Chapter 9

THE IMPORTANCE OF FINANCING. Financing is an indirect cost of owning property. Interest rates and the availability of mortgage money have a direct effect on the real estate market. When mortgage money is scarce and interest rates are high, prices tend to level off and go down. Falling interest rates stimulate sales, resulting in increased demand for homes and in higher prices. For most home buyers, the decision to purchase is largely determined by the size of the down payment and the amount of the monthly payment on principal, interest and taxes.

THE BROKER’S ROLE IN THE FINANCING PROCESS. Most sales depend upon the buyer’s ability to obtain suitable financing, and since most buyers are not familiar with the sources of available money and the steps necessary to obtain a loan, they depend upon the broker to arrange the mortgage. Brokers should know where the funds can be obtained and how to secure the most desirable terms. Lack of such knowledge can result in a sale being cancelled because it was made contingent upon unrealistic financing terms, causing hardship to both buyer and seller.

PROCEDURE FOR APPLYING FOR A MORTGAGE

The first step in applying for a mortgage is to find a bank or mortgage company, which is originating mortgage loans in the area. By simple inquiry, the broker should be able to determine the current interest rates and the type of loans being offered. This preliminary information is important for the broker to have when showing the property since it may have an influence- on the prospect’s decision to buy.

After the purchase agreement has been signed, the next step is for the buyer to file an application for a loan, This provides the lender with personal information regarding the buyer, including age, family status, employment, earning, assets and financial obligation. The application also provides details of the sale, including a legal description of the property, description of the parties, price, date of closing and mortgage contingency.

      The lender will require a credit report to determine the applicant’s total family income from all sources and the quality of such income. Employment records will be checked to determine whether the applicant’s current level of income can be ex­pected to continue or decline. A credit report will also indicate the applicant’s past record of credit transactions and punctuality of payment.

      Because of the possibility that most home mortgages will be sold on the secondary mortgage market, government guidelines require an independent appraisal of the property. The appraisal determines the fair market value of the real estate in order to determine the loan-to-value ratio.

LETTER OF COMMITMENT. When the mortgage has been approved, the lender will issue a letter of commitment, which indicates the amount of the loan, interest rate, and repayment options. The loan commitment is conditioned upon the buyer’s ability to furnish marketable title and gives the buyer a time limit of from thirty to sixty days to accept the loan.

LOAN-TO-VALUE RATIO. The loan-to--value ratio determines the maximum loan based upon a percentage of the appraised value or the purchase price, whichever is lower. For example, a 70% loan-to-value ratio would result in a $105,000 loan for a home, which was appraised for $150,000 and purchased for $155,000.

LOAN FEES - DISCOUNT POINTS, ORIGINATION FEES

Most lenders charge loan fees to cover the administrative costs of originating the loan and to offset any losses when the mortgage is sold in the secondary mortgage market. The fee is quoted in points with each point representing one percent of the amount of the loan. For example, a charge of two points for a $90,000 mortgage is $1,800.

Originally, loan fees were charged to increase the lender's effective yield in order to make up the difference between FHA/VA interest rates and higher conven­tional rates. Each discount point was equal to l/8th difference in the interest rate. A bank taking an FHA loan at 12% when the conventional rate is 12 1/2% would charge 4 points. Loan fees are now used to offset the discount rate charged by the secondary mortgage market when the mortgage is sold.

Loan fees may be referred to as discount points or origination fees, and except for VA mortgages, they are negotiable and payable by either buyer or seller. On VA loans, the borrower may pay only the origination fee, which is limited to one point. In many states, the banking commissioner may review loan fees in order to keep them at a reasonable level. Note: VA loans typically provide 100% loan-to- value ratio.

SOURCES OF FINANCING

PRIMARY MORTGAGE MARKET. The primary mortgage market is where mortgage loans are originated with funds obtained from banks, mortgage companies, institutions, insurance companies, and individual lenders. The primary lender assumes the risk of the loan and continues to service the mortgage (collect the payments) when the mortgage is sold in the secondary mortgage market.

 INSURANCE COMPANIES. Insurance companies accumulate large sums of money from the premiums paid by their policyholders. Although insurance companies are considered primary lenders, they tend to invest their money in large, long-term real estate loans that finance commercial, industrial and larger multi-family properties rather than single-family home mortgages.

SAVINGS AND LOAN ASSOCIATIONS (S&Ls) . Also known as fiduciary lenders because of their fiduciary obligations to protect and preserve their depositors' funds. State and federally chartered S&Ls nationally account for the greatest share of home loan mortgages among institutional lenders. Federally chartered S&Ls must use the word "Federal" in their name.

 MUTUAL SAVINGS BANKS. Mutual savings banks are owned by the depositors who share in the profit. Interest paid on savings is based upon the success or failure of the bank's lending operations. Deposits are generally less subject to withdrawal and are thus well suited for mortgage loan investment purposes. The majority of mutual savings banks are located in the northeast, principally in New York and Massachusetts. They operate in the same fashion as S&Ls, but their lending area is limited to their own state and contiguous states.

 COOPERATIVE BANKS. Cooperative banks were originally organized by local associa­ tions of prominent business people who sold "shares" to depositors. Because they were able to pay higher interest rates than most of the thrift institutions, they attracted a large number of depositors and were able to make low interest home mortgage loans. They operate in the same fashion as S&Ls,

 COMMERCIAL BANKS. As a rule, commercial banks finance short term commercial needs of the business community and must maintain a high degree of liquidity in order to meet withdrawal requests of their depositors. However, in the last ten years, commercial banks have become very active in the home mortgage market. Federally chartered commercial banks include the initials "N.A" after their name. State chartered commercial banks are called trust companies.

 CREDIT UNIONS. Credit unions are non-profit organizations composed of members of a particular profession, trade union, club, society or civil service, etc. Supposedly they pay higher interest to depositors and specialize in short term consumer loans. Most states have changed their banking laws to allow credit unions to participate and compete with other lending institutions in the home mortgage market. The Federal Credit Union Act allows credit unions to make thirty-year real estate loans to members to finance their principal residence. They can also make FHA/. Recently, however, they have branched out to originating longer-term first and second mortgage and deed of trust loans. Credit Unions may be state or federally chartered.

 MORTGAGE BANKING COMPANIES. Mortgage banking companies originate mortgages with their own funds and sell them to investors, such as insurance companies, commercial banks, and retirement and pension funds. The mortgage banker assumes the risk of the loan and, for a fee, services it for the purchaser. Mortgage bankers also sell their mortgages in the secondary mortgage market and make a profit on the origination fee. Mortgage bankers differ from S&Ls because they loan their own money rather than other people’s money. They also differ from loan correspondents who negotiate loans for conventional lending institutions.

MORTGAGE BROKERS. Mortgage brokers act as intermediaries, for a fee, between borrowers and lenders. They locate potential borrowers and process applications, which are submitted to lenders for final approval. Mortgage brokers do not originate loans or service them.

 PRIVATE, INDIVIDUAL LENDERS. Individuals are a good source of funds for financing since they are not subject to the strict regulations of institutional lenders. They are usually willing to take slightly greater risks since most of their activity is in the second or junior mortgage market. Under a federal program, home mortgages may be sold in the secondary mortgage market, provided they meet the HUD requirements.

 PENSION AND RETIREMENT FUNDS. Although they have traditionally invested conservatively in government bonds and blue chip corporate stocks and bonds, pension and retirement funds are a growing source of mortgage funds.

 FARMER’S HOME ADMINISTRATION (FmHa). This is an agency of the U.S. Department of Agriculture which guarantees loans made and serviced by private lenders for the purchase and improvement of single family homes in rural areas (population less then 10,000). The FmHa also has a direct loan program when local financing is not readily available.

GOVERNMENT REGULATION OF MORTGAGE LENDING

THE FEDERAL HOME LOAN BANK SYSTEM. The Federal Home Loan Bank System was created in 1932 as a regulatory agency to charter national savings and loan associations (S&Ls) and to supervise their operations. The Federal Home Loan Bank Board (FHLBB) is the governing body and issues federal charters to member banks. The Board regulates and monitors the lending activities of member associations through twelve regional Federal Home Loan Banks. The Board determines members' reserve require­ments and discount rates, and provides deposit insurance through the Federal Deposit Insurance Corporation (FDIC). Federally chartered S&Ls are required to be members of the FHLB System. State chartered S&Ls may join at their option, provided they conform to federal requirements and insure their depositors accounts through FDIC.

 FEDERAL RESERVE SYSTEM. The Federal Reserve System (The FED) is a central bank system, which serves each of the twelve FHL bank districts. The FED greatly influences the nation’s economy through the regulation of member banks' reserves (money available for lending), and by regulation of the discount rate, which the district banks charge member banks for the use of FED money.

DEPOSIT INSURANCE. Because of the S&L crisis, in 1989 congress passed the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). FIRREA created the Office of Thrift Supervision (OTS) to monitor and regulate the savings and loan industry and designated the Federal Deposit Insurance Corporation (FDIC) as the sole agency for insuring funds for both S&Ls and commercial banks. FIRREA also created the Resolution Trust Corporation (RTC) to liquidate the assets of failed savings and loan associations.

TYPES OF MORTGAGES

THREE MAIN TYPES OF MORTGAGES

Mortgages are classified according to the degree and type of backing the lender receives from public and private sources. The three main types of mortgages are:

1.   Conventional. No government backing. The lender assumes total risk of loss.

2.   Privately-backed. Payment is insured by private mortgage insurance (PMI).

3.   Government-backed:

• • • FHA — Loss Insured by the department of Housing and Urban Development (HUD).

    • VA — Payment is Guaranteed by the Veteran’s Administration.

CONVENTIONAL MORTGAGE. The term is used to specify loans, which are not backed either by VA/FHA or private mortgage insurance (PMI). The conventional lenders rely primarily on their own appraisal of the security and their own credit reports and information concerning the credit reliability of the prospective borrower. Because of this lack of government backing there are fewer regulations imposed on conventional lenders. Lenders are free to make changes in loan terms and rates as market conditions warrant, subject to their charter and state laws. The loan-to- value ratio for conventional loans is generally smaller than guaranteed or insured loans because the bank is assuming all the risk.

PRIVATE MORTGAGE INSURANCE (PMI). To make it possible for banks to take higher loan-to-value conventional mortgages, private mortgage insurance is used to back portions of the loan. By insuring the top twenty to twenty-five percent of the loan, PMI makes it possible for persons to buy homes with lower down payments, similar to FHA/VA financing. The Mortgage Guarantee Insurance Corporation of Wisconsin (MGIC) is one of the leading private mortgage insurers. The borrower pays a premium of 1% of the loan at closing and 1/4 percent of the outstanding loan balance each year until the loan-to-value ratio reaches a certain point (usually 75% to 80%). In case of foreclosure, PMI will buy the property or pay the lender for any deficiency. Note: Private mortgage insurance protects the lender against the insured's nonpayment of the mortgage.

FHA INSURED LOANS. The National Housing Act of 1934 created the Federal Housing Administration (FHA) as a means of stimulating real estate loans by insuring the approved lenders against loss caused by foreclosures. The FHA, acting under The Department of Housing and Urban Development (HUD), neither constructs homes nor lends money. The FHA insures loans made by approved lenders. Although there are several types of insured loans, the most popular program is Title II, Section 303— b, which insures loans for the purchase of one to four family owner-occupied resi­dences and condominiums. As of December 15, 1989, the home must be owner-occupied.

FHA REQUIREMENTS AND REGULATIONS:

1. Interest Rates. HUD or FHA does not regulate interest rates. Rates are negotiable with the lender.

2. Insurance. The borrower pays a one-time insurance premium at the closing, or it can be added to the mortgage. A mortgage insurance premium (MIP) is associated with FHA insurance.

3. Appraisal. A HUD appraiser estimates the property value and closing costs in order to determine the maximum insurable loan value. The appraisal permits the buyer to include a portion of the closing costs in the mortgage.

4. Minimum Property Standards. To qualify for FHA insurance, the property must meet certain minimum standards regarding the type and construction, quality of the neighborhood, and credit requirements of borrowers.

5. Statement of Occupancy. Buyer must certify that he or she intends to occupy the property.

6. Loan Prepayment Privileges. On loans for one to four family, owner-occupied homes, the borrower retains the privilege of prepaying the debt without penalty. The lender has the option of charging the thirty days interest if the borrower fails to give a thirty-day notice prior to prepaying the loan.

7. Discount Points and Origination Fee. The lender may charge a 1% origination fee, and whatever discount points are necessary to cover the costs of writing/L, II the loan. Either the buyer or seller may pay origination fee and discount points.

8. Secondary Financing. Secondary financing is not permitted at the time the ' 4 FHA loan is made. After the closing, there is no prohibition to secondary financing.

9. Maximum Loan Amounts. The amount of the loan which will be insured depends upon the FHA appraised value and not the purchase price. Generally, the amount of the loan insured cannot exceed 97% of the first $25,000 of appraised value plus 95% of the remainder. The buyer may pay the difference in cash if the purchase price exceeds the appraised value.

10. Assumption Rules. Generally, FHA loans are assumable but with buyer qualification. Prior to December 1986, an FHA loan could be assumed without any restrictions. Since then, a credit-worthiness review is required of the person assuming the loan on a single-family residence, if the loan is less than one year old or two years old for investment property. Since December 15, 1986, there are no assumptions without complete buyer qualification.

11. Other FHA Programs. In addition to insuring regular home and condominium purchase loans, the FHA has other programs, such as: (a) property improvement loans, (b) urban renewal, (c) low and moderate income programs, (d) loans for active military personnel, (e) graduated-payment mortgage plans and (f) adjustable rate mortgages (ARMs).

MORTGAGE LOAN REPAYMENT TECHNIQUES

STRAIGHT LOAN. A straight loan requires periodic payments of interest only, with the principal to be paid in full upon maturity. Straight loans are also referred to as term loans, or standing mortgages. The final payment is a balloon payment since it is larger than any of the preceding payments. For example, a five-year note is written for $4,000 at an annual interest rate of 12%. Interest is due quarterly in payments of $120.00 each, with the entire principal due in one payment at maturity.

INSTALLMENTS NOTE. This note requires a fixed amount to be paid on principal (level principal payment) at each installment, plus interest due on the outstanding loan balance since the previous payment. The amount of interest paid each month decreases as the principal balance decreases.

For Example: A loan is made for $12,000 at 6% interest for one year. Principal is payable in twelve equal monthly installments of $1,000 each plus interest on the unpaid balance. The interest for the first month is $60 (one-twelfth of $720), making the total first payment on principal and interest $1,060.00. Interest for the second month is $55.00 (one-twelfth of $660 which is 6% of the balance of $11,000). The final payment if $1,005.00.

AMORTIZED LOAN - DIRECT REDUCTION LOAN. Most mortgages are written as amortized loans with regular monthly payments to be applied first to interest, and the balance to the principal over a period of time (15 to 30 years). At the end of the term, the principal, as well as all interest due, will have been fully repaid. If the monthly payment is a constant amount, it is referred to as a level-payment loan. Mortgage payment tables and loan progress charts are available from banks and financial publishers to determine the monthly payment of amortized loans. Example of an Amortized Loan. A $90,000 loan for 25 years at 9% requires monthly payments of $756.00 according to the amortization table in Figure 9:2. Breakdown of principal and interest for the first three months is a follows:

Explanation: Each payment is applied first to interest, and to principal. As the principal is reduced, the interest portion decreases and the principal portion increases, while the total payment remains level.

Figure 9:2     Amortization Table — Monthly Payment per $1,000 of Loan

VARIATIONS OF DIRECT REDUCTION LOANS

During times of increasing or fluctuating interest rates, lenders are reluctant to make mortgage loans, which are locked into a fixed annual interest rate. To compensate for changing interest rates, lenders have introduced a variety of loan repayment methods. Basically, they fall into one of three categories or any combination, thereof:

1. Adjustable Rate Mortgages (ARM). (Variable Rate Mortgage).

2. Rollover Mortgages. (Reviewable Rate or Renegotiable Rate Mortgages).

3. Graduated Payment Mortgages.

ADJUSTABLE RATE MORTGAGE (ARM). 

The loan is originated at one rate of interest, with the rate fluctuating up or down during the loan term based on a certain economic indicator, such as the prime interest rate, six-month Treasury bills, or the consumer price index. The amount of the monthly payment on principal and interest may be constant, or it may vary as interest rates change. Interest adjustments may be affected through changes in the monthly payment, the outstanding principal, the loan term or a combination of all three. The loan may be capped to prevent the interest rate from rising above a designated amount. Note: The interest rate of an adjustable rate mortgage may be adjusted periodically using a predesignated index formula.

The method of repayment may result in negative amortization in situations where a fixed monthly payment is not sufficient to cover the interest resulting from a rate increase. The additional interest is added to the original debt, thus increasing the principal loan balance and reducing the homeowner's equity. This is also known as a "float’ mortgage. To minimize negative amortization, a cap or ceiling may be placed on payment adjustments for interest rate or balance.

ROLLOVER MORTGAGE. 

A rollover mortgage provides for a constant interest rate and a constant monthly payment, but only for a short period of time. The borrower signs a balloon note which allows for interest rate adjustments at periodic intervals, usually no more than five years. The monthly installment payments are calculated on the basis of a twenty-five or thirty year term and not on the original term of the note. Periodically, as the note matures, the bank may adjust the interest rate up or down according to an agreed upon index. There is usually a maximum on the adjustment of the interest rate during any given period. The mortgage term, at the borrower’s option, and not the lender’s, may be rolled over or extended for additional periods. If the index calls for a decrease, the rate must go down, but increases are at the lender’s option. Upon being notified of an increase in the interest rate, the borrower has the right to pay off the mortgage without penalty. Interest adjustments may be provided for in the same manner as an adjustable rate mortgage.

GRADUATED PAYMENT MORTGAGE. A graduated payment mortgage allows for lower payments in the early years of the contract than those under a standard mortgage. The monthly payments increase every five or ten years to higher levels in later years when, presumably, the homeowner can better afford them. The interest rate remains constant during the entire term of the mortgage. During the early years, little or nothing is principal in order to maintain a low monthly payment, which can result in negative amortization. Graduated payment mortgages originated with the FHA. Many lenders offer combinations of graduated payment and adjustable rate mortgages.

CREATIVE FINANCING

Creative financing refers to the use of any financing technique that will bring buyer and seller together for a mutually agreeable sale. During the late 1970’s and early 1980’s, real estate sales were down because of high interest rates and a shortage of money for real estate loans. This situation led to some innovative financing, most of which involves seller-assisted financing, such as purchase money mortgages, second mortgages, mortgage take-overs, buy-downs and wrap-around mortgages.

Deferred Purchase Money mortgage. A deferred purchase money mortgage is taken back by the seller to defer the payment the purchase price. It may be a first or a second mortgage.

MORTGAGE TAKE-OVER. The buyer takes title, subject to the seller’s existing mortgage, which is usually assumed by the buyer. For detailed discussion of mortgage take-overs, see Chapter 8.

Buy-Down or Subsidized Mortgage. A "buy-down” is a technique used by developers to promote sales when interest rates are high. The purchase agreement is conditioned upon the seller's agreement to pay ("buy-down") a portion of the buyer’s monthly mortgage payments for the first year or two after the sale. For example, a buyer obtains a $100,000 mortgage for 30 years at 11%. If the seller agrees to pay the portion of the buyer's interest which exceeds 9% for one year, the buyer’s monthly payments would be reduced about $150 per month for the agreed time period. A Lender’s Buy-Down is one where the lender deposits money into an escrow account to be used to "buy-down" the borrower's monthly payment for one or two years of the mortgage term. For income tax purposed, a buy-down may be treated as taxable income or as a capital gain when the property is subsequently sold.

Equity Sharing. An equity-sharing loan is used when a resident-owner shares the equity of a home with a non-resident owner or investor. For example, parents who wish to sell their present home to a son or daughter, may finance the purchase price in return for which they may continue to occupy it.

Wrap-Around Mortgage. Property is sold subject to a mortgage and with a seller take-back second mortgage. The buyer makes a single monthly payment to the seller to cover the second mortgage. The seller makes the first mortgage payments. For detailed discussion of wrap-around mortgages, see Chapter 8.

Installment Contract, Land Sales Contract, Contract For a Deed, Conditional Sale Contract. These are all agreements for the purchase of real estate whereby the seller retains the legal title as security for the buyer's promise to pay at a future date. The purchase price may be paid in installments of principal and interest over the period of the contract, with the balance due at maturity. The contract is usually recorded to protect the buyer’s interest. Until delivery of the deed, the buyer has equitable title.

Note: In an "installment land contract", the deed is typically delivered when the terms of the contract are satisfied. In the event of default, the seller would not have to go through foreclosure in order to recover title.

A contract for a deed may be used as an alternative method of financing in a tight money market. For example, a young couple that has difficulty qualifying for a bank loan can sign a contract for a deed, enabling them to take possession, and when their income increases, refinance to pay off the contract. A major disadvantage to a buyer in this type of sale is the possibility of the seller being unable to give good and marketable title at the required time because of a defect in title or a disability of the seller.

SECONDARY MORTGAGE MARKET

The secondary mortgage market is a system, which allows mortgage lenders to sell their loans. Most secondary mortgage market activity began in 1969 and 1970 when high interest rates being offered by competing borrowers caused may depositors to withdraw their money from savings banks for investments of higher yields than the fixed rates offered by the banks. This outflow of cash left the banks with insuf­ficient capital to make new home mortgage loans, and there was a danger that the outflow could exceed the repayments of outstanding loans. The secondary mortgage market provided primary lenders an opportunity to liquidate some of these mortgages and to reinvest the money at higher market rates. As a result, the secondary mort­ gage market has indirectly helped the sale of homes during tight mortgage times.

 The secondary mortgage market also provides a means for investing in real estate loans through the purchase of mortgage-backed securities. Mortgage market originators and lenders sell their loans at discount to secondary mortgage market participants. The mortgage loans are packaged and sold in small units by investment bankers and stockbrokers to investors in the form of "pass through" securities. Investors include individuals, institutions, pension funds, life insurance companies and S&Ls. Interestingly, S&Ls are the largest sellers and the largest buyers in the secondary mortgage market.

 In order to understand the secondary mortgage market, it is helpful to compare it to the traditional or primary mortgage system which is illustrated in Figure 9:3. Traditionally, mortgages were made to borrowers by local banks using money borrowed from depositors in the same community. These lenders consisted of S&Ls, mutual savings, cooperative banks, commercial banks and credit unions. The primary lenders established their own interest rates, loan terms, loan-to-value ratio, application procedure, borrower qualifications and appraisal requirements.

 In the secondary mortgage market system, as illustrated in Figure 9:3, money flows from investor to borrowers through a conduit of discount purchases (packagers), investment bankers and stock brokers. In order to maintain uniformity and to protect mortgage purchasers, HUD requires the use of standardized procedures and forms for loan applications, appraisals, title insurance, credit report, closing statements, approval requirements, promissory notes and mortgages.

Figure 9:3                                   

MONEY FLOW IN HOME MORTGAGE FINANCING

Primary or Traditional Market

Secondary Mortgage Market

THREE MAJOR DISCOUNT PURCHASERS IN THE SECONDARY MORTGAGE MARKET

There are several secondary market participants which purchase discounts mort­ gages at weekly auctions. The discount varies according to the current interest rates and other economic trends.

FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA). "Fannie Mae” was organized by Congress in 1938 as a government institution to purchase FHA mortgages from private lending institutions. In 1968, Fannie Mae became a private, profit-making mortgage corporation and since 1970 it has been authorized to purchase conventional loans as well as FHA loans. In 1982, Fannie Mae announced that it would purchase first mortgages and junior mortgages from any mortgage originator, including banks and individuals, such as sellers taking back purchase money mortgages. Note: The primary purpose of Fannie Mae is to purchase mortgages from primary mortgage lenders.

 Fannie Mae secures funds to operate from the sale of notes or bonds, which are traded on the major securities market. Purchases are made weekly from sellers at auctions. Prices are thus kept in line with money market conditions. Fannie Mae is owned by its shareholders and managed independently of the government.

 When a mortgage has been assigned to Fannie Mae, the originator or primary lender continues servicing the loan, acting as a collector for Fannie Mae. The original borrower may never be aware that the mortgage has been assigned. In anticipation of selling its mortgage to Fannie Mae, the lender may charge discount points at the closing to help offset its loss when the loan is sold in the secondary mortgage market. Prior to December 1986, mortgages purchased by Fannie Mae were treated as being assumable, regardless of the terms of the mortgage contract between the lender and the borrower. Since then, assumptions are subject to buyer qualification by the primary lender.

GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA). "Ginnie Mae" is a government owned corporation, which was created in 1968 when Fannie Mae became a private corporation. Through its mortgage backed securities (MBS) program, Ginnie Mae has created new sources of credit for FHA, VA, and FmHA mortgages. Primary lenders or mortgage originators create pools of mortgages of similar interest rate and maturity. This is known as "packaging", and the pools must have a minimum value of $1 million. Ginnie Mae sells government guaranteed certificates representing undivided ownership's in the pool. These are known as pass though securities since the investor receives periodic payments of principal and interest. The interest rate is 1/2% less than the interest rate on the loans in the pool. Mortgage backed securities are sold by security dealers in minimum units of $25,000 each.

FEDERAL HOME LOAN MORTGAGE CORPORATION (FHLMC). "Freddie Mac" provides a secondary mortgage market for S&L members of the Federal Home Loan Bank System. FHLMC deals primarily in conventional mortgages. Freddie Mac issues guaranteed securities known a Participation Certificates against its own mortgage pools.

OTHER ACTIVITIES OF FANNIE MAE AND GINNIE MAE

To stimulate bank loans for the construction of low and moderate income housing, Fannie Mae and Ginnie Mae can make commitments to lending banks to buy original loans at current market rates, thus enabling the banks to make loans below market interest. Ginnie Mae purchases home taken over by HUD on FHA foreclosures. The lender buys the property at foreclosure and sells it to HUD for the balance due on the mortgage plus costs. HUD the sells the property privately, and Fannie Mae and Ginnie Mae subsidize the new mortgages for low-income purchases.

Home Seller Program. The home seller program is a secondary market for sellers who take back purchase money mortgages, Fannie Mae will purchase seller take-back mortgages provided they meet Fannie Mae loan qualification specifications.

TRUTH IN LENDING

THE FEDERAL CONSUMER CREDIT PROTECTION ACT OP 1968. The Consumer Credit Protection Act, which is better known as the Truth-In-Lending Law (TIL), requires that everyone who regularly extends or arranges for loans to consumers must give the consumer a meaningful disclosure in writing of the terms of the transaction. The disclosure must spell out every detail of the credit transaction so that the borrower does not have to make any computations to translate percentages into dollar amounts or vice versa. The total finance charge or cost of borrowing the money must be disclosed as a dollar amount and as an annual percentage rate (APR). Truth-In-Lending imposed neither uniform interest rates nor finance charges. Rather, it addresses itself to the mode and language of disclosure.

Regulation Z. The federal Truth-In-Lending law is administered by the Federal Reserve Board, which established "Regulation Z” to implement the law. The Federal Trade Commission is responsible for enforcing TIL. In practice, the Federal Truth- In-Lending Law is referred to as "Regulation Z”

Note: "Regulation Z" is the law calling for "full disclosure" in advertising.

State Truth-In-Lending Law. States are required to adopt TIL laws, which are equivalent to the federal law, in which case the state administers and enforces the law. In Massachusetts, the TIL is covered by M.G.L., Chapter 140C.

LOAN TRANSACTIONS SUBJECT TO TIL. Loans not secured by a lien on real estate are subject to TIL if:

1. The Loan is for personal, family, agricultural, or household purposes.

2. The loan does not exceed $25,000.

3. A finance charge is required.

4. The borrower is allowed to repay the loan in more than four installments. 

LENDERS NOT SUBJECT TO TIL. Lenders who extend credit to business organizations or for commercial purposes are not subject to TIL.

REAL ESTATE MORTGAGE LENDERS SUBJECT TO TIL. TIL applies to all lenders who make mortgage loans as part of their regular business, such as banks, mortgage companies, insurance companies, etc.*, and to persons who arrange a mortgage for a fee. TIL covers first and second mortgages, home improvement loans, refinancing, and construction mortgages.

REAL ESTATE MORTGAGE LENDERS NOT COVERED BY TIL. TIL does not apply to individual lenders who do not make mortgage loans as part of their regular business, such as sellers who take back deferred purchase money mortgages or sell property subject to a mortgage takeover. This exception applies only to a first mortgage. For example, a homeowner who sells a home and takes back a first mortgage to secure part of the purchase price is not subject to TIL. However, if the seller takes back a second mortgage, the transaction is subject to TIL. In the case of a mortgage assumption, the bank that holds the mortgage is subject to the law if the buyer enters into a written agreement with the bank to become personally liable on the debt.

WRITTEN DISCLOSURE. A written disclosure statement of all finance charges, as well as the true annual interest rate (APR), must be given to the borrower prior to the closing. The disclosure must also include loan fees, finders’ fees, service charges and point. Charges for title fees, legal fees, appraisal fees, credit report, survey fees and closing expenses do not have to be included as part of the finance charge but must be disclosed.

THREE DAY RIGHT OF RESCISSION. In any contract or transaction resulting in a mortgage or lien being placed against a person's home or a home, which the person expects to acquire, the customer (buyer) has the right to rescind the transaction until midnight of the third business day following the date of consummation of the transaction or the date of delivery of the disclosure statement. The purpose of rescission is to give unwary homeowners an opportunity to cancel a home improvement contract, which results in a second mortgage or lien on their home to secure payment.

The right of rescission does not apply to first mortgage loans to finance the purchase of a home or initial construction of the borrower's principal residence, and to seller financing (purchase money mortgage) unless it is a second mortgage. Rescission does not apply to a mortgage take-over unless the buyer becomes contract­ usually liable to the lender. Purchase and sale agreements are not covered by TIL.

The right of rescission applies to refinancing a home mortgage loan and to financing the purchase of investment property, such as a non-owner, three family house. The bank withholds the funds until the fourth business day after the mortgage documents have been signed.

ADVERTISING, TRUTH-IN-LENDING REQUIREMENTS. The interest rate in an advertisement must only be stated as an annual percentage rate (APR). Any ad for the sale of real estate, which includes certain words or phrases, may trigger the required disclosure of other items. The following are trigger words or phrases:

1. The amount or percentage of down payment. "5% down" or "$5,000 down", or "95% financing", or "low down payment."

2. The dollar amount of payment. "Monthly payments only $599."

3. The number of payments. "Only 60 monthly payments and you own it."

4. The period for repayment. "35-year financing."

5. The finance charge in dollars or that there is no charge for credit. "Total finance charge for first year $1,999" or "No interest for the first year."

If the ad contains any of the above trigger terms, then the following disclosures must appear in the ad:

1. The cash price or amount of the loan.

2. The cash amount of the down payment or indication that no down payment is required.

3. The terms of repayment - number of payments, amount and frequency.

4. The Annual Percentage Rate (APR) .

For example, an ad that reads, "ONLY $4,500 DOWN" would be in violation unless it also contained the following statement: "Financing Terms: 9% APR, 30-year mortgage for $85,500, monthly payments $724.17 including P&I."

NOTE: An ad containing only the APR without any reference to down payment, or financing terms does not trigger other disclosures. Expressions such as "assumable loan", "financing available", "easy monthly payments" or "FHA/VA financing available" do not trigger disclosure.

ENFORCEMENT AND PENALTIES. The Federal Trade Commission (FTC) is responsible for enforcing Regulation Z real estate provisions. "Regulation Z" requires a "disclosure statement" on principal residences of any value. Creditors who violate the TIL are subject to civil and criminal sanctions. For an intentional violation, a borrower may recover up to $1,000 plus legal costs in a civil action against the creditor. A creditor who is convicted of knowingly and willfully violating the Truth-In-Lending Law can be fined up to $5,000, and sentenced to one year in prison. However, if the creditor makes a simple error in a disclosure statement (not a deliberate violation), the creditor will not be subject to sanctions provided to error is corrected within fifteen days from the time it is discovered. Massachusetts imposes similar civil and criminal sanctions for violations.

REAL ESTATE SETTLEMENT AND PROCEDURES ACT (RESPA) . In 1974 RESPA was passed by Congress to ensure that buyers and sellers of one to four family residences have knowledge of all the settlement costs. RESPA applies only to federally related first mortgage loans made by banking institutions. Federally related loans include those made by banks whose deposits are insured by the FDIC, or by lenders who originate FHA/VA loans, HUD loans and loans intended to be sold to Fannie Mae, Ginnie Mae or Freddie Mac.

RESPA does not apply to transactions financed by a purchase-money mortgage taken back by the seller, and installment contract or the buyer’s assumption of a take­ over mortgage.

RESPA requires the lender to give the buyer/borrower an approximation or "good faith” estimate of the closing costs upon issuing a written loan commitment. A special HUD booklet entitled, "Settlement Costs and You," must be given to the buyer along with the commitment. At the closing, the bank is required to provide the buyer and seller with closing information prepared on a special HUD form known as the Uniform Settlement Statement, which is designed to detail all financial particulars of a transaction. The actual settlement costs do not have to be given to the buyer until the day of the final closing unless the buyer requires them at least one business day prior to settlement. If such is the case the buyer must be shown any settlement costs that are known and available at the time of the request. The HUD Uniform Closing Statement is illustrated in Chapter 17.

KEY WORDS AND PHRASES