Residential and Commercial Property Financing

  • Understanding the Mortgage Concept
    • Secured vs. unsecured loans
    • Mortgage
      • See Figure 16.2 Mortgage
    • Hypothecation
    • Title theory
    • Lien theory
    • Promissory Note
      • A written promise to repay a debt that usually accompanies a mortgage document
        • See Figure 16.1 Promissory Note
      • Prepayment clause
      • Acceleration clause
      • Due-on-sale clause
    • Foreclosure
      • The process of seizing control of the collateral for a loan and using the proceeds from its sale to satisfy a defaulted debt
      • Judicial foreclosure
      • Nonjudicial foreclosure
      • Strict foreclosure
      • Deficiency judgments
  • Alternative Security Instruments
    • Trust Deeds
    • Land Contracts
  • Final Thoughts on Foreclosure
    • Absent a due-on-sale clause property can be sold “Subject to” existing mortgage, but this does not necessarily relieve original borrower from obligation on the debt
    • Assumption of mortgage can sometimes relieve original borrower of obligation
    • Deed in lieu of foreclosure
  • Structure of the S. Housing Finance System
    • The process of creating a new loan agreement between a borrower and lender is known as loan origination.
    • Loan originations occur in the primary mortgage market.
    • The secondary mortgage market consists of transactions involving existing loans being sold from originators to investors or from one investor to another.
    • Federal Housing Administration (FHA)
      • Created in 1934 to help restore confidence to the nation’s housing finance system
      • Helped develop lending standards that reduced lenders’ risk exposure
      • Promoted the use of long-term, fully amortizing loans
      • Established a mortgage insurance program to cover losses to lenders
        • Borrowers pay a fee to purchase an insurance policy that protects the lender from the risk of loss due to default by the borrower
        • In return, lenders are more willing to lend money at favorable rates with relatively small down payment requirements.
      • Upfront and annual fees changes can be implemented by FHA at their direction at any time.
    • Private Mortgage Insurance
      • Competes with government loan insurance and guarantee programs
      • Borrowers pay a fee to purchase an insurance policy that limits the risk of loss faced by lenders in the event of default by the borrower
      • In return, lenders are willing to lend money at favorable rates with relatively small down payment requirements
      • May be less expensive than FHA insurance, but requires a larger down payment amount than FHA insured loans
    • VA-Guaranteed Loans
      • As part of the “GI Bill of Rights,” veterans are able to obtain mortgage loans with little or no down payment and low interest rates.
      • Private lenders are protected from risk of default by a guarantee from the Department of Veteran Affairs that assures repayment of the loan in the event the borrowing veteran defaults on the debt.
      • Note that these loans are guaranteed (not insured), so no premium is charged to the borrower for the guarantee.
      • Borrower does pay a ‘funding fee’ that can change at the direction of the VA.
    • Federal National Mortgage Association (Fannie Mae)
      • Created as a government agency in 1938 to buy FHA-insured mortgages originated by lenders and to sell securities backed by these mortgages to investors, thus providing a secondary market for mortgage loans.
      • Converted to a private company in 1968.
      • Seized by Congress in 2008 at brink of bankruptcy as a company that was “too big to fail” during the recession.
      • Continues today to purchase mortgage loans from originators and repackage these loans into mortgage backed securities that are sold to investors.
    • Government National Mortgage Association (Ginnie Mae)
      • Created in 1968 as a federal agency, GNMA was anticipated to provide subsidized loans to borrowers.
      • In 1970, GNMA introduced a program that guarantees the timely payment of principal and interest on FHA and VA mortgages. This guarantee made “mortgage backed securities” more attractive in the secondary market.
    • Federal Home Loan Mortgage Corporation (Freddie Mac)
      • Created in 1970 to create and operate a secondary mortgage market for “conventional mortgages” (loans with private mortgage insurance or with no insurance).
      • Seized by Congress in 2008 at brink of bankruptcy as a company that was “too big to fail” during the recession
      • Competes with Fannie Mae in the market for all types of mortgages and mortgage backed securities.
  • Mortgage Market Participants and Size
    • As of mid-2014, total amount of mortgage debt in the U.S. slightly exceeded $13.2 trillion, with most of the amount secured by one to four-family structures.
    • As shown in Table 16.1, mortgage debt is held by
      • Commercial banks
      • Savings institutions
      • Life insurance companies
      • Federal agencies
      • Mortgage pools and trusts
      • Individuals and others
  • Federal Legislation Affecting Home Mortgage Lending
    • Equal Credit Opportunity Act
      • Prohibits discrimination based on certain protected classes
    • Consumer Credit Protection Act
      • Requires disclosure of APR
    • Real Estate Settlement Procedures Act (RESPA)
      • Information booklet
      • Good faith estimate of closing costs
      • Prohibits kickbacks
      • Right to copy of appraisal
      • Requires use of HUD-1
      • Limits amount of money that can be required in an escrow or impound account
    • Flood Disaster Protection Act
      • Requires borrower to obtain flood insurance if property is located in a flood zone.
    • Fair Credit Reporting Act
      • Requires borrower’s permission to investigate credit
      • Requires lender to disclose if loan denied for credit report reasons
  • Residential Mortgage Underwriting
    • The process of evaluating the risk of an applicant and the property being pledged as collateral and deciding whether or not to approve the loan.
    • See Close-Up “What is Credit Scoring?”
    • Qualifying the Applicant
      • Applicants are evaluated on the basis of their willingness to repay their debts using a residential mortgage credit report or a credit score.
      • Lenders consider the amount and source of down payment funds the borrower intends to use in the transaction. Lower “loan-to-value” ratios imply lower risk.
    • Qualifying the Property
      • Properties are evaluated by obtaining a title examination and an independent appraisal of the market value of the property.
    • Risk Assessment
      • Loan-to-value ratio (LTV)
        • LTV greater than 80% generally requires some kind of mortgage insurance or guarantee
        • Maximum LTV for FHA-insured loans is approximately 97%
        • Maximum LTV for VA-guaranteed loans is approximately 100%
      • Down payment source guidelines
        • Conventional loan with 80% or higher LTV generally requires 5% down payment from borrower’s own resources though some percentage may be gifted.
        • Government programs vary
      • Income and Debt Ratios
        • Mortgage Debt Ratio: most lenders recognize that principal, interest, taxes and insurance (PITI) obligations should be no more than 28% of the borrower’s gross monthly income for a conventional mortgage or 29% for a FHA-insured mortgage.
        • Total Debt Ratio: most lenders recognize that PITI and other monthly debt obligations should be no more than 36% of the borrower’s gross monthly income for a conventional mortgage or 41% for a FHA-insured mortgage.
        • Successful applicants must qualify under both ratios simultaneously.
  • Sources of Commercial Mortgage Market Capital
    • Individual Investors
    • Life Insurance Companies
    • Pension Funds
    • Real Estate Investment Trusts
    • Commercial Banks
    • Commercial Mortgage Backed Securities (CMBS)
    • Tax Increment Financing (TIF)
  • Commercial Financing Underwriting Criteria
    • Commercial loan underwriters are more concerned with the property’s ability to generate income to repay the debt than they are concerned with the borrower’s income.
    • Lenders typically require that a property’s net operating income exceed the debt service requirement by 15 to 20 percent. By definition, the debt coverage ratio is calculated by dividing the net operating income by the debt service payments.  A lender who requires a DCR of 1.2 is requiring that the property’s net operating income exceed the amount of the debt payments by 20%.
    • Lenders also set maximum loan-to-value ratios for commercial loans. 70% LTV is common as a maximum LTV.