Financing a Purchase
When the buyer cannot pay cash for a house (99.9% of the time), he/she needs to take out a loan to finance the purchase. The buyer signs a Promissory Note promising to pay for the house and a Lien is placed on the house by the lender. The buyer is obligated to pay and is the promisor/obligor. The lender receives payments and is the promisee/obligee.
1. Mortgage - Conventional mortgage is not backed by the Federal government and is backed by a Private Mortgage Insurance (PMI) company. Non-conventional loans are backed by the Federal government such as FHA (insured) and VA (guaranteed) financing.
2. Trust Deed (aka Trust Deed) - A 3rd party (trustee) holds title to the property until it is paid off. The lender is the beneficiary of the trust. When paid off, the trustee issues a Deed of Reconveyance to the buyer/trustor/ who is now the title owner.
3. Land Sales Contract - Owner/seller finances the purchase and retains title to the property. The buyer has what is called Equitable Title until paid off. Then the owner issues a Deed of Reconveyance.
4. Purchase Money Mortgage (PMM) - With buyers having to put 20% of the purchase price down to obtain a loan by a lender, a lot of owners are financing the down payment for the buyer by issuing a PMM to the buyer in the amount of 15% or 10% of the purchase price. This way the buyer only has to put 5% or 10% down to get the financing. These are known as 80/15/5 or 80/10/10 loans.
The seller has his/her mortgage paid off by the sale and then -TAKES BACK- a mortgage on the house as a lender in JUNIOR Position to the bank. The buyer makes payments to the seller/mortgagee on the PMM until the 15% or 10% is paid off.
Lien-Theory States vs. Title-Theory States
The lender can simply have a lien on the property or the lender can actually hold title until the loan/debt is paid off by the buyer/borrower.Lien-Theory State - Lien-theory States where title is held by the buyer/borrower (issued a deed at closing). The lender places a lien position (usually 1st in line) by recording the lien with the county where the property is located. Example: The lender records the mortgage lien it holds on the property.
Title-Theory State - Most States, including yours (Washington), are Title-Theory. The lender actually has -legal title- to the property. The buyer/borrower only has "equitable title" and possession of the property. Upon paying of the promissory note, the lender issues a "Deed of Reconveyance" to the buyer/borrower/now title owner.
Intermediate-Theory State - This is a combination of lien theory and title theory. The law says the lender only has a lien (not title), BUT if the borrower defaults on a loan the lender gains title to the property.
Forms of Mortgages
In 2002, the Federal Reserve encouraged lenders to issue more loans so -all sorts- of individuals could buy a home. The lending industry then came up with all sorts of -creative- financing that would allow people to buy a home. The problem was that the industry went over board and started issuing loans to questionable buyers who really couldn-t afford to buy a home. One of the worst cases was a waitress who was a single mom with few assets who qualified for a $700,000 loan down in Los Angeles.
Adjustable-Rate-Mortgage (ARM) - The interest amount that is charged is subject to an ESCALATION CLAUSE that allows the interest rate to be adjusted (usually upward) by the lender during the life of the debt payments. The rate of interest is tied to an index such as the discount rate of the Feds or to interest earned on U.S. Treasury Securities such as T-Bills sold in the market.
The lender establishes a MARGIN that adjusts. This is the difference added to index which is the profit level enjoyed by the lender. If the T-Bills are paying 3% and the lender-s margin is 4%, the buyer/borrower is paying 7% interest.
Some ARMs have a CAP specified on the loan. This is the maximum limit that the interest rate can increase to.
Graduated-Payment Mortgage (GPM) - This is also known as (a.k.a.) a FLEXIBLE PAYMENT PLAN. The buyer/borrower begins with very low monthly payments and payments increase later. If the low payments do not cover the interest charged, the debt owed will increase and this is called NEGATIVE AMORTIZATION. The loan balance increases. Our LA waitress had this type of program and she had a negative amortization of $28,000 the first year. The debt went from $700,000 to $728,000 after the first year.
This is also known as a Growing-Equity Mortgage or GEM because the buyer/borrower will have to make much larger payments in the future.
Wraparound Mortgage - A junior (2nd in line) mortgage is wrapped around the original (1st) mortgage. The lender for the wraparound junior takes on the 1st original loan and makes the payments. The home owner/mortgagor makes one payment to the junior (2nd) wraparound mortgage. Obviously, the original 1st mortgage would have to be assumable in construction.
Open-End Mortgage - Allows the homeowner/mortgagor to borrow continuous money up to a maximum. This is secured by the original 1st mortgage. The key is that this is not for contractors, but for the homeowner.
Budget Mortgage (PITI Loan) - This type of mortgage requires all the mandatory payments for a house to be paid to the lender on a monthly basis. This includes Principal, Interest, Property Tax, and Insurance (PITI). The monthly payments for Property Tax and Insurance go into an escrow account to make annual payment after 12 months.
Blanket Mortgage - This is used for subdivision and condominium construction. It covers (blankets) the development by a contractor for such developments. The mortgage has a PARTIAL RELEASE clause that allows the contractor to sell units/homes of the project and be released with payment to the lender.
Buydown Mortgage - Allows the buyer/borrower to make lump sum payments of interest to -BUY DOWN THE INTEREST RATE- for the loan over a number of years. Example: $100,000 loan at 6%. If the borrower pays $5,000 cash, the interest rate would be brought down to 5% for a 5 year period.
Package Mortgages - Such mortgages are made for condominium and new home contraction with appliances (personal property) and the property included in the purchase. This covers the buyer purchasing real and personal property in the purchase.
Construction Loan a.k.a. Short Term or Interim Loans - Contractors take this out to construct a project. The contractor will have a series of DRAWS with each stage of construction.
Straight Mortgage a.k.a. Term Loan - The mortgage allows the buyer/borrower to make ONLY INTEREST payments. Principal is due and fully payable at the end of the mortgage period.
Shared-Appreciation Mortgage - This is mainly for commercial development. The lender offers a lower rate of interest in turn for a share of the pie when the property is sold.
Reverse Annuity Mortgage (RAM) / Reverse Mortgage - Owner must be 62 years of age or older. The owner is allowed to obtain money/equity from the home on a regular or money draw basis or one single payment. When the person no longer resides in the home, the loan becomes due and payable (sold).
Federal Housing Administration (FHA) insures loans (Non-Conventional) issued by lenders. The FHA does NOT issue loans; they only insure them on behalf of the issuing lender.
203(b)B Program - FHA insures loans on single family homes and duplexes up to 4 family units.
Each county in America has a maximum limit for lender insured loans.
Mortgage Insurance Premium (MIP) is charged. It can be paid by the buyer or seller or financed. This is negotiated on the Purchase and Sale Agreement.
Minimum Down payment must be in cash. It cannot be provided by a loan. A parent-s gift would be allowed.
The FHA allows Interest Rates to be NEGOTIABLE, or by payment of DISCOUNT POINTS by the buyer or seller, and loans can have an origination fee of no more than 1%.
NO PREPAYMENT PENALTIES are allowed to be charged by the lender if there is an early payoff.
Assumable - Loans can be assumable if the new buyer meets FHA qualifying guidelines. If assumed by a new buyer, the lender would issue a CERTIFICATE OF REDUCTION to establish to existing principal owed by the new buyer.
The Serviceman-s Readjustment Act of 1944 established what is now the Veterans Administration; a government agency. It is to make government-backed (guaranteed) loans available for veterans as well as Non-Married Widows or Widowers of Veterans. The VA guarantees loans issued by lenders under this program for single family homes and up to 4-plexes with one unit being occupied by the veteran.
Veterans must apply for a CERTIFICATE OF ELIGIBILITY in determining how much of the lender loan will be guaranteed by the VA. A CERTIFICATE OF REASONABLE VALUE will also be issued by the VA regarding the maximum for each property that the VA will guarantee the lender. This is the market value determined by a VA approved appraiser in the area.
Funding FEE - The buyer or seller can pay this fee which is a percentage of the loan amount. The funding fee MAY BE FINANCED as opposed to a FHA loan.
Assumable - Loans can be assumable if the new buyer meets VA qualifying guidelines. However, if the new buyer is NOT A VETERAN, the original veteran will be liable if the new buyer defaults. Novation (new loan) by the lender does not preclude this responsibility. Only the VA can make the original veteran eligible for another loan.
Secondary Mortgage Markets
These markets provide a ROLLOVER OF FUNDS for the primary mortgage market. These markets continually buy and sell EXISTING MORTGAGES offered by lenders. Lenders can sell mortgages to these markets if they need cash. They can buy existing mortgages if they have money to invest.
Nonconforming Loans - In order for lenders to sell their loans in the market, they must conform to the guidelines established by the markets. If they do not conform (NONCONFORMING LOANS), the markets do no have to purchase them from the lender.
The loans that are purchased by the secondary markets are POOLED (PACKAGED) and sold to investors in the form of MORTGAGE-BACKED SECURITIES (MBS).
Pass-Through Participation Certificates - When an investor buys into one of these PACKAGES, the interest and principal payments by the borrowers of these loans flows through to the investors direct. Thus, part of the received monthly payment of an investor is principal (non-taxable) and interest (taxable).
Government National Mortgage Association (GNMA-Ginnie Mae)
This is a FEDERAL AGENCY owned by the Government and a division of the Department of Housing and Urban Development (HUD). This agency specializes in -high risk- programs like development of slum areas and special assistance programs like housing for the elderly.
Ginnie Mae issues mortgage-backed guaranteed certificates to investors. These are PASS-THROUGH CERTIFICATES that send principal and interest payments to investors.
Tandem Plan - Ginnie Mae works close with Fannie Mae and their program when -money is tight-. Fannie Mae can purchase high risk/low yield investments and Fannie Mae will pick up the slack to Ginnie Mae if these investments go south.
Ginnie Mae purchases VA, FHA, and Rural Development loans from lenders when they need cash or want out of the loan.
Federal National Mortgage Association (FNMA - Fannie Mae)
In 1968 Fannie Mae became a government-sponsored ENTERPRISE (GSE) that was chartered by Congress as a PRIVATE SHAREHOLDER-OWNED COMPANY.
Fannie Mae is to provide liquidity and stability for FHA insured loans and VA guaranteed loans issued by lenders. It also provides liquidity for lenders for other types of conventional loans.
In 2008, Fannie Mae was taken over by the Federal government and the Director of the Federal Housing Finance Agency was appointed conservator.
Feral Home Loan Mortgage Corporation (FHLMC - Freddie Mac)Freddie Mac was established to ASSIST SAVINGS AND LOAN ASSOCIATION with their issued CONVENTIONAL mortgages. Freddie Mac is a publicly owned corporation that purchases mortgages and then pools/packages them together into a bond product sold in the open market as MORTGAGE- BACKED SECURITIES (MBS).
Since Freddie Mac GUARANTEES payments to investors purchasing their MBS product, in 2008 they were taken over by the Director of the Federal Housing Finance Agency (FHFA) with the Director as the conservator.
Down Payment Assistance Programs
The Housing and Economic Recovery Act of 2008 NO LONGER ALLOWS sellers to participate in Down Payment Assistance (DPA) programs for loans backed/insured by the FHA. Down payments for FHA loans can not be financed UNLESS funded by -Local- or State grant programs to help buyers make the down payment.
Not Needed to Be Repaid - The reason the FHA allows local and State funding of the down payment is because these -grants- usually do no have to be repaid. YOU should work with a reputable lender when offering these local and State grants.
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