Financing Real Estate
99% of residential purchases are financed by loans from a lending institution. There are different types of lenders, but they pretty much follow the same lending practices and loan requirements. That is, the requirements a purchaser must follow before the lending institution will finance the purchase of their client's home.
Hypothecation is the practice where (usually through a letter of hypothecation) a borrower pledges collateral to secure a debt or a borrower, as a condition precedent to a loan, has a third party (usually an affiliate) pledge collateral for the borrower. The borrower retains ownership of the collateral, but the creditor has the right to seize possession if the borrower defaults. A common example occurs when a consumer enters into a mortgage agreement, in which the consumer's house becomes collateral until the mortgage loan is paid off.
Hypothecation - Buyer offers a note promising to pay on the loan thus places a lien (hypothecates) on the property allowing the lender to foreclose on the house if note payments are not paid as contracted.
Pledge - The buyer offers a note (only) without a lien on the property. This is usually done when the seller owned the house "free and clear" and becomes the lender. The buyer makes monthly agreed upon payments to the seller until the note is paid off. If payments are not paid, the seller can only sue the buyer for not making contracted payments.
CONCERNS OF A LENDER
Quality of Collateral - Quality of the real property as collateral for the loan.
Value - Is the home worth the purchase price? Is the house worth more or less than the price the purchaser paid? To determine this, the lender will usually require a licensed appraiser to provide an opinion. This appraiser has several different methods that can be utilized in determining value and we will go over appraisal a little later in the course.
Quality of Title - Will the purchaser obtain a fee simple absolute estate without a "cloud on title?" If there is a cloud on title, or the possibility of one, it could present difficulties in the future. A cloud may disallow the lending institution from financing the purchase.
The Federal Government - As you will see later in the course, the Federal government provides most of the money for institutions to lend. The Federal government has very stringent requirements that have to be met before Federal money can be utilized to finance the purchase of a home.
Loan To Value Ratio
When a buyer applies for a loan, the lending institution will also look at what is called the Loan To Value Ratio of the home they would finance. The value is determined by the appraisal of the house. The loan ratio is a percentage of the appraised value. We have to use the appraised value, rather than the purchase price, because this shows us the market value if the lender has to foreclose on the loan and sell the home.
Loan To Value (LTV) - A percentage of the appraised value. In determining the feasibility of a loan on a newly purchased home, a lender will utilize a predetermined formula. This formula is a percentage of the appraised value or sales price, whichever is less.
There are an innumerable number of different types of loans that the general public can obtain for financing a real estate purchase. This course is designed to simply show the different forms. It is best to check with the institutions and request information on the programs available. The following are some of the basic loan forms utilized in financing a home purchase:
Conventional Loan - When a loan is issued through a private lender without any outside source; like the Federal Government.
The lender looks directly at the creditor's ability to repay the loan. There are no outside sources of funds or intervention. This type of loan is not backed by any outside government agency.
Lender Has No Guarantee - Because the government does not guarantee the loan there is no direct governmental involvement; just simply a loan between the borrower and the lender.
Less Regulations - Because of this there are fewer governmental regulations. The lender is allowed to loan money with only its own paper requirements to meet. It can make loans under its own charter. The government will still have lending regulations that have to be followed, but not as much as a non-conventional loan where the Federal Government is directly involved.
Flexibility - Conventional loans usually allow the lender to offer the borrower more flexibility regarding terms of the loan. They are also able to be more flexible regarding interest rates that can be offered the borrower.
Conventional enders will loan up to 97% of the valule; requiring the buyer to place 3% down. However, most conventional loans range from 80-95%.
A non-conventional loan means that a government agency is going to be involved in the process. A government agency is going to insure or guarantee the loan. These loans can be obtained at the Federal and State level. In either case, the lender will have an outside source overseeing the loan. A lot more is required from the borrower to qualify and obtain the loan.
Definition - A non-conventional loan is one that is:
Agency Rules - Because the government is involved, the involved government agency will set the terms and interest rate maximums. These are fixed by government statute and the lender must adhere to these regulations.
Bank Funds - The interesting aspect involved with these insured/guaranteed loans is that the bank or savings & loans uses their own money. The government agency only insures or guarantees the loan.
Non-Conventional loans have a fair amount of additional requirements that have to be met by a borrower in order for them to qualify for a loan. FHA insured loans, & VA guaranteed loansare the most prevalent type of Government loan options.
Federal Housing Authority (FHA) - These are insured loans available to the public.
The FHA was created in 1934 during the great depression. It was formed as part of the National Housing Act.
This act was among many during this time that was designed to get the economy going. America had 33% unemployment and banks were failing because people couldn't pay their mortgage payments. The concept was that the FHA would insure mortgages under its loan program and banks could be reimbursed for losses suffered when a loan was defaulted.
Standards - The National Housing Act also gave the FHA the power to improve housing standards in that loans could not be granted unless the home met these standards.
Economy - Since the loans by institutions were insured by the FHA, the institutions could allow more access to more loans for residential housing. Thus causing the economy to move forward with more jobs for residential housing.
Act - The act and the FHA established several titles and sections regarding procedures in granting loans to the public. These requirements are still utilized today with FHA insured loans.
Residences Only - FHA loans can be used for single residence homes as well as residence apartment buildings.
The loan-to-value ratio on a mortgage will "most likely" be the:
A) mortgage loan as a percentage of the insured value
B) monthly payments as a percentage of the remaining balance of the loan
C) loan as a percentage of the sales price
D) loan amount as a percentage of the appraised value
Which of the following statements about residential loans with federal government support is false?
A) the federal government supplies funds to the lending agency
B) the federal government insures the lending agency against foreclosure losses
C) FHA may insure mortgages for either apartment house projects or single family residences
D) VA loan guarantees may be used for condominium unit financing
The Federal Housing Administration (FHA) obtains its funds, which are used to pay losses on foreclosure, for its loans by:
A) depending on the general revenues of the federal government
B) imposing charges on the lending institutions
C) imposing charges on the borrowers
D) floating annual issues of stock
The home buyer who pays mortgage insurance premiums in addition to the mortgage payment is probably using:
A) a VA mortgage
B) a FHA mortgage
C) a conventional mortgage
D) a private mortgage
Under the terms of an FHA loan, if the borrower decides to sell the property two years after purchasing:
A) the note becomes due and payable immediately, and the new purchaser must secure new financing
B) the new purchaser cannot assume the FHA loan, but must buy the property subject to the loan
C) the new purchaser may assume the FHA loan, but his credit must be approved by the FHA
D) the sale must be for all cash to the amount of the FHA loan because the FHA does not allow secondary financing
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