Conforming and Nonconforming Loans
There is many types of mortgage loans. Conventional loans are loans made by private parties and nongovernment lending institutions without any government insurance or government guarantee against loss for the lender. Mortgage loans that are not FHA, VA or USDA (or Rural Housing Service) loans are conventional loans. They may be conforming or nonconforming.
Conventional loans that conform to the eligibility guidelines for purchase by Fannie Mae or Freddie Mac are considered conforming loans. Fannie Mae and Freddie Mac have a maximum loan limit for loans they will purchase, which is adjusted annually.
Loans to persons with satisfactory credit but that exceed this loan limit are called jumbo loans or non-conforming loans. Because these loans cannot be sold to Fannie Mae or Freddie Mac, they often have a higher interest rate than conforming loans.
Conventional loans can be insured or uninsured. Generally, a conventional loan of up to 80 percent of the property’s value will be made without private mortgage insurance. Some lenders will charge higher interest rates to compensate for the increased risk inherent in making a loan that is more than 80 percent of the value; however, most require that the loan be insured by a private mortgage insurance company.
Private mortgage insurance (PMI) is an insurance policy issued to provide protection to the mortgage lender in the event of financial loss due to a borrower’s default that results in foreclosure. In the event of a foreclosure, the insurance company will either purchase the loan or let the lender foreclose and pay the lender for losses up to the face amount of the policy.
So that he may get a loan with a small down payment, the borrower pays a mortgage insurance premium either as a lump sum at closing covering the life of the loan, or by paying the first year’s premium at closing and then paying annual premiums as part of his mortgage payment. The amount of the premium is a percentage of the loan amount based on the borrower’s down payment. The annual premiums and the insurance stop automatically once the loan is paid down to 78 percent, or may be canceled at the borrower’s request once the loan balance reaches 80 percent of the value of the property at the time the loan was made.
Subprime Loans – one of Types Of Mortgage Loans
Until 2008, credit-impaired borrowers and other borrowers unable to obtain credit in the prime market were able to easily obtain financing from lenders specializing in subprime loans. Loans made to borrowers meeting Fannie Mae and Freddie Mac credit requirements are called A-paper loans. A-paper loans are conforming loans. Loans not meeting these requirements were called “Alt-A,” “B,” “C” and “D” paper loans, or subprime loans. Alt-A loans were treated as “A-” (A-minus) loans, in some cases because of less-than-prime credit, in other cases because of a lack of supporting documentation.
Factors causing a borrower to seek a loan from a subprime lender include:
- a weak past credit performance.
- a high monthly debt payment relative to income.
- a lack of assets other than current income to support loan payments.
- self-employment, variable income, or a desire to limit disclosure of his financial situation.
Under the risk-based pricing model used for subprime loans, up-front fees and interest rates were based on the degree of risk posed by the subprime borrower: the higher the risk, the higher a borrower’s rate and costs.
However, due to laxity and abuses in the origination and securitization of subprime loans, the actual loss far exceeded the estimated risk, resulting in bankruptcy and foreclosure for many borrowers and upheaval in primary and secondary markets, as well as real estate markets across the country.
Many real estate mortgage loans are insured or guaranteed by the federal government through such programs as:
- FHA-insured loans.
- VA-guaranteed loans.
- USDA-guaranteed loans.
These programs are one of the types of mortgage loans that have more liberal qualification criteria in terms of qualifying ratios and credit standards and higher loan-to-value ratios (LTVs). They also have requirements for some loan terms, including a limit of 4 percent as a late charge on a payment 15 days late and loan assumability.
Federal Housing Administration (FHA) Loans
The FHA is a division of HUD. FHA loans are loans that meet FHA program criteria and are made by approved lenders. For these loans, the FHA insures the issuing lender against loss in the event of default. Under the FHA program the lender can charge whatever points and interest a borrower is willing to pay, as the cost of the loan is negotiable. The advantage to the borrower is that the lender will make the loan with a very high LTV because it is insured.
However, FHA loan limits restrict the size of mortgages that can be insured by the Federal Housing Administration. The floor for a low-cost area is 65 percent of the national conforming loan limit. This is currently $417,000 for a one-unit property. For areas that have been designated high-cost areas, the ceiling loan limit is 150 percent of $417,000, as prescribed by the National Housing Act and the Economic Stimulus Act of 2008. The following table itemizes the floor/ceiling limits through December 31, 2016. (Single Family Housing Policy Handbook 4000.1)
Low–Cost Area Floor
High–Cost Area Ceiling
The states and territories of Alaska, Guam, Hawaii and the U.S. Virgin Islands are special exception areas allowing loan limits to be adjusted up to 150 percent of the national ceiling.
Federal Housing Administration (FHA) Loans
The FHA funds the insurance from a mortgage insurance premium (MIP) charged to the borrower. Most FHA mortgages require payment of an up-front mortgage insurance premium (UFMIP). The UFMIP is nonrefundable (except to the extent that a portion may be applied to the UFMIP of another FHA-insured mortgage within three years).
In addition, most FHA loans require payment of an annual mortgage insurance premium, payable monthly as part of the mortgage payment. This premium is based on the loan program, the loan term and the LTV.
- For all mortgages, regardless of their amortization terms, involving an original principal obligation (excluding financed UFMIP) less than or equal to 90 percent LTV, the annual MIP will be assessed until the end of the mortgage term or for the first 11 years of the mortgage term, whichever occurs first.
- For any mortgage involving an original principal obligation (excluding financed UFMIP) with an LTV greater than 90 percent, the FHA will assess the annual MIP until the end of the mortgage term or for the first 30 years of the term, whichever occurs first. (12 USC §1709(c)(2)(B), Single Family Housing Policy Handbook 4000.1)
Federal Housing Administration (FHA) Loans
The table below shows the previous and the new duration of annual MIP by amortization term and LTV ratio at origination. (Single Family Housing Policy Handbook 4000.1)
|≤ 15 yrs||≤ 78%||No annual MIP||
|≤ 15 yrs||78.01% – 90%||Canceled at 78% LTV||
|≤ 15 yrs||> 90%||Canceled at 78% LTV||
|> 15 yrs||≤ 78%||5 years||
|> 15 yrs||78.01% – 90%||Canceled at 78% LTV & 5 yrs||
|> 15 yrs||> 90%||Canceled at 78% LTV & 5 yrs||
Under Public Law 111-229(1)(b), the FHA may adjust its mortgage insurance premium rates, as measured in basis points (bps).
This first table shows the previous and the new annual MIP rates by amortization term, base loan amount and LTV ratio. All MIPs in this table are effective for case numbers assigned on or after January 26, 2015.
Term > 15 Years
Base Loan Amt.
This second table shows the effective annual MIP rates for loans with terms of up to 15 years. The new annual MIP for these loans is effective for case numbers assigned on or after January 26, 2015.
Term ≤ 15 Years
Base Loan Amt.
78.01 – 90%
The increases in the annual MIP specified in the Single Family Housing Policy Handbook 4000.1 apply to all mortgages insured under the FHA’s single-family mortgage insurance programs except:
- streamline refinance transactions of existing FHA loans that were endorsed on or before May 31, 2009.
- Section 247 (Hawaiian Homelands).
The most popular of the FHA loan programs is the 203(b) program. This program helps finance the purchase of a one- to four-unit family home that the borrower intends to occupy as his residence (i.e., move in within 60 days after closing and stay in the property for 12 months), using a 15- or 30-year loan and a cash investment of as little as 3.5 percent of the lesser of the property value or the purchase price. An applicant with a credit score of at least 580 can qualify for the 3.5 percent rate. One with a score of 500-579 can qualify with a cash investment of 10 percent. One with a score below 500 is not eligible for the loan.
Some or all of the cash investment can come from a gift from:
- an immediate relative.
- a labor union or employer.
- a government agency or public entity.
- a nonprofit charitable organization.
The gift donor, and the source of the gift donor’s funds, may not be a person or entity with an interest in the sale of the property (e.g., the seller, the real estate agent or broker, the builder, or an associated entity). A gift from any of these sources would be considered an inducement to purchase and would have to be deducted from the sales price. Therefore, a seller could not give the buyer a gift directly or channel funds through a nonprofit charitable organization to assist the buyer in acquiring the funds for his down payment.
The FHA allows the seller to contribute up to 6 percent of the purchase price toward the buyer’s actual closing costs, prepaid taxes and insurance, discount points, buydown fees, mortgage insurance premiums, and other financing concessions, but nothing toward the down payment.
Home Equity Conversion Mortgages (HECMs) The FHA’s Home Equity Conversion Mortgage (HECM) is a loan that enables an individual age 62 or older to:
- convert some of the equity in his primary residence to cash to pay living expenses; or
- purchase a primary residence, if he has the cash to pay the down payment and closing costs.
The borrower may take the loan funds in monthly advances for a fixed period or until he no longer qualifies and/or through a line of credit. Each month’s interest is added to the principal loan balance, causing the interest to be compounded.
The key points regarding HECM loans include the following:
- The borrower must be 62 years of age or older, have significant equity in the property, occupy the property as his principal residence, and participate in a consumer information session given by an approved HECM counselor.
- The loan amount is based on the age of the youngest borrower, the current interest rate, and the lesser of appraised value or the HECM FHA mortgage limit. The loan amount may include closing costs.
- The borrower can select a fixed interest rate or an adjustable rate and choose whether the rate will adjust monthly or annually.
- The loan has no specified term, prepayment penalties, or credit or income qualifications, as it requires no repayment until either the property is sold or the owner:
- permanently moves;
- fails to live in the house for 12 consecutive months; or
- fails to pay property taxes, maintain hazard and/or flood insurance coverage, or maintain the property (i.e., perform necessary repairs).
Unlike other FHA mortgage programs, the HECM has:
- a UFMIP of 0.5 percent or 2.5 percent, depending on the disbursements;
- an annual MIP of 1.25 percent; and
- a loan origination fee limit of:
- the greater of $2,500 or 2 percent of the first $200,000; and
- 1 percent of the amount over $200,000 of value.
HECM origination fees are capped at $6,000.
The FHA used to provide a second option, known as the HECM Saver, but the two programs were consolidated in 2013.
HECM Counseling (HUD Mortgagee Letter 2010-37; 2011-26; 2011-31)
All owners shown on the property deed (or legal representative in cases involving documented lack of competency) and a nonborrowing spouse must personally receive HECM counseling prior to entering an HECM contract. The counseling certificate must be signed and dated by:
- the counselor;
- all owners shown on the property deed (or legal representative in cases involving documented lack of competency); and
- the nonborrowing spouse.
Lenders are required to provide each client with a list of HECM counseling agencies that includes no fewer than nine HUD-approved counseling agencies, including:
- five agencies within the local area and/or state of the prospective borrower;
- one agency within reasonable driving distance for the purpose of face-to-face counseling; and
- national intermediaries awarded HECM counseling grant funds by HUD.
Fees and Loan Limits
The FHA allows most loan and closing fees, including discount points and yield spread premiums. However, it does prohibit the borrower from being charged a tax service fee, and it limits:
- the loan origination fee on its HECM and Section 203(k) rehabilitation loans.
- appraisal and credit report charges to their actual cost.
- other closing costs to what would be customary and reasonable.
The maximum insurable mortgage amount is the lesser of:
- a statutory loan limit for the area (based on housing costs), typically a county or metropolitan statistical area (MSA); or
- the applicable LTV limit.
Neither limit includes the UFMIP, even if it is added to the base loan amount.
Income and Credit Qualifications
FHA loans are not restricted to first-time homebuyers or those with low or moderate income. Anyone who can meet the FHA’s liberal underwriting criteria can obtain such a loan. The borrower’s income and employment must be verified, and his credit history will be analyzed (e.g., a court-ordered judgment must be paid off or be in the process of being paid off under an agreement with the creditor for regular and timely payments). The FHA also accepts nontraditional mortgage credit reports on borrowers lacking the types of trade references that normally appear on traditional credit reports, provided the information is verified and documented. These may be a substitute or a supplement to a traditional credit report. Such reports include credit references relating to rental housing payments, utility payments and other bill payments (e.g., insurance, child care, phone, auto leases, etc.)
A borrower can qualify for an FHA loan with monthly payments for principal, interest, and property taxes and insurance (PITI) of up to 31 percent of his gross monthly income; and total monthly debt of up to 43 percent of his gross monthly income. In addition, sources of regular income not subject to federal taxes (e.g., certain types of disability and public assistance payments, Social Security income, and military allowances) and child support income can be grossed up by 25 percent in calculating the borrower’s income for qualifying purposes. This means the amount of continuing tax savings attributable to that source may be added to the borrower’s gross income. When a borrower does not have to file a federal income tax return, the tax rate used is 25 percent. On the other hand, the FHA requires that gross rental income be reduced by either 25 percent or a percentage developed by HUD’s jurisdictional Homeownership Center (HOC) for vacancies and maintenance.
Before agreeing to insure a loan, the FHA can require repairs necessary to preserve the continued marketability of the subject property and protect the health and safety of the occupants. If the home requires flood insurance and is not located in an area where the National Flood Insurance Program is in force, it is not eligible for FHA financing.
The FHA requires that a “For Your Protection: Get a Home Inspection” notice be given to a prospective homebuyer at first contact (whether for prequalification, preapproval or initial application), but never later than at the time of the initial application. The notice informs the buyer of the importance of a home inspection prior to purchasing a home. It also makes clear that:
- the FHA does not insure the condition of the property.
- the appraisal is intended only to assist the lender.
The FHA also requires the use of an amendatory clause in most transactions. This provides that the buyer is not obligated to conclude the transaction and is entitled to a full refund of his earnest money deposit if the property is appraised at less than the purchase price.
Most FHA loans are assumable, subject to the person assuming the loan qualifying. However, a loan insured after 1989 can only be assumed by an owner-occupant. A lender cannot approve the sale or other transfer of a property to a person (e.g., an investor) who will not be using the property as a primary residence or a secondary residence.
VA loans are made by approved lenders and guaranteed by the U.S. Department of Veterans Affairs. The guarantee is similar to mortgage insurance in that it limits the lender’s exposure to loss in the event of a borrower’s default that results in foreclosure. However, the veteran borrower is charged a nonrefundable up-front funding fee that can be financed, instead of a mortgage insurance premium for the guarantee. A veteran receiving VA compensation for a service-connected disability is exempt from the fee requirement.
The fee varies based on whether the borrower:
is a first-time VA borrower or a repeat borrower;
is eligible because of service in the regular military, or because of service in the Reserves or National Guard; and
puts nothing down, or puts at least 5 percent down.
The fee for a first-time VA borrower who is a veteran of the regular military is 2.15 percent of the loan amount. It is higher if he qualifies as a Reservist or has obtained a VA loan previously. It is lower if he makes a down payment of at least 5 percent. As with the FHA premium, this fee can be financed in the loan.
Advantages of VA Loans
VA loans are types of mortgage loans that primary advantage of a VA loan is that there is no down payment required on a loan of up to Freddie Mac’s conforming loan limit. In addition, the seller can pay:
- all of the borrower’s nonrecurring closing costs and discount points, with no limit.
- up to 4 percent of the sales price in seller concessions (i.e., anything of value added to the transaction for which the borrower pays no additional amount and that the seller is not customarily expected to pay). Concessions include prepaid taxes and insurance, the VA funding fee, payoff of the borrower’s existing debts, temporary buydown fees, and gifts.
Additionally, it is easier to qualify for a VA loan than for a conventional loan. The VA uses two methods for qualifying its borrowers:
- A 41 percent debt-to-income ratio (including housing and fixed debt)
- The residual income method, which determines whether the veteran has enough income after paying his fixed debts to cover his daily living expenses and which can qualify a borrower whose ratio might exceed the 41 percent limit
However, the interest rate is not lower than that for other loans, the seller is generally not required to make repairs, and finance charges are not significantly lower.
A VA loan is available only to veterans of the armed services, certain active and discharged military personnel, and their spouses; however, the loan is assumable by nonveterans. In order to obtain the loan, the applicant must obtain a Certificate of Eligibility from the VA (directly online, through the lender online, or by mail). This will determine whether he is eligible for a VA loan and whether he is eligible for a loan with the full guarantee.
The maximum loan guarantee varies depending on the location of the property. While the VA does not have a maximum loan amount, it will guarantee to the lender the lesser of 25 percent of the loan balance or 25 percent of the Freddie Mac limit. For high-cost counties, the guarantee is the lesser of 25 percent of the loan balance or 25 percent of the VA county loan limit, which takes into consideration the county’s median home price and the Freddie Mac conforming loan limit. The guarantee enables the lender to avoid losing money if he can recoup 75 percent of the loan balance from a sale of the borrower’s property at or after foreclosure.
U.S. Department of Veterans Affairs (VA) Loans
An applicant who has used all or part of his entitlement for a VA loan can get it back to purchase another home if any of the following applies:
- The prior property has been sold and the VA loan has been paid in full.
- A qualified veteran buyer has agreed to assume the outstanding balance on the VA loan and substitute his entitlement for the same amount of entitlement the applicant originally used to get the loan.
- One time only, the applicant has repaid the prior VA loan in full without disposing of the property securing that loan.
- Even if an existing VA loan has not been paid off, the applicant has “remaining entitlement” due to an increase in the maximum entitlement amount since he obtained that loan.
- The borrower must also sign a Certificate of Occupancy, certifying that he will use the property as his primary residence. As with an FHA loan, for a VA loan, the applicant must intend to move in within 60 days after closing and stay in the property for 12 months.
A veteran cannot borrow more than the value shown on the VA appraisal, called a Certificate of Reasonable Value (CRV). He can, however, buy the property for a higher purchase price if he pays the difference in cash. If he does not wish to do so, he can terminate the transaction and receive a refund of his earnest money, utilizing an escape clause required in the VA sales agreement.
The VA does not warrant the condition of the property and is not concerned with cosmetic items, such as chipped paint. However, if the property was constructed before 1978, any area with chipping or peeling paint must be stabilized (i.e., scraped and painted to remove the lead-based paint hazard) and a lead paint notification and disclosure must be provided to the buyer.
The Rural Housing Service (RHS), within the USDA, makes financing available in rural areas through its Section 502 guaranteed loan program.
The loan funds can be used to build, repair, rehabilitate, renovate or relocate a primary residence or to purchase and prepare a site for one, including providing water and sewage facilities. The housing must be modest in size, design and cost and also meet the voluntary national model building code adopted by the state and the Housing and Community Facilities Program’s (HCFP) thermal and site standards.
This program is similar to that offered by the federal VA in that both involve loans with a 30-year term, a fixed interest rate set by the lender, no required down payment and an up-front 2 percent guarantee fee (which may be financed). However, the USDA guarantee applies to 90 percent of the loan. Lenders for this program include state housing agencies and lenders approved for participation in FHA, VA, Fannie Mae or Freddie Mac loan programs.
Loan applicants must:
- be without adequate housing.
- have less than 20 percent liquid assets (not including retirement accounts).
- have a steady income of up to 115 percent of the median income for the area;
- have a reasonable credit history; and
- be able to afford the mortgage payments, including taxes and insurance.
The lender must determine repayment feasibility, using 29 percent housing-to-income and 41 percent debt-to-income ratios.
For low-income creditworthy households unable to obtain credit elsewhere, the USDA is authorized to make loans through Section 502.
Fixed-Rate Mortgage (FRM)
Names (or terms) are often applied to mortgages and trust deeds to describe a certain feature of the loan, such as its purpose, the type of interest charged, the security used for the loan, etc. The mortgage or trust deed itself would not show the term, but a feature of that document would cause people to use the term to describe it. In most instances, in fact, one document could be described using any number of terms.
With a level-payment fixed-rate mortgage (FRM), both the interest rate and the monthly principal and interest payments stay the same for the entire loan term. The fixed interest rate will not change, regardless of future changes in the money supply, rate of inflation or anything else. The only possible change in monthly payments on the loan will result from changes in the cost of property taxes and insurance, if those are included in the monthly payment. The lender will change the payment amount after performing its annual escrow analysis.
In the case of a balloon/reset loan (or two-step loan), the interest rate and payments remain fixed for a specified term. At the end of that term, the borrower has the choice of repaying the loan or resetting the interest rate to the current interest rate and having a new fixed rate and payment amount for the remainder of the loan term.
Fixed-Rate Mortgage (FRM)
Particularly during periods when the interest rates are relatively low, borrowers will select the fixed-rate loan over a variable-rate loan. Those last one are more popular types of mortgage loans. The drawbacks of this type of loan, however, are that:
- the rate is usually higher than the initial variable rate being offered at the same time.
- if interest rates were to decrease during the term of the loan, the borrower would have to refinance the loan (i.e., obtain a new loan to pay off all or part of the existing loan) and incur new loan costs in order to take advantage of the lower rates. As a result, during periods of high interest rates more borrowers will lean toward adjustable-rate mortgages (ARMs).
A fixed-rate loan has no index rate or adjustment period; those are features of an ARM.
Adjustable-Rate Mortgage (ARM)
The initial (start) interest rate for an ARM is lower than that for fixed-rate mortgages for those types of mortgage loans. The initial rate and payment amount will remain in effect for a limited time. After the initial period, the ARM interest rate will be based on an index rate, which increases or decreases periodically during the term of the loan according to an index specified in the loan agreement, plus a fixed margin amount. An ARM is subject to any limits, or caps, on changes in the rate or payment amount.
Amortization is the process of paying off a loan by gradually reducing the balance through a series of installment payments.
Fully Amortizing Loan
A fully amortizing (or self-liquidating) mortgage provides for periodic payments that repay the loan in its entirety by the end of the mortgage term. The most common methods of payment used for these loans are:
- the level payment mortgage, which provides for equal payments of principal and interest throughout the loan period. As the principal balance is paid down, the portion of each payment that applies to the principal increases while the portion applying to interest goes down. However, the total monthly payment remains the same.
- the budget mortgage, which provides for monthly mortgage payments to include an amount equal to 1/12 of the estimated annual property taxes and property insurance premiums, homeowners’ association dues and/or special assessments.
Partially Amortizing Loan
A partially amortized (balloon) mortgage provides for some, but not total, amortization during the mortgage term. It has payments that are equal and regular in nature. However, the loan term is shorter than the time needed to repay the full loan balance by making those payments. Therefore, at the end of the loan term, a large balloon payment is needed to pay off the remaining balance.
If periodic installment payments on a loan are insufficient to pay all of the interest due, the unpaid interest is added to the principal, causing the loan balance to increase rather than decrease. This is called negative amortization.
Negative amortization may occur when the loan is:
- a graduated-payment mortgage (GPM). In a GPM, payments start at a level that does not pay all of the interest being charged, so the unpaid interest is added to the loan balance, causing negative amortization. The payments gradually increase in scheduled amounts at scheduled times until they finally level out at the amount needed to amortize the loan over the remainder of the loan term.
- an ARM with a payment cap. This loan allows a borrower to make payments that do not cover all of the interest being charged, while the lender adds unpaid interest to the outstanding loan balance.
- an option ARM, or payment-option ARM, which gives the borrower options to make payments to amortize the loan over 15 years or 30 years, to pay interest-only for a period, or to make minimum payments. Payments under the minimum payment option (negative amortization, deferred interest) will not pay all the interest being charged, so the unpaid interest is added to the loan balance. (This type of loan is no longer generally available.)
- a reverse mortgage, or reverse annuity mortgage. This loan has a balance that increases as loan proceeds are disbursed to the borrower and as interest is added to the balance.
An interest-only mortgage, also called a term or a straight mortgage, provides for no amortization during the term of the loan. The principal is repaid at the end of the loan term through a balloon payment. Some interest-only loans are really combination loans, as they have an initial period during which payments are interest-only followed by a period of substantially higher payments amortizing the loan for the remainder of the loan term.
Construction financing is one of the types of mortgage loans and is high-interest interim (or temporary) financing that serves to finance the cost of labor and materials used during construction. It extends from the start to the completion of the work, when it is then paid off, often with the proceeds of a more permanent form of financing (a take-out loan).
At the time a construction mortgage is created, the building that is pledged as part of the collateral for the loan does not exist, so only the land value is available as collateral. Generally, the lender wants the loan to be a first mortgage on the property. This means that either the land must be free of liens or the existing liens must be subordinated to the construction loan.
The loan is generally an open-end mortgage or a line of credit, in which the lender commits to lending (or authorizes) a certain amount, usually around 75 percent of the expected value of the property after the work has been completed. However, the lender does not initially release the full loan amount. Instead, it provides advances, or draws, as work is completed. If the mortgage provides for obligatory future advances (i.e., advances that must be provided if certain conditions are met by the borrower), those advances have priority over intervening liens.
The lender may withhold the final release of funds until the building inspector issues a certificate of completion and:
- the lien period has expired, to ensure no liens are filed against the property for unpaid work; or
- all labor and materials have been paid for, as evidenced by lien waivers from each of the contractors and subcontractors on the job.
Interest is charged on the money only as it is disbursed. It is generally repaid in interest-only installments during the loan period, although some lenders will allow interest to be repaid in a lump sum after the work is complete. In either case, the entire loan amount is due in full within a short period after completion of the work.
Permanent construction loans or construction-to-permanent loans which are types of mortgage loans for investors may be made to owner-occupants and developers. Fannie Mae’s construction-to-permanent mortgage is a 15- or 30-year loan that can be used to finance construction of one- or two-unit owner-occupied homes, one-unit second homes, or investor homes. The loan amount may be up to 95 percent of the construction cost or the value of the property upon completion of construction, and the funds may be used to purchase the land for the home.
The three devices typically used to secure real estate for a loan (such as in a sales transaction) are the land contract, the mortgage and the trust deed.
A land contract is known by different names in different parts of the country, including “agreement of sale,” “land sales contract,” “real estate contract,” “installment sales contract” and “contract for deed.”
In such a contract, the seller (or vendor) finances the purchase of his property for the buyer. The buyer (or vendee) makes payments to the seller in installments until he can pay off the entire debt, generally by refinancing, at which time he is given a deed transferring ownership of the property to the buyer. The transfer of property, and the deed itself, may be called a conveyance.
Until the contract is paid off, the seller keeps legal title to the property, even though the contract may give the buyer possession and equitable title as soon as it is signed. Equitable title means the buyer is entitled to a deed conveying the legal title when the contract is fully paid and performed. If the vendee defaults, the vendor may foreclose or, depending on state statute, declare forfeiture to regain his property.
Note and Mortgage (or Trust Deed)
In the typical real estate sales transaction, the seller gives the buyer a deed at closing and the buyer gives the lender a promissory note and a security instrument (i.e., a mortgage or trust deed) that creates a lien on the property. When the seller finances the purchase and does not actually give the buyer any cash, the loan may be called a soft money loan. When a third-party lender provides actual funds for the loan, it is called a hard money loan.
The promissory note is both a promise to repay the money borrowed with interest and evidence of the debt. It shows:
- the payor and payee.
- the amount owed.
- the rate of interest and whether it is fixed or adjustable.
- the due date(s) for payment.
- loan terms, which may include:
- a prepayment privilege, which allows the borrower to prepay the loan;
- a prepayment penalty, which imposes an extra charge if the borrower does prepay. While government-backed loans (e.g., FHA and VA loans) have no prepayment penalties,
- conventional loans (i.e., loans not backed by government insurance or guarantees) may have prepayment penalties;
- a lock-in clause, which prohibits prepayment;
- an acceleration clause, which permits the lender to declare the entire balance of the loan due at once if the borrower defaults; or
- a late payment penalty, which imposes a charge if the borrower’s payment is late.
Note and Mortgage (or Trust Deed)
Mortgage or Trust Deed
The mortgage or trust deed secures repayment of the note. In lien theory states, this instrument hypothecates the property, meaning the property is pledged as security, or collateral, but the borrower retains equitable title or possession.
The borrower, in giving a mortgage to the lender, is called a mortgagor, while the lender receiving it is called a mortgagee. The borrower, in giving a trust deed to the lender, is called a grantor or trustor; the lender receiving it is called a beneficiary; and a third party with a power of sale allowing him to foreclose without going to court is the trustee.
NOTE: Because the trust deed has the same legal effect as a mortgage, the term “mortgage” is often used when referring to a trust deed.
Among the provisions of the security instrument are:
- a due-on-sale (alienation) clause, which allows the lender to:
- declare the entire balance of the loan due at once; or
- refuse to allow another person to assume the loan if the title is transferred. FHA or VA loans are assumable by qualified buyers. Fannie Mae and Freddie Mac conforming loans may or may not be assumable based on the contents of the mortgage documents and the type of transfer.
- a defeasance clause, which provides for release of the lien when the borrower pays off the debt. However, to provide public notice that the debt has been repaid and to clear it from the public record:
- a satisfaction or release is recorded to clear a mortgage lien; or
- a deed of reconveyance is recorded to clear a trust deed lien (or in some states, a mortgage).
The security instrument typically provides that monthly payments are applied in the following order:
- Principal due
- Taxes and insurance, if paid to the lender
- Late charges
- Any other amounts due
- Additional principal reduction
Primary and Subordinate Financing
A primary mortgage (first mortgage) is a loan that has priority over all other unsatisfied mortgages secured by the same property, generally because it was recorded before them.
A subordinate mortgage (junior mortgage or second mortgage) secures a loan that is secondary to one or more other loans on the property. A mortgage is a second mortgage when:
- it is recorded after another mortgage that is still outstanding on the same property; or
- it has a subordination clause specifying that it:
- has lower priority (i.e., is subordinate) even though it may have had priority based on its date of recording; or
- will remain subordinate in the event that the first mortgage is refinanced.
In the event of a foreclosure on a first mortgage, the subordinate loan will be removed as a lien even if foreclosure sale proceeds are not sufficient to pay it off. Because of this risk, such loans have higher interest rates than first loans.
Subordinate financing can be obtained:
- at the same time as a primary mortgage to finance a down payment or closing costs (as a piggyback mortgage); or
- after closing, as either a closed-end second mortgage or as a home equity loan or home equity line of credit (HELOC).
Foreclosure laws vary from state to state. If a borrower defaults on his mortgage or trust deed loan, the lender can ask the court for a judicial foreclosure and a court-ordered sheriff’s sale of the property to repay the debt. After the sale, the sheriff will issue a sheriff’s deed conveying title to the purchaser.
If included in a trust deed or mortgage, a power-of-sale provision allows a trustee to foreclose and sell the property on behalf of the lender without a court order and issue a trustee’s deed conveying title to the purchaser.
Depending on state statute, the debtor may be liable for a deficiency judgment when sale proceeds are insufficient to satisfy the debt.
Also, depending upon state statute, an owner or other person with an interest in the property may, by paying off the entire debt and court costs, exercise:
an equitable right of redemption prior to the sale, to prevent a foreclosure sale.
a statutory right of redemption following a foreclosure, to reclaim the property. If there is a statutory right of redemption, the sheriff’s deed or trustee’s deed will not be issued until the redemption period expires.
If a mortgage or trust deed has the right of reinstatement, a defaulted borrower has a period after default to stop a foreclosure by paying all past-due payments and penalties and bringing the loan current, instead of having to pay off the entire debt.
Often, the high bidder at a foreclosure sale is the lender holding the note. Property that the lender has acquired through foreclosure is called an REO, for “real estate owned.”
The lender will attempt to recover as much as it can from resale of its inventory of REOs.
Among the options available to a lender in order to prevent or avoid foreclosure are:
- acceptance of a deed in lieu of foreclosure, or estoppel deed, from a borrower facing foreclosure in return for releasing him from his debt.
- a forbearance, which allows a borrower experiencing temporary financial difficulty to delay his monthly mortgage payments for a short period of time. It is often combined with other programs designed to help bring the monthly mortgage payments current after a negotiated period of time.
Closing costs are fees paid at the closing by seller or buyer after a real estate transaction. It happens when a title of a property is transferred to the buyer. The fees are related to home purchase and home loan (FHA, VA Loan, Conventional loan, USDA / RHS Loans or Jumbo vs. Conforming Loan).
Estimate of closing costs is required when the creditor/loan originator receives an application containing
- Borrower’s name
- Borrower’s income
- Borrower’s social security number
- Property address
- Estimated property value
- Requested amount of mortgage loan
Good Faith Estimate & Loan Estimate Revisions
Creditor may not revise an estimate because of
- technical issues
- incorrect calculations
- low estimate
They can also revise the estimate if changing circumstances:
- If the closing costs increased (interest rate on an unlocked loan)
- Value of property changed (storm damage or lien recorded)
- Negative borrower’s ability to qualify for the loan (got fired, documents prove less income)
- Borrower waits more than 10 business days to indicate an Intent to Proceed.
- If the settlement is delayed for more than 60 days for a new construction loan if the original Loan Estimate includes the statement that the estiamte can be revised for this reason.
When reissuing an estimate lender needs to stick with those timeframes
- Delivered within 3 days with a new information that has been required to reissuance.
- Needs to be delivered before closing.
- 4 days before a loan consummation (mailed at least 7 days prior). Business day is everyday but Sunday and federal holidays.
Closing Costs Estimates Tolerance Levels
They are grouped in a 3 categories with 3 different corresponding tolerance levels.
GFE/HUD-1 tolerance are as follows:
- Real estate transfer taxes, and creditor’s or mortgage broker’s charges for its own services (loan origination fees and interest rate) have zero variance. They must be identical on GFE and HUD-1.
- Fees identified by lender (credit report, appraisal, government recording fees, title insurance – if selected as “recommended” by a lender). Cannot vary more than 10% on both documents.
- Fees for service that owner choose for themselves (title or hazard insurance). If the borrower doesn’t choose one of the identified by a lender and pre-paid mortgage interest.
Loan Estimate/Closing Disclosure tolerance are as follow:
- Real estate transfer taxes, loan originator fees, interest rate, charges for services provided by affiliate of the creditor or mortgage broker, credit report & appraisal (if the creditor or a mortgage broker doesn’t permit to shop for). They must be identical on the Loan Estimate and Closing Disclosure. They must be identical on the Loan Estimate and Closing Disclosure.
- Fees identified by a lender (government recording fees, title insurance if selected as “recommended” by a lender). Cannot vary for more than 10%.
- Title or hazard insurance – same as above for GFE/HUD-1 tolerance
The borrower needs to receive it at least 3 days before consummation (no Sundays and federal holidays).
If the following items change than a new Closing Disclosure must be provided to the borrower and settlement is delayed for an additional 3 business days.
- Loan product
- Addition of a prepayment penalty
If there are other changes than the borrower has the right to review Closing Disclosure 1 business day before consummation.
Lenders or closing agents prepare the Closing Disclosure. Sellers are permitted to receive a disclosure (costs and credits). They may receive the disclosure when the loan is consummated (no 3 days waiting period here).
If some changes occur than a lender has 30 days to change the payment to a borrower or seller. Non-numeric clerical errors and tolerance violations trigger a new Closing Disclosure that must be delivered within 60 days following loan consumption.
Closing Costs For Seller Case scenario
How to estimate the closing cost? The are based on three major factors
- location where you live
- type of property
- type of loan
Below is a list of fees you may need to pay
- Points – Loan Discount Points, 1 point = 1% of your loan amount. They are pre-paid by the buyer and can be reimbursement by the seller . They reduce usually interest rate by the 1/8%. They work as lump sum payment that lowers your monthly payment. Cost between 0-3% of loan amount
- Attorney/Lawyer Fees – For preparing official documents. Usually hired by both parties. Can cost from $300 – $600.
- Home Inspection/Pest & Lead-Based Paint Inspection – Usually paid by the buyer. The buyer needs to check the condition of the property and make sure it doesn’t require repairs before closing. Some lenders requires the pest/termite inspection (wood destroying pest inspection and allocation of costs) and paint inspection in some states. Lead paint is toxic and hazardous. Home inspection cost from $175 to $350. Pets inspections runs from $60 to $125.
- Owner’s & Lender’s Policy Title Insurance – A borrower usually pays for the insurance. It protects the lender in case of any issues with a title. The second policy is for the owner, it protects you against (errors or omissions in deeds, mistakes in examining records, forgery, undisclosed heirs).
- UPMIP – FHA Up-Front Mortgage Insurance Premium which is 1.7% of the loan size. If you use backed mortgage for a purchase and your loan size is $200,000 then your Upfront MIP will be $3,500. The fee is not paid by cash.
- PMI – Private Mortgage Insurance, typically costs between 0,5%-1% of the loan size. On a loan size $200,000 you need to pay as much as $2,000 a year or $167 per month.
- Mortgage Application Fees – paid by the borrower to the lender. It covers cost of processing the loan. Before paying make sure to ask what the fee covers. Sometimes this cost is negotiable and it covers a credit report and appraisal.
- Home Appraisal – Cost from $300 to $700. For multi level buildings can be more. This is paid to an appraisal company which in some cases needs to be approved by HUD. The appraisal covers the fair market value of the property.
- Survey Fee – Cost from $150 to $400, paid to a survey company for a survey of a lot and all structures on it. The survey also confirms the lot size and dimensions. It’s require by institutional/commercial lenders.
- Flood Determination Fee – Life of Loan Coverage, cost from $15 – $50. The buyer needs to make sure that the property it’s not located in a flood zone. If yes than the buyer needs to buy a flood insurance.
- Exam Fee – Title Company Title Search, the company needs to make sure that nobody has a claim to the property. It usually covers (Chain of Title, Tax Search, Report on Possession, Judgment and Name Search, Commitment).
- VA Funding Fee –
Downpayment Veteran Reservist/National Guard Less than 5% 2,15% 2,40% Less than 5%-10% 1,5% 1,75% Less than 10% or more 1,25% 1,5%
- Credit Report – Fee covering a credit report received from 3 different bureaus (Experian, Equifax and TransUnion). By law, a credit reporting company can charge no more than $12.00 for a credit report.
- Closing Fee – An Escrow Fee, paid to an attorney, escrow company or title company. Calculated a $2.00 per thousand of purchase price plus $250.
- Home Owners Association Transfer Fees – HOA transfer fees usually run anywhere from $100 to $400 with an average HOA transfer fee being around $225 to $250. It’s paid by the buyer to get a copy of the association financial statements, minutes and notices making sure that association dues are paid current.
- Recording Fee – to record and update public land records this fee needs to be paid. (usually charged by city or county).
- Underwriting Fee – cost up to $795, goes to the lender for time spent on checking your loan with guidelines and deciding to approve or not you loan.
- Property Tax (usually 6 months of county property tax). RESPA allows the lender to collect a maximum cushion in months of property tax and two months of hazard insurance at closing as an escrow cushion in case the borrower misses some mortgage payments., or final charges are higher than estimated.
- Transfer Taxes – This is the tax when a real estate transaction is finalized.
- Prepaid Interest – money paid to get interest paid up through the first of the month.
- Origination Fee – Cost 1% of the total loan amount,. If you are not a high risk borrower with a bad credit and undocumented income you can negotiate this fee. There is a lot of mortgage brokers that will not charge you a penny for origination fee.
- Courier Fee – cost of transporting documents.
How To Avoid Paying Closing Cost?
Sometimes the seller will agree to assume the buyer’s closing fees. In many cases (Discount Points, Origination Fees, Underwriting Fees, Application Fees and Appraisal Fee) are not paid or partially paid. There are some mortgage brokers who put all closing cost into loan amount and get you best rate as possible. You can avoid upfront fees by getting a non-closing cost mortgage, in which you don’t pay a penny at closing. However, in most cases this type of “deal” will end up costing you in the long run. The lender will possibly charge you a higher interest rate on the loan amount for not paying closing costs.
Before 2015 there were 2 disclosures in mortgage: TILA (Truth-In-Lending Act) and RESPA (Real Estate Settlement Procedures). After October 3, 2015 there were combined and integrated into one disclosure TILA-RESPA. This rules modified disclosure requirements for most closed-end loans. A reverse mortgage (an Open-end loan) require four disclosures:
- TILA (an initial disclosure containing the annual percentage rate)
- Good Faith Estimate of closing costs
- HUD-1 Settlement Statement
- a final TILA Disclosure
Most closed end loans (including construction-only loans as well as loans for vacant land) are required to use only two disclosures
- Loan Estimate form (contains the initial APR disclosure )
- Closing Disclosure form (contains the final APR disclosure)
To make it even more complicated, above types of loans require a TILD Disclosure but not a Good faith Estimate or Loan Estimate and not a HUD-1 Settlement Statement or Closing Disclosure: equity line of credit, a manufactured housing loan that is not secured by real estate, and some types of home-buyer assistance loans.
Real Estate Settlement Procedures Act
In 1974 congress passed RSPA to provide consumer protection for loans or residential properties (1-4 units). This law involved into
- disclosure of closing costs (prevention of kickbacks, to avoid raising amount of closing costs to the consumer)
HUD – The Department of Housing and Urban Development was enforced of the law, however enactment and enforcement responsibilities were shifted to the CFPB (Consumer Financial Protection Bureau) in 2011.
RESPA applies only to loans, a financed transactions and has no impact on cash purchases. It also applies to
- home improvement loans
- reverse mortgages (Good Faith Estimate & HUD-1 Closing Statement)
- equity lines of credit
1. 3 Loan Application Disclosures in Mortgage
There are three disclosures in mortgage that Loan Originator needs to give or mail the borrower within 3 business days of receiving the signed loan application. However, the requirements doesn’t apply if a lender tuns down the application during those days. RESPA doesn’t specify a penalty for noncompliance. Disclosures are
- Special Information Pamphlet (common mortgage terms & closing costs) – only for purchase mortgage loans
- GFE – Good Faith Estimate of the anticipated closings costs (reverse mortgage) or the Loan Estimate
- MSDS – Mortgage Service Disclosure Statement that informs the applicant whether the lender intends to service the loan or transfer the servicing rights to another lender.
2. Pre-Settlement Disclosures
a) HUD-1 Settlement Statement (reverse mortgages) or Closing Disclousre
Shows all credits and debits to they buyer and any disbursements to third parties.
The borrower has the right to review the HUD-1 one business day before closing date (the initial Closing Disclosure must be received at least 3 business days before closing)
b) Affiliated Business Agreement
One-stop shopping it’s possible when one parent company owns multiple service provider firms. For example one entity may own or have a partial interest in real estate, mortgage and title companies. RESPA requires that when one of these entities refers the applicant to another affiliated provider, the loan applicant receives an Affiliated Business Arrangement Disclosure at or prior companies and the charges for the second company.
3. Settlement Disclosures
- Final HUD-1 Settlement Statement or Financial Closing Disclosure (needs to be signed by buyer)
- Initial Escrow Statement – the borrower receives it within 45 days after closing. It estimates the first-year escrow payment for property taxes and homeowners insurance.
4. Post-Settlement Disclosures
a) Servicing Transfer Statement
Servicing rights for loans may change hands frequently, sometimes a borrower receives multiple notifications that instruct them to send payment to a different address and company. These Servicing Transfer Statementsare required by RESPA. Borrowers cannot be penalized for non-payment if they continued to make payments to the prior servicer. (they should receive a phone call in 60 days from a new company).
5. Annual Escrow Analysis Statement
Lenders are required to conduct an annual analysis of all escrow accounts, inform the borrower of the findings and refund an excess of $50 or more.
6. Good Faith & Loan Estimate Conditions
The Loan Estimate includes also the financing charges and terms, which eliminates the need for a separate TILA disclosure.
- Credit report fee it’s the only fee that can be collected before a delivery of the Loan Estimate and the borrower’s notification of moving forward with loan process.
- Any estimates of costs provided to the borrower before the estimate must clearly state that the charges could change.
- The borrower cannot be required to submit any documents prior the delivery of the estimate.
- The estimate may be provided by the lender or the loan originator.
- It must be delivered not later than 3 days after a loan application is submitted.
- It must be delivered or mailed no later than seven business days prior to loan consummation. This can be waived if the borrower has an emergency, such as an impending foreclosure, that justifies an approved faster closing. The borrower must provide a written explanation of the emergency.