Mortgage Rates and Mortgage Brokers
To understand the function of a mortgage broker, a key component of understanding how they operate is to understand how the mortgage broker sets their mortgage rates.
A mortgage broker is predominantly a credit facilitator. Their job is to obtain the customer, which is the home loan borrower, process the loan request which entails verifying the borrowers employment as well as their assets and credit, submit the loan to a wholesale lender and upon loan approval, coordinate the loan closing.
Mortgage brokers may offer the lowest mortgage rates in the local market or they be the highest or just somewhere in between. Since mortgage broker is technically a facilitator of credit, the mortgage loan is funded by a wholesale mortgage lender or bank. Mortgage wholesale lenders fund the loans for the broker and provide the price at which they will fund the loans.
During the peak boom in mortgage originations, most all of the major banks in the U.S. engaged in wholesale mortgage lending or obtaining mortgage loans from brokers. Citibank, Wells Fargo, Bank of America, US Bank, National City Bank, Chase Bank and HSBC all had wholesale lending divisions which acquired home loans from brokers.
The mortgage rate and any discount points determine the price the wholesale lender will pay for the loan. The mortgage broker makes their money on any extra fees and the increase in rate or points over that paid by the wholesale lender. As an example, if the wholesale lender offers to pay the mortgage broker a mortgage rate of 5.25% and 1 point for a standard $200,000.00 mortgage loan and the broker in turn offers the customer a mortgage rate of 5.25% and 2 points, the mortgage broker makes the 1 point. 1 point represents 1% of the loan amount. The broker could offer the customer 5.75% and 1 point and make their income based on the difference between the 5.25% and 5.75%, as well.
When the amount of money the mortgage broker makes is based upon the difference between the wholesale mortgage rate and the rate to the borrower, this difference is referred to as a yield spread premium.
The mortgage rates established by the mortgage lender will be influenced by the type of loan, the size of the loan and how long the loan is locked for. Different loan types such as adjustable rate mortgages or FHA mortgages have different rates. Since most of the income derived form mortgage originating is based on a percentage of the loan amount, it is not uncommon to see minor difference sin rates base on loan size. And finally, longer loan lock costs more money since the mortgage lender has to honor that rate regardless of what happens to interest rates and mortgage rates in the market during the time of the loan lock and loan closing.
As a real life example of how this functions, the following is a rate from a wholesale mortgage lender in the U.S that funds loans for mortgage brokers and also engages in retail mortgages or loan that are direct to the consumer. The mortgage lender’s name will not be mentioned.
For a 30 year loan, this mortgage lender offers brokers a mortgage rate of 5.00% on a 30 day loan lock at a price of 101.509. This price means the mortgage broker that delivers to the lender on that 30 day lock at 5.00% will be paid 1.509% of the loan amount as a fee or yield spread premium.
That same wholesale lender offers a mortgage rate of 4.625% on 30 day lock at price of 99.253. This means the mortgage lender needs to be paid .747 points to obtain that rate. This can be accomplished if the mortgage broker closed the loan with the borrower at a rate of 4.625% and 2 points. 0.747 points would go the wholesale lender and 1.253 points would be kept by the mortgage broker. This kind of pricing is similar to bond pricing, in which 100 represents the par rate, over 100 is a premium and under 100 is a discount where each point represents 1% of the loan amount.
The longer the loan lock the higher the cost of the home loans. In this example, that same mortgage lender offers the 5.00% rate at 101.022 for a 6o day lock. Since it costs more for a longer lock, the broker makes 1.509% on the 30 day lock and only 1.022% on the 60 day lock. It is a fair assumption that shorter lock makes more money. In this case, the mortgage lender in fact offers a price of 101.696 on a 15 day lock, which is a slightly higher fee for the mortgage broker than the 30 day lock.
Here is what the rate sheet would like to the mortgage broker with the mortgage rate, lock period and price paid:
Rate 15 Day Lock 30 Day Lock 45 Day Lock 60 Day Lock
4.625 99.455 99.253 99.005 98.765
4.750 100.450 100.253 100.000 99.764
4.875 101.188 100.997 100.738 100.509
4.990 101.530 101.343 101.080 100.856
5.000 101.696 101.509 101.246 101.022
5.125 102.122 101.940 101.672 101.453
5.250 103.119 102.943 102.669 102.456
5.375 103.798 103.628 103.348 103.141
Now, to make this fun. Since this example involves a mortgage lender that offers retail services, we can compare the current mortgage rate offered on their website to any old home borrower to those rates they offer mortgage brokers. ( the wholesale rate sheet is not available to consumers and therefore this comparison is available for those in the mortgage business that have access to wholesale mortgage lender rate sheets )
On the mortgage lenders website, this bank is currently offering a 30 year fixed rate loan on a 30 day lock with a mortgage rate of 4.875% and 0.488 points. The same loan can be had at a rate of 4.750% and 1.323 points or 4.990% and 0.142 points per the website on a home loan in Illinois for $200,000.00.
It has been some months since we have reviewed the mortgage broker / retail lender pricing and I must say that the rates to the mortgage brokers look fairly aggressive. If I apply for a mortgage loan with this lender, the 4.99% rate will cost me 0.142 points and whatever other closing costs they have at closing, the mortgage broker can offer a 4.99% rate to me as well and get paid 1.343 points from the lender and make another 0.142 points if they charged the same points that the retail division of that lender charges. That is a total of 1.485 points on the home loan. If the loan amount is $200,000.00 that equates to a payment to the mortgage broker of $2,970.00. Not bad income for originating one loan. Of course, the mortgage broker will have cost for processing the borrowers loan request as well as fixed costs and marketing costs to finds the customers.
Freddie Mac Finally Stops Buying Interest Only Mortgages
Freddie Mac announced, with little fanfare, that it will stop buying and securing mortgage loans that are based on interest only payments. Freddie Mac is the second largest purchaser of home mortgages in the U.S. behind only Fannie Mae. The press release provide by Freddie Mac announced that on or about September 1, 2010, the company will cease purchasing and securitizing interest only mortgages, including Freddie Mac Initial Interest fixed-rate and adjustable-rate mortgages.
Interest only mortgages became popular near the top of the housing boom, allowing buyers to purchase a larger home based on a lower mortgage payment provided by the interest only loan feature. Interest only mortgage loans offered the borrowers the ability to make monthly payments that were only the interest portion of the debt and paid off none of the principal balance.
The interest only option would be for a specified period after which time the loan would require interest and principal payments to retire the debt in full. The interest only period frequently ran from five to ten years and then principal and interest payments would be scheduled on a fully amortizing basis for the remainder of the mortgage term.
Interest only options were available on both fixed rate mortgages and adjustable rate mortgages. These loans allowed homeowners to make purchases during the period when homes were becoming less affordable. The rational for these home loans is certainly suspect, the borrower is eventually going to be confronted with a larger more mortgage payment once the interest only period expires and for both the mortgage lender and home owner, there is no increase in equity during the interest only period unless housing prices continue to ratchet up. The end result, these types of mortgage loans ended up performing worse than conventional, fully amortizing fixed rate loans.
Fewer of these home loan have been produced in the past months since underwriting standards have become stricter. Borrowers need to qualify for the loan based on a fully amortizing payment instead of just the interest only payment and they often require a larger down payment.
These changes may not put an end to these type of home loans forever but there are certainly fewer banks that make loans that do meet the qualifications established by Fannie Mae and Freddie Mac. It is not likely that very many banks will be willing to take the risk of originating these loans without the security of Freddie Mac purchasing or securitizing the loans and leaving the possibly the bank will get stuck with a greater number of non-performing loans.
Mortgage Loans and Earnest Money Deposits
Once an interested home buyer wants to make an offer on a property, along with a contract to make the offer, the buyer will make an earnest money deposit to go with the offer.
The earnest money deposit is a good faith deposit to indicate that the buyer is serious about the offer and their intentions to consummate a transaction. The earnest money deposit is not to be confused with a down payment. The mortgage loan approval is not dependent or related to the earnest money deposit.
This deposit money is given to the real estate agent, attorney or seller at the time of the offer and if the seller accepts the offer, the earnest money is held in escrow until closing. If the earnest money is documented properly, it will generally be applied to the down payment or the buyer’s portion of the closing costs when the purchase goes forward.
If the purchase offer for the home is rejected, the earnest money is usually returned, since there is no legal contract between the buyer and seller. If the buyer withdraws the offer or does not fulfill the contract terms after the contract is properly executed by buyer and seller, the earnest money may be forfeited.
The amount of the earnest money deposit varies significantly depending on factors such as local practices in the specific market area, the price of the home, and the supply and demand for homes at that time of contract negotiations.
It is, of course, generally in the seller’s best interest to see a large earnest money deposit. With the larger deposit, the seller is in general more convinced to accept the purchase offer. This is a strategy that is more likely to be utilized in high demand markets where homes are selling at a brisk pace. In other markets, earnest money deposits of $500.00 or $1,000.00 are quite acceptable.
Understanding the market is the principal guideline for determining the amount of the deposit. Real estate professionals will all have opinions on what is a satisfactory amount, but unless the housing market has a strong demand and low supply, a lower earnest money deposit is not likely to dissuade a seller.
The buyer should have a contingency to inspect the property and withdraw the offer within a certain time frame written into the contract, with this in mind; it is in the buyer’s interest to make the smallest amount of earnest money possible. If the buyer cannot obtain a mortgage within a certain time frame, for example, the earnest money will be returned in full if the offer stated such a contingency.
To avoid any complications with a mortgage lender about the earnest money deposit and subsequent credit at the time of the mortgage loan closing, copy the check before submitting it with the contract and then copy the front and back once it clears the bank. The mortgage lender will then have ample proof that the funds deposited were the buyers and have already cleared the bank and the buyer will get a full credit for those funds as they may be applied to the down payment or mortgage closing costs at the time of settlement.
Mortgage Clauses and Covenants
When a home loan borrower closes on a new mortgage loan, included in the documents that have to be executed is the mortgage document. The mortgage is the security instrument that pledges the property as collateral for the loan. The mortgage secures your promise that the money borrowed will be repaid.
The terms mortgage and loan are often used interchangeably. But, to be precise the mortgage is actually a lien on the property which secures the loan. The terms of the loan such as the mortgage rate, term and monthly payment are set out on the note not the mortgage. Conditions of default and the terms regarding the security of the property are established in the mortgage document.
The mortgage will include various clauses and terms that protect the mortgage lender as well as the home loan borrower. Examples of the various clauses and covenants that may be included in a mortgage or deed of trust may include:
The mortgage is dated and contains the names of mortgagor and mortgagee. If the deed of trust from is used, the borrowers name appears, identified as trustor, grantor, or mortgagor. The name of the trustee or grantee and the name of the mortgage lender, who is both the trust beneficiary and the note holder also appear.
The note executed by the borrower is reproduced in the mortgage or deed of trust. The note includes an acceleration clause allowing the mortgage lender to declare the entire home loan balance remaining immediately due and payable if the borrower is in default.
The note may provide that the borrower is permitted to pay off the loan any time prior expiration of the full mortgage term without incurring a financial penalty for the early payoff, or it may provide for a penalty to be imposed on the borrower (prepayment penalty) if the debt is satisfied prior to expiration of the full term. FHA, VA and conforming fixed rate loans do not have a prepayment penalties.
The mortgage requires the borrower to pay all real property taxes and assessments on a timely basis, keep the building in a proper state of repair and preservation, and protect the building against loss by fire or other casualty by an insurance policy written in an amount at least 80 percent of the value of the structures. Many mortgage lenders may also require insurance for 100 percent of the loan value minus the lot value.
The mortgage contains a defeasance clause giving the borrower the right to defeat and remove the lien by paying the loan indebtedness in full.
The mortgage provides the right of foreclosure to the mortgage lender if the borrower fails to make payments as scheduled or fails to fulfill other obligations as set forth in the mortgage.
In the deed of trust form, a clause gives the mortgage lender irrevocable power to appoint a substitute trustee or trustees without notice and without specifying any reason, by recording and instrument of appointment on the public record where the deed of trust is recorded.
In both the mortgage form and the deed of trust form, a covenant always specifies that the mortgagor has a good and marketable title to the property pledged to secure payment of the note.
The mortgage or deed of trust may contain an alienation or due on sale clause entitling the lender to declare the principal balance immediately due and payable if the borrower sells the property during the mortgage term and making the mortgage unassumable without the mortgage lenders permission. Permission to assume the mortgage at a mortgage rate prevailing at the time of assumption can be given at the mortgage lenders discretion. The alienation clause may provide for release of the original borrowers from liability if an assumption is permitted. This release is sometimes referred to as a novation.
The mortgage or deed of trust always provides for execution by the borrower. The mortgage or deed of trust provides for acknowledgment by the borrower to make the document eligible for recording on the public record for the mortgage lenders protection.
Mortgage Loans and the Mortgage Note
In making a mortgage loan, the mortgage lender requires the borrower to sign a promissory note. The mortgage note or loan note, which must be in writing, provides evidence that a valid debt exists. The note covers the terms of repayment for the home loan. The note contains a promise that the borrower will be personally liable for paying the amount of money set forth in the note and specifies the manner in which the debt is to be paid. Payment is typically in monthly installments of a stated amount, starting on a specific date. The note also states the annual rate of interest or mortgage rate to be charged on the outstanding principal balance of the home loan.
The mortgage note is a negotiable instrument. It is an unconditional promise or order to pay a specified sum of money on demand at a definite time or, in the case of home loans, at definite time intervals. The note is made “to the order of “or “to bearer”. The negotiability of an instrument allows it to function the same as currency. Promissory notes, stocks, bonds, and checks are examples of negotiable instruments. The person responsible for the notes payment may be called the payor, promisor, or obligor. The person who is to receive the money may be called a payee, promise, or oblige. In real estate, mortgage lenders will require the buyer to sign a security instrument such as a mortgage or trust deed, which are not negotiable instruments. The mortgage is the security instrument that pledges the property as collateral for the loan.
Understanding the terms, interest rate and principal is essential to understanding notes, mortgages, deeds of trust, and all real estate financing methods. Interest is the money paid for using someone else’s money the interest rate is the rate at which the interest is calculated. The principal is the amount of money on which interest is either paid or received. In the case of an interest bearing note, principal is the amount of money the lender has lent the borrower and on which the borrower will pay interest to the mortgage lender.
The note can be an interest only note on which interest is paid periodically until the note matures and the entire principal balance is paid at maturity. Construction loans or notes are usually of this type. Or the note can be a single payment loan that requires no monthly mortgage payments on either principal or interest until the note matures, and the entire principal and interest is paid at maturity. This is seen more frequently in short term notes. The note also can be an amortizing note in which periodic monthly payments are made on both principal and interest until such time as the principal is completely paid. Most mortgage loans are of this type.
The original principal is the total amount of the note or the home loan. This amount remains the same in an interest only or a one payment loan until the entire principal is paid. In a amortizing mortgage loan, periodic monthly mortgage payments are applied first toward the interest and amount of principal gradually decreases. As each successive payment is made, the interest is applied to the declining principal balance; therefore with each successive payment, the interest portion of the payment decreases and the principal portion increases. The first payment is applied mostly toward interest, and the last payment is applied mostly toward principal. The payments can be set at a fixed rate for the life of the home loan, or they can fluctuate as adjustable rate mortgages do based on a specified index, or they can change at set intervals according to a set formula.
Simple interest is usually used to calculate mortgage loan interest. This means the annual rate of interest is used to calculate payments even though payments normally are made monthly. Payments sometimes are set up to be paid quarterly or annually. A payment plan in which payments are made every two weeks or biweekly mortgages have become popular because it reduces the term of the loan and saves a significant amount of interest over the life of the loan. A current home loan can sometimes be converted into a biweekly payment plan.
Mortgage loan interest almost always is calculated in arrears, although it sometimes is calculated in advance. If interest is calculated in arrears, a monthly payment due on the first of the month includes interest for using the money during the previous month. If interest is calculated in advance, a monthly payment due on the first of the month includes interest for the month in which the payment is due. When paying off or assuming a mortgage loan, one must know if the interest is paid in advance or in arrears to determine the amount of interest owed or to be prorated at the home loan closing. Interest must be paid in arrears on all loans sold in the secondary mortgage market.
Mortgage Closings and Per Diem Interest
Many home loan borrowers are confused about a charge on their mortgage loan closing statement referred to as per diem interest. Part of the confusion stems from the fact that this charge is referred to as a closing cost on the good faith estimate provided to the borrower.
Per diem interest means the amount of daily interest payable under a home loan. The mortgage lender needs to calculate per diem interest in order to determine the amount of interest payable by a borrower at the loan closing.
At the loan closing, this will the daily cost of interest form the time the funds are disbursed to either purchase the home or after the three day right of rescission on a mortgage refinance to the time period when the mortgage interest starts to accrue for the first payment.
Most all home mortgages have loans monthly payments that cover a 30 day period of time due on the first of the month. A borrower’s first monthly payment is typically due the first day of the second month after closing. For example, if a loan closes on January 15, then the first monthly payment will be due on March 1 not February 1.
Interest paid on home loans is payable in arrears, using the above payment date example, the March 1 monthly payment will cover interest which accrued during the month of February. Normally, rent payments are calculated another way and are forward payments, the March 1 payment covers the rent for the month of March not February.
Following this same example, the borrower that would close on the home loan on January 15 has their first monthly mortgage payment due on March 1, whether the loan was a refinance or for a purchase. The borrower has a payment due on March 1st that covers all of February’s interest charges and any principal due, but the borrower had access to the funds from the time it disbursed in mid January. To cover the interest charges from January 15 to the February 1st, at the closing the borrower will have to pay interest covering that period from January 15 through January 31 since this interest will not be included in the March 1 monthly payment.
Per diem interest is determined by first multiplying the principal amount of the loan by the interest rate to determine the annual amount of interest payable under the loan. Next, the annual amount is divided by 360 days to determine the per diem interest amount (note mortgage lenders typically calculate per diem interest based on a 360 day year; when calculating per diem interest it always divided by 360 days unless the mortgage lender specifically instructs otherwise). Finally, the per diem interest amount is multiplied by the number of days remaining in the month of closing, including the date of closing.
For example assume that a loan with an original principal amount equal to $100,000 and an annual mortgage interest rate of 7.00% is funded on January 15. To determine all charges at the closing, the mortgage lender must determine the amount of per diem interest which will be payable by the borrower at closing.
The total annual interest is equal to $7,000 or 100,000 x 7%. This is interest for the year and therefore has to be divided by 360 to obtain the daily interest of $19.44. This figure is now multiplied by the 15 days remaining in the month to come up with a total interest charge of $291.60.
This charge will be depicted as a closing cost on the settlement statement but this would seem like a misnomer. The interest charge is simply the cost of having access to that money before the first mortgage payment, referring to interest charges as a closing cost in the same general category as origination fees can appear confusing.
Fundamentals of the Real Estate Transaction
The home buying process involves many steps for both the seller and the buyer from the home listing to the closing on the mortgage loan and transfer of ownership. The fundamental steps involved in a real estate transaction are; the home listing, marketing of the property, the offer and acceptance, real estate sales contract, the mortgage loan financing and settlement.
Listing
The real estate transaction begins when an owner decides to sell a property. The owner may sell the house on their own or more frequently, will enlist the services of a real estate professional through a listing agreement. The listing is a contract wherein a property owner employs a real estate firm to market a property for an agreed period of time at a given price and terms. Under this contract, the real estate firm becomes the agent of the seller. Real estate professionals are generally trained to prepare a competitive market analyses (CMA) and to analyze the prices of recent property sales, current home listings, and properties that have been pulled off the market without being sold. This information is used by the real estate agent to help the seller set an asking price for the property on the listing.
Real estate professionals continue to play a central role in real estate transactions. The most recent statistics show that over 75% of all home purchases involved the use of a Realtor.
Marketing the Property
The real estate broker’s expertise essentially lies in the marketing of the property for the seller. The broker will employ a marketing plan, which often includes the property to be entered on the MLS or multiple listing service with the listing agent, conducting open houses as well as advertising the home in various advertising media. While the listing agent implements the marketing plan, other real estate professionals may assist buyers in locating properties that meet their requirements. Whether a broker is the designated agent of the seller or of the buyer is defined both in common law and in the real estate license law of many states.
Offer and Acceptance
Once the property is made available for sale and marketed, prospective buyers will review and evaluate the property to comparable housing opportunities within the region. Prospective buyers will then narrow down their search and inspect the seller’s property. If the property appeals to one of the buyers looking at houses in the region, one or more of the prospective buyers will make an offer to purchase the property. The buyer’s agent or attorney will prepare an offer to purchase. The offer to purchase will state the buyers offer for the property and the contingencies or conditions upon which the buyer is making the offer including any mortgage or financing contingencies.
Financing
After the acceptance of the offer, the buyer applies for a home loan or financing. The mortgage lender underwrites the loan which entails a detailed risk evaluation of the mortgage applicant and the property. The mortgage lender verifies the borrower’s employment, income assets and completes a credit check to determine the creditworthiness of the borrower. The mortgage lender is also concerned with the property to be used as collateral and whether it will warrant the amount of home loan the borrowers are seeking. An appraiser will provide the mortgage lender with information about the property’s features, condition and value.
Title Examination
While the mortgage lender is underwriting the home loan request, the attorneys in the transaction or sometimes the mortgage lender, will hire a professional called an abstractor or a title insurance company to search the public records on the property. The title search process or search of documents recorded in the public record will reveal how the seller came to be vested in the property and what liens on the property need to be paid at the settlement or closing.
Settlement
After the mortgage lender has underwritten the home loan and the attorneys or title company representative have reviewed the title search, the buyers and sellers are ready for the closing. At the closing , the closing agent will make sure the funds for taxes and other costs have been properly prorated between the buyer and seller and the proper escrows set up for the payment of future real estate taxes. The seller’s attorney will have the seller execute the deed and deliver it to the buyer. The buyer’s attorney will make sure the deed is recorded. Many legal documents are exchanged among the seller, buyer, and mortgage lender including the mortgage and note that details the terms of the home loan.
Mortgages, Title Reports and Encumbrances
Obtaining a new mortgage or home loan requires that the mortgage lender obtain a title and title report on the property that will be used as collateral for the loan. The title report will indicate the owner of the property, the taxes due and any encumbrances against the property.
An encumbrance is a claim, liability, or burden held by someone other than the titleholder which limits or restricts the titleholders’ rights or interest in the property. It is the encumbrance created by the mortgage that gives the mortgage lender security for the home loan. Encumbrances by there selves do not transfer ownership. Encumbrances can be either governmental or private party in nature. Easements, encroachments, mortgages and restrictions are all forms of encumbrances that affect the use of property.
Encumbrances that affect the title are called liens. Liens are the record of financial obligations owed by the title holder. The liens give notice to the world that the property could possibly be sold to satisfy the debt, without the titleholders consent.
There are at least two important reasons why the mortgage lender reviews how encumbrances affect real property. First, the mortgage request being processed will be a lien or encumbrance on the title and any other mortgages that need to be satisfied or paid are also encumbrances on the title. Second, it is important that the mortgage lender understand the consequences of other encumbrances and how they may affect the secured property. This is especially true in the event that the property must be sold at foreclosure or if the mortgage lender takes title to the secured property. The mortgage lender will often not approve a home loan if the property that has the mortgage will have difficulty being sold or transferred.
Liens are generally separated into two categories: general and specific. A general lien is one that encumbers all of a debtor’s property both real and personal. A specific lien applies only to the property specifically named in the lien. Property taxes, for example, are specific liens that encumber only a parcel of real property.
Lis pendens is a term that describes pending legal action that can encumber a title. If a creditor believes that he will not be paid, he may begin a court action to achieve a judgment to secure the debt owed. This judgment gives him the right to place liens on the property of the debtor. When a suit is filed, the person filing the law suit also has the right to record a notice, called a lis pendens, with the recorder in the county where the property is located. The lis pendens gives notice to other creditors as well as to anyone who desires to acquire an interest in the property, that the property may be encumbered by the outcome of the lawsuit.
A mortgage lender will be concerned about lis pendens filed against the title of a property intended to be the security for a home loan.
When there are multiple liens on a property, the priority of the lien is generally determined by the date of the recording. The date that a lien is recorded in the office of the county recorder is most important. Liens are given priority, for order of payment in the event of foreclosure, based specifically on the date that they are recorded. Liens against real property including mortgages for home loans usually are be recorded with the county clerk in the county where the property is located.
The government also has the power to place liens or encumbrances on a property. The government has four significant powers which it can exercise over real property: police powers, eminent domain, escheat and taxation.
Police powers protect and promote the health, safety, and general welfare of the people; these police powers also enhance value. Police powers are protective powers, which are also an involuntary encumbrance on real property. Specific police powers include zoning laws, building codes, subdivision regulations and environmental protection laws.
Zoning laws restrict the way an owner may use his property. The purpose of zoning is to create uniform use of real estate in each area. This uniformity protects the health, safety, and welfare of the community by keeping residences away from the noise, dirt, traffic and pollution caused by industry.
Variances and non-conforming uses are zoning issues that can impact a mortgage lenders position regarding a property. If an owner believes that the zoning law governing his property is unjust, he may present his case to a zoning review board, sometimes called the zoning board of appeals. If the zoning review board agrees that zoning for the property is unjust, the board will issue a variance permit (often called a variance) that exempts the owner from complying with that particular zoning law. The zoning board can also issue a conditional use permit, which allows a variance subject to certain conditions.
Another exception to regular zoning ordinances is a non conforming use ordinance. When the government changes the zoning for a particular area in a way that would not allow the current use of the property, the owner could apply for a non conforming use exception. Once the zoning board approves the non conforming use the owner would be permitted to continue using the property as it was before the zoning changed.
Variances and non conforming uses are very different concepts. When an owner has been granted the right to a non conforming use, the permission will usually terminate with any major change to the use, ownership, or major physical change to the property. In contrast, when the owner has received a variance, the owner has the right to continue that use even after changes occur.
Mortgage lenders would be particularly concerned if a property being used as security is under non conforming use permit because the termination of the non conforming use could greatly affect the properties value.
Building codes set the standards for construction. Building codes specify the materials to be used and also how the materials must be installed. Before building a new structure or modifying an existing one, a building permit must be obtained from the building department of the governing authority, usually the local municipality. Mortgage lenders must be concerned that building codes have been followed correctly during construction and when repairs have been done to the property being used as security. Violations of building codes are punishable by fines, stoppage of construction, or even forced demolition of a building.
In recent years a number of laws to protect the environment have been passed by federal, state, and local government authorities. These include rules regarding lead based paint, radon, asbestos and other pollutants. These laws are important to mortgage lenders because if a property is found to be contaminated it can lesson the property’s value, make it worthless, or even create a cleanup cost exceeding the value.
Eminent domain is a process that permits the government to acquire privately owned real property for a public use or purpose, against the wishes of a private owner. The process by which the government exercises this right is called condemnation. To be successful in its condemnation action, the government must prove to the court that it is paying a fair market price and that the use for which it is taking the property is a greater public need or purpose than that of the owner. The power of eminent domain could be used for example if the government needed to clear an area to build a new public highway. However, the use does not have to be an ongoing public use like highway, park, or school, as long as the use benefits the public. An example could be the city building a property with a store on it and selling it to a developer who will build a new store that is farther from the street and creates a safer traffic pattern for the public.
A mortgage lender would most likely not wish to lend, using a property as security, if the property was currently involved in a condemnation proceeding.
Escheat allows the government to claim ownerless land. If a landowner dies without leaving a will and no heirs can be found, the ownership escheats, or transfers to the government. This law has no real effect on the mortgage lending process.
Real estate taxes and other taxes create their own special liens. Real estate taxes are specific liens which encumber only the specific property to which they are related. Income taxes and other taxes owed by an individual become general liens which encumber all of his property. There are two categories of real property taxes: ad valorem taxes and special assessments.
Ad valorem means “according to value”. Ad valorem taxes are the annual taxes charged real property owners, according to the value of the property. The local assessor determines the value of the property. Ad valorem taxes are generally paid semi annually, sometimes in advance and sometimes in arrears.
If an owner fails to pay his property taxes, there is a lengthy process by which the county can collect the past due tax. This process is designed to prevent errors and to protect against improper or wrongful taking of private property. However, the government can eventually seize the encumbered real property and sell it at auction to satisfy the lien for unpaid taxes. If the property is sold voluntarily, or at a foreclosure sale held to satisfy other debts, unpaid taxes remain a lien on the property. The new owner may lose the property if the taxes and penalties are not paid. Mortgage lenders often charge home loan borrowers a tax service fee at the loan closing which is a one time fee used to pay for monitoring the real estate taxes on the property to assure future delinquent real estate taxes do not impair the loan of the mortgage lender.
In contrast to ad valorem taxes, special assessments are imposed on a select community segment that will benefit from certain necessary improvements. Examples of these local improvements include sidewalks, curbs, streets, lighting and water mains. Special assessments for the cost of these improvements are divided among the properties that will benefit from these improvements. These costs can be divided in a number of ways; front footage (width of the property), estimated anticipated benefit, or overall size of property. However, the assessment will never be divided based on the value of the properties.
Mortgage lenders must be concerned with taxes since they could result in foreclosure and in the borrower’s loss of the property or in a decrease in the property’s value.
There are a number of non-governmental encumbrances that impact the mortgage lenders approval process and the property title. Private parties may encumber real property. Private encumbrances on real property can be voluntary or involuntary. Examples of voluntary encumbrances include mortgages, restrictive covenants and conditions, easements and licenses. Involuntary encumbrances include mechanics liens, prescriptive easements, and encroachments.
A mortgage on real property is an owners pledge to have his property held as security for payment of a debt or obligation. When a property is encumbered by a mortgage, a voluntary lien is placed against the property. If the lien is not satisfied, the property may be foreclosed upon, with the proceeds applied to the borrower’s debt. Actually, a borrower does not get a mortgage from a mortgage lender when they buy a home; the borrower gives a mortgage to the mortgage lender using their home as collateral or security.
Covenants, conditions, and restrictions, as described with regard to determinable fee estates, are the limitations placed on real property by previous owners and can certainly affect value and, thereby, become a concern to the mortgage lender.
An easement grants a person or persons the right to use a portion of another owner’s land for a particular purpose. An easement may exist in the subsurface, the surface or the air space above a property. The easement only grants an interest in the land, never the rights of possession.
A mortgage lender would look individually at any easement which affects the property to be used as security. Utility easements along property boundaries are fairly common and have little effect on the property’s use as security for a loan; however, if an easement ran through the center of the house and gave the utility company the right to tear down the house to get to its pipeline, it would be of major concern.
Involuntary encumbrances may include mechanics liens, encroachments and judgments.
A mechanic’s lien is a specific, involuntary lien that protects the interest of workers who have expended time, energy, and/or materials to improve a property. The theory behind the mechanic’s lien is that the mechanic’s effort and/or materials have increased the value of the real property and, thus, he should be entitled to place a lien against the property to ensure payment.
Mechanic’s liens also have a special feature. If the mechanic begins suit within a specified period of time after completion of the work, the lien will be given priority based on the date work commenced, rather than the date the judgment was granted.
This special feature allowing the date of the lien to relate back to the date work started makes it necessary for a mortgage lender to check to see if it appears any work has been completed recently to the property being used as security of the loan. The appraiser is generally asked to take note of any work appearing to be recently completed; the borrower is also asked to sign a statement to this effect at closing of the home loan.
An encroachment is the illegal use or occupation of one owner’s real property onto another owner’s real property. An encroachment typically occurs when a tree, fence, garage, or even a home crosses over the lot line onto a neighboring property. Encroachments are not usually disclosed by a title search; instead they are discovered through physical inspection or a survey of the land. The title to property that has been encroached upon may be unmarketable until the encroachment is removed and thus a mortgage lender is not likely to approve a home loan with a noted encroachment.
Encroachments are one of the important reasons that the mortgage lender will insist upon a survey including all the improvements currently on the property.
Judgments are a third category of involuntary encumbrances. A creditor who wants to collect an unpaid debt can file suit asking the court to enter judgment creating a lien on the debtors’ property. The creditor may then foreclose and force a sale of the property to satisfy the debt.
Mortgage Approvals and Compensating Factors
Mortgage loans are approved based on a fairly strict set of guidelines. Some of the guidelines are hard rules that can not be broken. An example of hard rule is the maximum loan to value ratios or down payment requirements. If a home loan for a particular 30 year fixed rate mortgage requires a 5% down payment or a loan to value of 95%, 4.75% down payment will not be accepted. On the other hand, some rules are general guidelines.
An example of a general guideline is the debt ratio requirement. Standard debt ratios are approximately 32% for the amount of the borrowers’ gross monthly income that can be used for the monthly mortgage payment and a 38% ratio representing the amount of the gross monthly income that can be allocated for the monthly mortgage payment and all other monthly debt obligations. These debt ratios are guidelines. A home loan applicant that has debt ratios of 33% and 40% may very well be approved for a mortgage loan.
In situations where a home loan borrower has debt ratios that exceed the guidelines or perhaps a credit history that is slightly below the requirements, a mortgage lender will look for compensating factors to justify making the home loan approval.
Compensating factors that may be used to justify approval of mortgage loans with ratios exceeding the benchmark guidelines are evaluated on a case by case scenario. Any compensating factor used to justify mortgage approval must be supported by documentation with the mortgage lender.
Common compensating factors that are reviewed to approve a home loan that is just marginally beneath the loan guidelines include:
The borrower has successfully demonstrated the ability to pay housing expenses equal to or greater than the proposed monthly housing expense for the new mortgage over the past 12-24 months.
The borrower makes a large down payment, one that is above the minimum established for the home loan program applied for, toward the purchase of the property.
The borrower has demonstrated an ability to accumulate savings and a conservative attitude toward the use of credit.
A previous credit history shows that the borrower has the ability to devote a greater portion of income to housing expenses.
The borrower receives documented compensation or income not reflected in effective income, but directly affecting the ability to pay the mortgage, including food stamps and similar public benefits.
There is only a minimal increase in the borrower’s housing expense.
The borrower has substantial documented cash reserves (at least 3 months worth) after closing. In determining if an asset can be included as cash reserves or cash to close, the mortgage lender must judge whether or not the asset is liquid or readily convertible to cash and can be done so, absent retirement or job termination.
Funds borrowed against these accounts may be used for home loan closing, but are not to be considered as cash reserves. “Assets” such as equity in other properties and the proceeds from a cash-out refinance are not to be considered as cash reserves. Similarly, funds from gifts from any source are not to be included as cash reserves.
The borrower has substantial non-taxable income (if no adjustment was made previously in the ratio computations)
The borrower has potential for increased earnings, as indicated by job training or education in the borrower’s profession
The home is being purchased as the result of relocation of the primary wage earner and the secondary wage earner has an established history of employment is expected to return to work, and reasonable prospects exist for securing employment in a similar occupation in the new area. The mortgage loan underwriter must document the availability of such possible employment.
Mortgage Loans and the role of the Secondary Market
The secondary market is where mortgage loans are sold by mortgage lenders and banks and purchased by investors. The secondary market provides a number of benefits for mortgage originators and mortgage lenders, which in turn provides benefits to home loan borrowers.
In order for the secondary mortgage market to work effectively and efficiently, uniform mortgage lending standards needed to be established. The secondary market promoted standardization and uniformity of credit requirements, loan types and loan documents and required forms. This standardization could be a detriment to those potential home loan borrowers that needed special financing but a standardized market improves mortgage rates and greatly facilitates the home loan borrower’s process of comparing and shopping mortgage rates and terms.
Providing liquidity to the mortgage market so that mortgage lenders and investors can buy and sell home loans is the primary value and function of the secondary market. A market to buy and sells mortgage loans allows the mortgage lenders to offer competitive mortgage rates and keep and continual flow of funds available for mortgage lending.
The secondary mortgage market permits mortgage lenders to obtain cash required to fund new home loans at any time. The liquidity in the secondary market also encourages investors to participate and purchase home loan and mortgage backed securities, as the investors can be confident that the home loans can be readily sold at a later time if necessary. The liquidity in the market provides a constant flow of new money into real estate finance that helps to maintain and orderly and competitive market.
Liquidity that is inherent in the secondary market also allows the mortgage lenders to manage their interest rate risk. Mortgage lenders not only have the ability to sell the mortgage loans they originate but they can buy mortgage loans with different terms and mortgage rates to maintain a diversified mortgage loan portfolio. An investor in mortgage loans or a mortgage lender can buy home loans with different mortgage rates and within different geographic areas.
From the mortgage lenders perspective, risk that is in mortgage lending that can be ameliorated through the secondary mortgage market includes interest rate risk, liquidity of funds risks and potential default risk through loan portfolio diversification.
The major institutions that which invest in the secondary mortgage market include the Federal National Mortgage Association or FNMA, the Federal Home Loan Mortgage Corporation or FHLMC, the Government National Mortgage Association or GNMA and a variety of banks and institutional investors.
FNMA, FHLMC and GNMA are government sponsored enterprises that guarantee mortgage loans, purchase mortgage loans and establish portfolios of loans for sale as mortgage backed securities. FNMA and FHLMC operate with conforming loans while GNMA handles FHA home loans and VA home loans. The majority of home loans that are closed meet the lending criteria that are established by one of these entities. Home loans that are originated that do not meet the guidelines established by these entities are often referred to as portfolio loans since the mortgage lender is not concerned about loan resale and holds the mortgage loan for their own portfolio.