right to occupy land, but no title is transferred until all,

or part of, payments are made.

–

Buyer has

equitable title

under a land contract. States

differ in how they treat land contracts.

–

Problems for the buyer include difficulty in borrowing

against equity with a land contract and protecting equity

if land contract is not recorded.

–

Lender may consent to deal using an

estoppel

letter.

71

Summary

9.

Other alternative financing:

–

A

lease/option

has the seller (optionee) lease to a tenant (optionor)

who has the right (but not the obligation) to buy the property at a

set price within a certain time. An option can be used for profit,

speculation, investment, comparison, or to give the optionor time

to acquire cash, to qualify, or credit rent toward purchase price.

–

A

lease/purchase

combines a lease with a purchase contract.

–

An

equity exchange

(tax-deferred exchange, Section 1031) is

property traded for value in other property. Properties must be

exchanged (or delayed exchange), like kind, and held for trade,

business, or investment. Capital gains tax is deferred, but boot

(unlike property added to balance value) is taxed. Tax-free

exchanges are not available for residential property.

–

Participation plans

have investors share equity of the property

instead of or in addition to receiving interest.

Summary

10. Homebuyer assistance programs:

–

Down payment assistance programs (DAP)

–

Subsidized mortgage interest rates

–

Help with closing costs (or combination)

–

Programs can be offered by government or

non-profit groups, or by lenders

(25)

73

Chapter 8 Quiz

1.

A borrower is purchasing a home for $100,000.

The LTV on the loan is 80%. If the borrower pays a

total of 6 points on the loan, how much will the

points cost him?

A. $2,400

B. $3,400

C. $4,800

D. $6,000

74

Chapter 8 Quiz

2. A buydown plan can reduce the borrower’s

payments

A. early in the loan only, but requires a large

balloon payment.

B. early in the loan or for the entire life of the

loan.

C. for the entire life of a loan, but with an

automatic prepayment penalty.

D. with gradual payment decreases throughout

the life of the loan.

Chapter 8 Quiz

3. Which statement is true about interest rate

buydowns on FHA loans?

A. Borrowers may qualify at the buydown

rate.

B. Borrowers must qualify at the note rate.

C. FHA does not allow builder-paid

buydowns.

D. FHA does not allow seller-paid

buydowns.

(26)

76

Chapter 8 Quiz

4. Which of the following is NOT an element

of an ARM?

A. index

B. margin

C. positive amortization cap

D. rate

77

Chapter 8 Quiz

5. What is the adjustable number used to

compute the interest rate on an ARM

called?

A. cap

B. index

C. margin

D. prepayment

Chapter 8 Quiz

6.

With an ARM, the index is added to the

______ to determine the _________ .

A. APR / cost of funds

B. home value / amount borrowed

C. margin / interest rate charged

D. qualifying ratio / maximum monthly

(27)

79

Chapter 8 Quiz

7. Negative amortization occurs when

A. a borrower suffers payment shock.

B. each mortgage payment is adjusted more

frequently than is the interest rate.

C. the payment made does not cover the

interest due for that period.

D. all of the above

80

Chapter 8 Quiz

8. How are subprime loans different from

conforming loans?

A. They allow for lower interest rates.

B. They allow for more risk.

C. They are only offered by banks.

D. They are sold in the secondary market.

Chapter 8 Quiz

9.

Which scenario best describes a land contract?

A. A buyer makes payments to the seller in exchange for

the right to occupy, use, and enjoy the property, but

no deed or title transfers until a specified portion of

payments have been made.

B. A buyer takes over primary liability for the loan of a

seller, usually implying no change in loan terms.

C. A seller keeps the existing loan and continues to pay

on it while giving the buyer another loan.

D. A seller leases the property with the provision that

part of the rent payments be applied to the sale price

if the tenant decides to purchase before the lease

expires.

(28)

82

Chapter 8 Quiz

10. An equity exchange may be treated as a

tax-free exchange when property is

A. for profit and of like kind.

B. held for sale by a dealer only.

C. owner-occupied.

D. rental only.

83

Chapter 8 Quiz

11. In which federal law would you find the

definition of a nontraditional loan?

A. Homeowners Equity Protection Act

B. Real Estate Settlement Procedures Act

C. Secure and Fair Enforcement for

Mortgage Licensing Act

D. Truth in Lending Act

Chapter 8 Quiz

12. During the life of a typical reverse

mortgage, which of the following factors is

decreased?

A. debt

B. equity

C. interest

(29)

85

Chapter 8 Quiz

13. According to the Interagency Guidance on

Nontraditional Mortgage Products,

nontraditional mortgage loans may be

LEAST risky for borrowers with

A. high debt-to-income ratios.

B. high loan-to-value.

C. low credit scores.

D. low debt-to-income ratios.

86

Chapter 8 Quiz

14. Each of these are characteristics that could

make a loan nontraditional EXCEPT

A. 15-year term.

B. adjustable rate.

C. fixed rate.

D. temporary buydown.

Chapter 8 Quiz

15. A borrower has a ARM with a 5/2/6 interest

rate cap. The start rate is 4%, the current

index is 3%, and the margin is 3%. What is

the borrower’s interest rate if the index

rises to 5% at the time of the first

adjustment?

A. 5%

B. 6%

C. 8%

D. 9%