Real Estate Practice 051623

1. The Real Estate School
U N I T 1 9
FINANCING THE REAL ESTATE
TRANSACTION
1
Page 369

2. OBTAINING CREDIT
• Cost of Credit – Loan is an investment by the lender
• Lenders evaluate two aspects of the investment:
1. Yield – Return or income that
can be generated
2. Risk – Likelihood that the
investor will lose money
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Page 370

3. OBTAINING CREDIT
• Cost of Credit (cont’d)
• The interest rate that the lender charges the borrower depends
on four factors:
1. Term of Loan – Length of time
2. Type of Loan – Fixed vs. adjustable
3. Amount – Jumbo loans carry greater risk
4. Cost of Money – Rates fluctuate with market
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Page 370

4. OBTAINING CREDIT
• Most real estate licensees encourage buyers to meet with lenders
before looking at property
• Preapproval – Based on a preliminary credit application
• Prequalification – Process by
which lender determines the
upper loan limit of the
borrower
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Page 370

5. OBTAINING CREDIT
• Credit Scores – Result of an analysis of factors characteristic of
repayment and credit risk
• Scores range from less than 400
up to 900
• The higher the score, the lower
the credit risk
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Page 371

6. OBTAINING CREDIT
• Credit Scores (cont’d)
• Five major factors are analyzed:
1. Past payment performance
2. Credit use
3. Credit history
4. Types of credit in use
5. Credit report inquiries
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Page 371

7. OBTAINING CREDIT
• Cost of Credit (cont’d)
• Credit scores not only affect a
borrower’s ability to obtain a loan
but also the interest rate a lender
will charge
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Page 371

8. OBTAINING CREDIT
• Fair and Accurate Credit Transactions Act (FACTA) –
Requires that each of the three major credit bureaus
provides a FREE credit report every 12 months upon
request
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Page 371

9. OBTAINING CREDIT
• Fair and Accurate Credit Transactions Act (FACTA) – Agencies
are required to provide a toll-free number to assist consumers,
correct mistakes, and remove disputed information
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Page 371

10. OBTAINING CREDIT
• Loan Application – Requires loan applicants submit personal
information about their employment, income, assets, and other
financial obligations
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Page 371

11. OBTAINING CREDIT
• Underwriting the Loan – Process of
analyzing the extent of risk a lender
will assume in connection with a
mortgage loan
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Page 372

12. OBTAINING CREDIT
• Underwriting the Loan (cont’d)
• Borrower is evaluated based on the following criteria:
• Occupancy – Owner occupied or investment
• Income – Enough to support borrower
• Assets and Cash Reserves – Verification needed
• Debt – House payment plus other debts
• Loan-to-Value (LTV) – Mortgage ÷ Property Value
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Page 372

13. OBTAINING CREDIT
• Underwriting the Loan (cont’d)
• Lenders often rely on automated scoring systems as part of the
underwriting process
• Freddie Mac’s
Loan Prospector
• Fannie Mae’s
Desktop Underwriter
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Page 372

14. OBTAINING CREDIT
• Loan Commitment – Lender’s pledge to lend a certain
amount of money to a borrower under specific terms using a
particular property as collateral
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Page 372

15. OBTAINING CREDIT
• Loan Commitment (cont’d)
• Commitment letter is in writing and creates a contract between
the lender and the borrower
• May contain conditions that affect the lender’s ultimately
fulfilling its promise of a loan
• Examples: house for sale contingency, title insurance
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Page 372

16. FINANCING LEGISLATION
• Federal government regulates the lending practices of mortgage
lenders through:
• Truth in Lending Act
• Equal Credit Opportunity Act
• Real Estate Settlement Procedures Act
• Community Reinvestment Act
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Page 373

17. FINANCING LEGISLATION
• Truth in Lending Act
• Regulation Z – Requires that credit institutions inform borrowers
of the true cost of obtaining credit
• Generally applies when a
credit transaction is
secured by a residence
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Page 373

18. FINANCING LEGISLATION
• Truth in Lending Act (cont’d)
• Regulation Z (cont’d)
• Consumer must be informed of all finance charges such as
loan fees, finder’s fees, service charges, points, and interest
• The lender must compute and disclose the Annual Percentage
Rate (APR)
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Page 373

19. FINANCING LEGISLATION
• Truth in Lending Act (cont’d)
• Creditor – A person who extends consumer credit more than 25
times a year or more than 5 times a year if the transactions
involve dwellings as security
• Must be subject to a
finance charge or payable
in more than 4 installments
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Page 373

20. FINANCING LEGISLATION
• Truth in Lending Act (cont’d)
• Three-day Right of Recission – Most consumer credit
transactions have three (3) days in which to rescind the
transaction by notifying the lender
• Does NOT apply to owner-occupied residential mortgages
• Does apply to refinancing a home mortgage or home equity
loan
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Page 373

21. FINANCING LEGISLATION
• Truth in Lending Act (cont’d)
• Advertising – Provides strict
regulation of real estate
advertisements that refer to
mortgage financing terms
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Page 373

22. FINANCING LEGISLATION
• Truth in Lending Act (cont’d)
• Advertising (cont’d)
• Annual Percentage Rate (APR) must be stated
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Page 373
APR
+ ÷ =
Interest
Rate
Fees &
Costs
Mortgage
Amount
Annual
Percentage
Rate

23. FINANCING LEGISLATION
• Truth in Lending Act (cont’d)
• Advertising (cont’d)
• Buydowns or reduced-rate mortgages must show both the
limited term to which the interest rate applies and the annual
percentage rate
• Variable-rate mortgages must show the number and timing of
payments, amount of largest and smallest payments, and statement
that payments will vary
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Page 373-374

24. FINANCING LEGISLATION
• Truth in Lending Act (cont’d)
• Advertising (cont’d)
• Trigger Terms – If any of the following terms
are used in the advertisement, they all must
be included:
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Page 374
• Cash price
• Down payment
• Number, amount, and due date of
all payments
• Annual Percentage Rate
• Total of all payments to be made
over the term of the loan

25. FINANCING LEGISLATION
• Truth in Lending Act (cont’d)
• Penalties for non-compliance include:
• $10,000 for each day violation continues
• $10,000 for engaging in unfair or deceptive practice
• Creditor may be liable to consumer for twice the amount of
the finance charge, court costs, attorney fees, and actual
damages
• Willful violations: $5,000 and/or 1 year imprisonment
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Page 374

26. FINANCING LEGISLATION
• Equal Credit Opportunity Act (ECOA) – Prohibits lenders who grant
or arrange credit from discriminating against credit applicants
because of:
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Page 374
• Race
• Color
• Religion
• National origin
• Sex
• Marital status
• Age
• Public assistance

27. FINANCING LEGISLATION
• Equal Credit Opportunity Act (ECOA) (cont’d)
• Must inform rejected credit applicants of the reason(s) for
denial in writing within 30 days
• Borrower is entitled to a
copy of the appraisal
report if they paid for it
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Page 374

28. FINANCING LEGISLATION
• Community Reinvestment Act (CRA) – Financial institutions are
expected to:
• Meet the deposit and credit needs of their community
• Participate and invest in community development and
rehabilitation projects
• Participate in loan programs for housing, small business, and
small farms
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Page 375

29. FINANCING LEGISLATION
• Community Reinvestment Act (CRA) (cont’d)
• Law requires federally supervised financial institutions to
prepare a statement containing:
• Definition of geographic boundaries of community
• ID the types of community reinvestment offered
• Comments from the public about their performance
• Periodically reviewed by federal supervisory agencies
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Page 375

30. LOAN PROGRAMS
• Loan-to-Value (LTV) Ratio = Mortgage ÷ Value
• Higher LTV = Higher Risk
• Lower LTV = Lower Risk
• Example: If a property has an appraised value of $200,000,
secured by an $180,000 loan, what is the LTV?
Answer: $180,000 ÷ $200,000 = 90% LTV
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Page 375

31. LOAN PROGRAMS
• Conventional Loans – Any loans that are not government insured
or guaranteed
• Most secure loan
because the
loan-to-value ratio is
usually 80% or less with
a down payment of
20% or more
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Page 376

32. LOAN PROGRAMS
• Conventional Loans (cont’d)
• Security for the loan is provided solely by
the mortgage and payment of the debt
rests on the ability of the borrower to pay
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Page 376

33. LOAN PROGRAMS
• Conventional Loans (cont’d)
• Qualifications for a conventional loan:
• Total monthly housing expense ≤ 28% of total monthly gross
income
• Total monthly obligations ≤ 36% of total monthly gross
income
• Loans that meet these guidelines are called conforming loans
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Page 376

34. LOAN PROGRAMS
• Conventional Loans (cont’d)
• Maximum loan limits for 2023
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Page 376
General Loan Limits $726,200
High-Cost Areas $1,089,300
NOTE: Updated
limits different than
book

35. LOAN PROGRAMS
• Conventional Loans (cont’d)
• Qualification Example: (NOTE: Be able to qualify the borrowers
based on the facts presented in the example on pages 376-377)
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Page 376-377

36. LOAN PROGRAMS
• Conventional Loans (cont’d)
• Private Mortgage Insurance (PMI) – Insurance policy purchased
by borrowers on loans with LTV greater than 80%
• Provides the lender with funds in
the event that the borrower
defaults on the loan
• Borrower pays monthly premiums
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Page 377

37. LOAN PROGRAMS
• Conventional Loans (cont’d)
• Private Mortgage Insurance (PMI) (cont’d)
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Page 377
$200,000 $180,000
(90% LTV)
Sales Price Mortgage
Lender wants to insure this portion
(10%) of the loan by having Buyer pay
for PMI
Dotted line box represents 20% of the
sales price

38. LOAN PROGRAMS
• Conventional Loans (cont’d)
• Private Mortgage Insurance (PMI) (cont’d)
• Federal law requires that PMI
automatically terminate if a
borrower has accumulated at
least 22% equity in the home
(based on original purchase price)
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Page 377

39. LOAN PROGRAMS
• Conventional Loans (cont’d)
• Private Mortgage Insurance (PMI) (cont’d)
• Borrowers can petition lender
to drop PMI if the home is
located in an area where
homes have appreciated
and equity has reached 22%
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Page 377

40. LOAN PROGRAMS
• FHA Insured Loans
• FHA insurance provides security
to the lender against loss from
borrower default
• Interest rates are competitive with other types of loans
• Borrowers eligible for 96.5% loan-to-value financing for one to
four unit structures
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Page 377-378

41. LOAN PROGRAMS
• FHA Insured Loans (cont’d)
• Technical requirements for FHA loans:
• Minimum 3.5 % down payment
• Borrower pays Mortgage Insurance Premium (MIP)
• Appraised by an approved FHA appraiser
• Maximum mortgage amount varies by area
• Borrower must meet FHA credit qualifications
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Page 378

42. LOAN PROGRAMS
• FHA Insured Loans (cont’d)
• A qualified buyer may assume an existing FHA loan originated
after December 15, 1989
• Investors may not
assume FHA loans
made after
December 14, 1989
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Page 379

43. LOAN PROGRAMS
• FHA Insured Loans (cont’d)
• Discount Points – Allowed
to be charged by lender
• Seller may pay up to 6%
of the buyer’s closing
costs
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Page 379

44. LOAN PROGRAMS
• VA Guaranteed Loans
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Page 379
• VA is authorized to guarantee loans to
purchase or construct homes for eligible
veterans and their spouses
• Little or no down payment
• VA sets qualifications
• Must be owner-occupied

45. LOAN PROGRAMS
• VA Guaranteed Loans (cont’d)
• Certificate of Eligibility – Sets forth the maximum guarantee for
which the veteran is eligible
• Certificate of Reasonable Value (CRV) – States the property’s
current market value based on a VA-approved appraisal
• VA Funding Fee – Financed or payable at settlement and varies
depending on the down payment amount
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Page 380

46. LOAN PROGRAMS
• VA Guaranteed Loans (cont’d)
• Prepayment Privileges – No penalty
• Assumption Rules – In most cases, the VA must approve the new
buyer and assumption agreement
• Original veteran-borrower remains personally liable for
repayment unless the VA approves a Release of Liability
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Page 380

47. LOAN PROGRAMS
• Agricultural Loan Programs
• Farm Service Agency (FSA) offers programs to help families
purchase or operate family farms
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Page 380

48. LOAN PROGRAMS
• Agricultural Loan Programs (cont’d)
• Rural Housing and Community Development Service – Provides
loans to help families purchase or improve single-family homes
in rural areas
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Page 380

49. LOAN PROGRAMS
• Agricultural Loan Programs (cont’d)
• Farm Credit System – Provides loans to farmers, ranchers, rural
homeowners, agricultural cooperatives, rural utility systems, and
agribusiness
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Page 381

50. LOAN PROGRAMS
• Agricultural Loan Programs (cont’d)
• Farmer Mac – Pools or bundles agricultural loans form lenders
for sale as mortgage-backed securities
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Page 381

51. 51

52. FINANCING TECHNIQUES
• Adjustable Rate Mortgage (ARM) – Loan originates at one rate of
interest, then fluctuates up or down during the loan term based
on an economic indicator
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Page 381

53. FINANCING TECHNIQUES
• Adjustable Rate Mortgage (ARM) (cont’d)
• Common components of an ARM include:
• Index – Undeterminable economic indicator that is used to
adjust the interest rate
• Margin – Index plus a premium
• Rate Caps – Limits the amount the interest rate may change
during a specific period and the life-of-the-loan
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Page 381

54. FINANCING TECHNIQUES
• Adjustable Rate Mortgage (ARM) (cont’d)
• Common components of an ARM include: (cont’d)
• Payment Cap – Maximum amount for payments
• Adjustment Period – How often the rate may change (i.e. 1
year, 3 years, 5 years)
• Conversion Option – Permits borrower to convert to a fixed
rate mortgage at certain intervals
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Page 381

55. FINANCING TECHNIQUES
• Balloon Payment Loan – When the periodic payments are not
large enough to fully amortize the loan by the time the final
payment is due
• The final payment is called
a balloon payment
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Page 382

56. FINANCING TECHNIQUES
• Growing Equity Mortgage (GEM) – Uses a fixed interest rate but
payments of principal increase according to an index or a schedule
• Also known as a rapid-payoff mortgage
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Page 382

57. FINANCING TECHNIQUES
• Reverse Annuity Mortgage (RAM) – Allows people 62 or older to
borrow money against the equity they have built up in their home
• Borrower is charged a fixed rate
of interest and no payments are
due to the lender until the
property is sold or the borrower
defaults, moves, or dies
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Page 382

58. FINANCING TECHNIQUES
• Purchase Money Mortgage – Created when the seller agrees to
finance all or part of the purchase price for the buyer
• Often called seller financing or owner financing
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Page 382
OWNER FINANCING AVAILABLE

59. FINANCING TECHNIQUES
• Purchase Money Mortgage (cont’d)
• The buyer/borrower executes a note and a mortgage at the
time of purchase and the seller records the mortgage against
the property
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Page 382

60. FINANCING TECHNIQUES
• Package Loans – Include real
and personal property
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Page 383
• Blanket Loans – Cover more
than one parcel or lot

61. FINANCING TECHNIQUES
• Wraparound Loans – Enables a borrower with an existing loan to
obtain additional financing from a 2nd lender without paying off
the 1st loan
• 2nd lender gives the borrower a new, larger loan at a higher
interest rate and assumes payment of the existing loan
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Page 383

62. FINANCING TECHNIQUES
• Open-End Loans – Secures a note
executed by the borrower to the
lender to secure future advances of
funds made by the lender to the
borrower
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Page 383

63. FINANCING TECHNIQUES
• Construction Loans – Made to finance the construction of
improvements on real estate
• Lender commits to the full
amount of the loan but
disburses the funds periodically
during construction
• Borrower arranges permanent loan to pay off construction
financing when the work is completed
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Page 384

64. FINANCING TECHNIQUES
• Sale and Leaseback – Real estate used by seller for business
purposes is sold to an investor who then leases the property back
to the seller
• Enables a business to free
money tied up in real estate
and use it as working capital
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Page 384

65. FINANCING TECHNIQUES
• Buydowns – A way to temporarily (or permanently) lower the
interest rate on a mortgage loan
• Lump sum is paid to the lender
in cash at closing to offset the
interest rate and monthly
payments during the loan’s
first few years
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Page 384

66. FINANCING TECHNIQUES
• Home Equity Loans – A source of funds using a home’s equity
• The original mortgage loan
remains in place and the
home equity loan is junior
to the original loan
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Page 385