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Transcript of Washington Real Estate Fundamentals Lesson 10: Principles of Real Estate Financing © 2011 Rockwell...
Washington Real Estate Fundamentals
Lesson 10:
Principles of Real Estate Financing
© 2011 Rockwell Publishing
Economics of Real Estate Finance
For a lender, a loan is an investment. Interest paid on loan is lender’s return.Riskier loan requires higher return
(higher interest rate).
Interest rate charged on a loan also depends on market forces and real estate cycles.
© 2011 Rockwell Publishing
Economics of Real Estate FinanceReal estate cycles
Real estate cycles: Periodic shifts in level of activity in real estate market.
Real estate cycles obey law of supply and demand.
© 2011 Rockwell Publishing
Real Estate CyclesLaw of supply and demand
Home prices go up when demand is high and supply is low.
Seller’s market.High prices stimulate home construction.
Home prices go down when supply is high and demand is low.
Buyer’s market.Low prices stimulate demand, and cycle
begins again.
© 2011 Rockwell Publishing
Real Estate CyclesMortgage loan funds
Demand for homes tied to changes in supply of and demand for mortgage loan funds.
When supply of mortgage funds is large: interest rates lowdemand for home loans increases
When funds are scarce:interest rates high (tight money market)demand for home loans decreases
© 2011 Rockwell Publishing
Real Estate CyclesMortgage loan funds
Supply of mortgage loan funds depends on: how much money investors have availablehow much they choose to invest in
mortgage loans
This is affected by:overall economymarket interest rateshow mortgage lending compares to other
investments
© 2011 Rockwell Publishing
Economics of Real Estate FinanceInterest rates and federal policy
Federal government influences real estate financing and rest of economy through:
fiscal policymonetary policy
© 2011 Rockwell Publishing
Interest Rates and Federal PolicyFiscal policy
Fiscal policy includes:spendingtaxationdebt management
Set by Congress and the President, through tax legislation and federal budget.
© 2011 Rockwell Publishing
Interest Rates and Federal PolicyFiscal policy
Federal deficit: Shortfall created when U.S. government spends more than it collects in revenue. To cover deficit, Treasury borrows money by
selling interest-bearing securities to investors.Less money available for investment in
private sector. Increase in deficit tends to make interest
rates rise.
© 2011 Rockwell Publishing
Interest Rates and Federal PolicyMonetary policy
Monetary policy: Federal government’s direct efforts to control money supply and interest rates.
Monetary policy determined by Federal Reserve (“the Fed”).
Major goals:economic growthstability in interest rates and markets
© 2011 Rockwell Publishing
Interest Rates and Federal PolicyMonetary policy
Federal Reserve sets monetary policy using these tools:
key interest ratesreserve requirementsopen market operations
© 2011 Rockwell Publishing
Monetary PolicyKey interest rates
Fed has control over two interest rates:federal funds ratediscount rate
These are rates charged when a bank borrows from another bank or from a Federal Reserve Bank.
© 2011 Rockwell Publishing
Monetary PolicyKey interest rates
If Fed raises key rates, banks also raise interest rates they charge borrowers.
If Fed lowers key rates, banks also lower their interest rates.
Lower interest rates usually stimulate economy.
© 2011 Rockwell Publishing
Monetary PolicyReserve requirements
Reserve requirements: Amount of money (percentage of deposits) banks must maintain on deposit, to meet requests for withdrawals.
If Fed raises reserve requirements:less money available for lendinginterest rates go up
If Fed lowers reserve requirements:more money available for lendinginterest rates go down
© 2011 Rockwell Publishing
Monetary PolicyOpen market operations
Open market operations: When Fed buys and sells government securities (such as Treasury notes).
Fed’s primary method of managing money supply.
© 2011 Rockwell Publishing
Monetary PolicyOpen market operations
Buying government securities from investors puts more money into circulation, so that:
money supply increasesinterest rates go down
Selling government securities to investors takes money out of circulation, so that:
money supply decreasesinterest rates go up
© 2011 Rockwell Publishing
Interest Rates and Federal PolicyOther agencies that affect financing
Several other federal agencies also affect real estate financing, such as:
Federal Home Loan Bank SystemFederal Deposit Insurance Corp. (FDIC)Dept. of Housing and Urban
Development (HUD)Rural Housing ServiceFarm Credit System
© 2011 Rockwell Publishing
SummaryEconomics of Real Estate Finance
• Real estate cycles• Supply and demand• Fiscal policy• Federal deficit• Monetary policy• Key interest rates• Reserve requirements• Open market operations
© 2011 Rockwell Publishing
Real Estate Finance Markets
Two finance markets supply funds for real estate loans:
primary marketsecondary market
© 2011 Rockwell Publishing
Real Estate Finance MarketsPrimary market
Primary market: Market in which mortgage lenders make loans to home buyers.
Historically, primary market was strictly local: local banks and savings & loans.
Now much more diverse, but local economic conditions still have impact on amount of funds lenders have available.
© 2011 Rockwell Publishing
Real Estate Finance MarketsPrimary market
When local economy booming:less money savedlocal lenders can’t keep up with demand
for loans
When local economy slow:more money savedlocal lenders have ample funds but little
demand for loans
© 2011 Rockwell Publishing
Real Estate Finance MarketsPrimary market
For lenders, it’s a problem to have either too much or too little money on deposit.
To address this problem, lenders look for opportunities beyond the local market.
© 2011 Rockwell Publishing
Real Estate Finance MarketsSecondary market
Secondary market: Market in which private investors and government-sponsored agencies buy and sell mortgages secured by real estate nationwide.
Allows local lenders to sell loans, to obtain more funds to make more loans.
Moderates local real estate cycles because it’s a national market.
© 2011 Rockwell Publishing
Secondary MarketBuying and selling loans
Mortgage loans can be bought and sold like other investments (such as stocks or bonds).
Value of loan depends on rate of return and risk of default.
Investors generally buy loans at a discount (for less than face value).But discounted loans can be foreclosed
for face value if borrower defaults.
© 2011 Rockwell Publishing
Secondary MarketGovernment-sponsored agencies
Federal government established three secondary market agencies:
Fannie MaeFreddie MacGinnie Mae
© 2011 Rockwell Publishing
Secondary Market AgenciesSecuritizing loans
Role of secondary market agencies:buying loans from primary market
lendersissuing securities using the loans as
collateralselling these mortgage-backed securities
to investorsguaranteeing investors a return even if
borrowers default
© 2011 Rockwell Publishing
Secondary Market AgenciesUnderwriting standards
To reduce risk of default, agencies established their own underwriting standards.
Underwriting standards: Criteria used to evaluate loan applicant and property offered as security.
Primary market lenders that want to sell loans on secondary market generally must meet agencies’ standards.
© 2011 Rockwell Publishing
Secondary Market AgenciesFannie Mae
Federal National Mortgage Association (FNMA)
Created as federal agency in 1938 to establish secondary market for FHA loans.
Reorganized as private corporation (government-sponsored enterprise, or GSE) in 1968.
Buys and securitizes conventional, FHA, and VA loans.
© 2011 Rockwell Publishing
Secondary Market Agencies Freddie Mac
Federal Home Loan Mortgage Corporation Created in 1970 to provide secondary
market for savings and loans.Like Fannie Mae:
government-sponsored enterprisebuys and securitizes conventional,
FHA, and VA loans
© 2011 Rockwell Publishing
Secondary Market Agencies Ginnie Mae
Government National Mortgage AssociationGovernment agency within HUD.Guarantees securities backed by FHA
and VA loans.
© 2011 Rockwell Publishing
Secondary Market AgenciesRecent developments
Because of severe financial problems brought on by the recession, federal government placed both Fannie Mae and Freddie Mac in conservatorship in 2008.
Also created new regulator for them: Federal Housing Financing Agency (FHFA).
© 2011 Rockwell Publishing
SummaryReal Estate Finance Markets
• Primary market• Secondary market• Secondary market agencies• Government-sponsored enterprises• Loan discounting• Mortgage-backed securities• Underwriting standards
© 2011 Rockwell Publishing
Real Estate Finance Documents
Most real estate buyers are required to sign two finance documents:
promissory notesecurity instrument
(either a mortgage or a deed of trust)
© 2011 Rockwell Publishing
Real Estate Finance DocumentsPromissory notes
Promissory note: Written promise to repay a debt (plus interest, in most cases).
Borrower = MakerLender = Payee
© 2011 Rockwell Publishing
Promissory NotesBasic provisions
Promissory note states:amount borrowed (principal)interest rate (and whether fixed or variable)payment amountwhen and how payments are to be madematurity date (when loan to be paid in full)consequences of default
Does not include property description.
© 2011 Rockwell Publishing
Promissory NotesTypes of notes
Promissory notes classified according to how principal and interest are repaid:
Straight noteInstallment note
© 2011 Rockwell Publishing
Types of NotesStraight note
Straight note: Promissory note used for term loan, also called interest-only loan.
Payments during loan term cover only interest (no principal).
At end of term, borrower must pay back entire principal amount with one balloon payment.
© 2011 Rockwell Publishing
Types of NotesInstallment note
Installment note: Promissory note used for amortized loan.
Part of each payment is interest and the rest is principal.
Each payment gradually reduces loan’s principal balance.
If note fully amortized, payments pay off all principal and interest by end of term.
© 2011 Rockwell Publishing
Promissory NotesSimple interest
Interest paid on a real estate loan is almost always simple interest, as opposed to compound interest.
Interest is computed only on remaining principal balance.
Not computed on previously accrued interest as well as on principal.
© 2011 Rockwell Publishing
Promissory NotesNegotiable instruments
Most promissory notes used in real estate transactions are negotiable instruments.
Negotiable instrument: Debt can be assigned to someone else by endorsement (like a check).
Endorsing note transfers right of payment to new party.
© 2011 Rockwell Publishing
Real Estate Finance DocumentsSecurity instruments
Security instrument: Contract that makes borrower’s property collateral for loan.
Either a mortgage or a deed of trust.If borrower doesn’t repay loan,
lender can foreclose on property.
Foreclosure: Forced sale of debtor’s property so that creditor can collect debt from sale proceeds.
© 2011 Rockwell Publishing
Security InstrumentsSecured creditor
Secured creditor: Creditor who has security interest in debtor’s property.
Promissory note can be enforced without security instrument.Creditor can sue to enforce note.
But secured creditor more certain of collecting debt than unsecured creditor.
© 2011 Rockwell Publishing
Security InstrumentsHistorical background
Hypothecation: Borrower transferred title to lender as security, but retained possession of collateral property.
Lender held legal title (also called naked or bare title): title without possessory rights.
Borrower had equitable title: possessory rights without legal title.
Still works this way in some states.© 2011 Rockwell Publishing
Security InstrumentsHistorical background
In title theory states, lender holds legal title throughout loan term.
In lien theory states: Borrower retains full title while paying
loan off.Lender only has lien against property.
Most states, including Washington, are lien theory states.
© 2011 Rockwell Publishing
Security InstrumentsTypes of security instruments
Two types of real estate security instruments:mortgagesdeeds of trust
Main difference: Foreclosure easier with deed of trust.
Deeds of trust much more widely used than mortgages in Washington and some other states.
© 2011 Rockwell Publishing
Types of Security InstrumentsMortgage
Two parties to a mortgage:mortgagor (borrower) mortgagee (lender)
But note that “mortgage” and “mortgage loan” are commonly used to refer to any loan secured by real estate, regardless of type of security instrument actually used.
© 2011 Rockwell Publishing
Types of Security InstrumentsDeed of trust
Three parties to a deed of trust:trustor or grantor (borrower)beneficiary (lender)trustee (neutral third party who handles
foreclosure if necessary)
Language in deed of trust based in title theory; says legal title conveyed to trustee pending repayment of debt.
© 2011 Rockwell Publishing
Security InstrumentsRecording
Lender should record security instrument as soon as loan is made.
Recording:gives public notice of lender’s lien
against the propertyprotects lender from subsequent claims
© 2011 Rockwell Publishing
SummaryReal Estate Finance Documents
• Promissory note• Straight note• Installment note• Security instrument• Foreclosure• Secured creditor• Mortgage• Deed of trust• Hypothecation• Title theory and lien theory
© 2011 Rockwell Publishing
Finance Document Provisions
Mortgaging or granting clauseTaxes and insuranceAcceleration clauseAlienation clauseLate payment penalty provisionLock-in clausePrepayment provisionSubordination clauseDefeasance clause
© 2011 Rockwell Publishing
Finance Document ProvisionsMortgaging or granting clause
Security instrument must include statement that property is pledged as security for loan.
Mortgaging clause in mortgage.Granting clause in deed of trust.
Must also include description adequate to identify the security property.
© 2011 Rockwell Publishing
Finance Document ProvisionsTaxes and insurance
Security instrument provides that borrower must:
keep security property adequately insured against hazards such as fire
pay all property taxes and special assessments
Failure to comply is default on the mortgage, just like failing to make loan payments.
© 2011 Rockwell Publishing
Finance Document Provisions Acceleration clause
Acceleration clause: Gives lender right to demand immediate payment of entire principal balance if borrower defaults.
Aka call provision (“calling the note”).Clause in both note and security
instrument.Triggered by any default on terms of
either document.
© 2011 Rockwell Publishing
Finance Document Provisions Alienation clause
Alienation clause: Gives lender right to accelerate loan if borrower sells security property or transfers an interest.
Aka due-on-sale clause.
Doesn’t prohibit sale of property.
Does allow lender to force borrower to pay off loan if property sold without lender’s approval.
© 2011 Rockwell Publishing
Alienation Clause Sale without loan payoff
If loan not paid off when property sold, buyer takes title subject to lender’s lien.
Buyer may assume mortgage or deed of trust.Buyer has primary liability to lender.Original borrower has secondary liability.
If buyer does not assume loan:buyer not personally liable for repayment lender can still foreclose in case of default
© 2011 Rockwell Publishing
Alienation Clause Assumption with lender’s approval
If mortgage or deed of trust has alienation clause, lender has opportunity to screen buyer.
If buyer creditworthy, lender will:approve buyer’s assumption of loanrelease original borrower from liability
Lender charges buyer assumption fee and may raise interest rate.
© 2011 Rockwell Publishing
Alienation Clause Assumption with lender’s approval
Buyer assuming loan should ask lender to provide certificate of reduction.
Certificate of reduction: States loan’s principal balance as of assumption date.Also called estoppel certificate.
© 2011 Rockwell Publishing
Finance Document Provisions Late payment penalty provision
Late payment charges allowed only if clearly defined in finance documents and reasonable.
Federal law limits late fees for many residential loans.
IRS does not regard late payment penalties as interest, so not tax-deductible.
© 2011 Rockwell Publishing
Finance Document Provisions Lock-in clause
Lock-in clause: Prohibits borrower from paying loan off early (prepaying loan).
Borrower locked in to loan payments for full term, or for specified number of years.
Helps ensure that lender will receive anticipated return on investment.
© 2011 Rockwell Publishing
Finance Document Provisions Prepayment provision
Prepayment penalty: Charge borrower must pay lender if more than a specified amount of principal repaid before payment due.
Many loans have no prepayment penalty.This type is called an open mortgage.
Prepayment penalties are:more common with subprime loanslimited by federal and state law
© 2011 Rockwell Publishing
Finance Document Provisions Subordination clause
Subordination clause: Gives this security instrument lower lien priority than another security instrument to be recorded later.
Common in loans for purchase of vacant land that borrower intends to develop.When construction loan obtained, that
later lender will demand first lien position.
Construction loans are high-risk.
© 2011 Rockwell Publishing
Finance Document Provisions Defeasance clause
Defeasance clause: Provision in which lender agrees to cancel security instrument when debt has been paid off.
Lender must provide lien release document for recording:deed of reconveyancesatisfaction of mortgage
© 2011 Rockwell Publishing
SummaryFinance Document Provisions
• Mortgaging or granting clause• Acceleration clause• Alienation clause• Assumption• Lock-in clause• Prepayment provision• Subordination clause• Defeasance clause• Deed of reconveyance• Satisfaction of mortgage
© 2011 Rockwell Publishing
Foreclosure Procedures
Foreclosure: Forced sale of debtor’s property so that creditor can collect debt from sale proceeds.
Foreclosure is real estate lender’s remedy when borrower defaults. Default may be:
failure to repay loanfailure to insure property or pay taxesbreach of other loan agreement provision
© 2011 Rockwell Publishing
Foreclosure Procedures
Two main forms of foreclosure:judicial foreclosurenonjudicial foreclosure
As a general rule:mortgages are foreclosed judiciallydeeds of trust are foreclosed
nonjudicially
© 2011 Rockwell Publishing
Foreclosure ProceduresJudicial foreclosure
Main steps in judicial foreclosure:Mortgagee files lawsuit against
mortgagor called foreclosure action.Junior lienholders notified.Judge issues decree of foreclosure.Property sold at public auction called
sheriff’s sale.Highest bidder given certificate of sale.
© 2011 Rockwell Publishing
Judicial ForeclosureEquitable redemption
Equitable redemption period: Period from filing of foreclosure action until sheriff’s sale.
During this period, borrower may stop foreclosure and redeem property by paying:
mortgage debt in full, including all principal and interest
costs incurred because of foreclosure
© 2011 Rockwell Publishing
Judicial ForeclosureStatutory redemption
Statutory redemption period: Period after sheriff’s sale when borrower has final chance to redeem property. In Washington:
eight months if lender waives right to deficiency judgment
one year if lender does not
Sheriff’s deed: Deed given to holder of certificate of sale at end of statutory redemption period if property not redeemed.
© 2011 Rockwell Publishing
Judicial ForeclosureSurplus or deficiency
After judicial foreclosure:Borrower entitled to any surplus left after
mortgage and other liens paid off.But if proceeds don’t even cover loan
amount, lender may be entitled to deficiency judgment for the difference.
Non-recourse mortgage: Mortgage that does not permit deficiency judgment.
© 2011 Rockwell Publishing
Foreclosure ProceduresNonjudicial foreclosure
Power of sale clause: Provision in deed of trust authorizing trustee to sell property (without going to court) if borrower defaults.
© 2011 Rockwell Publishing
Nonjudicial ForeclosureMain steps
Trustee sends borrower notice of default. Trustee issues notice of sale one month later.
Notice of sale recorded and sent to borrower, junior lienholders, and anyone who recorded request for notice.
Trustee conducts auction called trustee’s sale.
Successful bidder receives trustee’s deed.
© 2011 Rockwell Publishing
Nonjudicial ForeclosureReinstatement and redemption
Borrower may reinstate loan and stop foreclosure:
by paying only past due amount plus costsuntil shortly before date of trustee’s sale
Or borrower may redeem property:by paying off entire debt plus costsat any time until trustee’s sale held
No post-sale redemption allowed.
© 2011 Rockwell Publishing
Nonjudicial ForeclosureSurplus or deficiency
As with judicial foreclosure, borrower entitled to any surplus after deed of trust and other liens paid off.
However, deficiency judgment not permitted after nonjudicial foreclosure.
If proceeds don’t cover amount owed, lender can’t sue borrower for difference.
© 2011 Rockwell Publishing
Alternatives to Foreclosure
Three alternatives to foreclosure for defaulting borrower:
loan workoutdeed in lieu of foreclosureshort sale
© 2011 Rockwell Publishing
Alternatives to ForeclosureLoan workouts
Loan workout: Arrangement in which lender agrees to change payment schedule or other loan terms to help borrower avoid foreclosure.
Forbearance: Extra time to repay.
Loan modification might involve:changing variable interest rate to fixedlowering interest ratereducing principal amount owed
© 2011 Rockwell Publishing
Alternatives to ForeclosureDeeds in lieu of foreclosure
Deed in lieu: Borrower who can’t arrange loan workout may avoid foreclosure by giving lender a deed in lieu of foreclosure.
Deed transfers title from borrower to lender.
Lender takes title subject to any liens other than its own.
Borrower should make sure lender can’t sue for deficiency.
© 2011 Rockwell Publishing
Alternatives to ForeclosureShort sales
Short sale: When security property is sold for whatever it will bring on open market, but “short” of amount still owed on loan.
Lender generally agrees to accept proceeds from sale as payment in full.Borrower should make sure lender
can’t sue for deficiency.Difficult to arrange if multiple lenders.
© 2011 Rockwell Publishing
SummaryForeclosure and Alternatives
• Judicial foreclosure• Nonjudicial foreclosure• Reinstatement• Redemption• Deficiency judgment• Loan workout• Deed in lieu • Short sale
© 2011 Rockwell Publishing
Land Contracts
Land contract: Financing agreement in which real estate buyer agrees to pay seller purchase price in installments over time.
Alternative to note plus mortgage or deed of trust, in seller-financed transaction.
Also called real estate contract, real property sales contract, conditional sales contract, installment sales contract, or contract for deed.
© 2011 Rockwell Publishing
Land ContractsVendor and vendee
Seller = Vendor
Buyer = Vendee
Vendee agrees to make regular payments of principal and interest to vendor over specified period.
Vendee takes immediate possession of property.
© 2011 Rockwell Publishing
Land ContractsEquitable title and legal title
Although vendee takes possession immediately, holds only equitable title to property during contract term.
Vendor keeps legal title until contract price paid in full.
When contract paid off, vendor delivers deed to vendee, transferring fee simple estate.
© 2011 Rockwell Publishing
Land ContractsRights and responsibilities
Vendee should record land contract to protect equitable interest.
Vendee responsible for paying property taxes and insuring property while paying off contract.
Vendor may encumber property, but not in a way that prevents delivery of clear title when contract paid off.
© 2011 Rockwell Publishing
Land ContractsDefault
If vendee defaults on land contract, vendor may:
foreclose judiciallydeclare a forfeiture
© 2011 Rockwell Publishing
Land ContractsForfeiture
Forfeiture allows vendor to terminate land contract and regain possession of property:
without having to go to courtwithout refunding vendee’s payments
In Washington, this option applies only if contract has forfeiture clause and is recorded.
Law also gives vendee with substantial equity some protection against forfeiture.
© 2011 Rockwell Publishing
SummaryLand Contracts
• Land contract• Vendor• Vendee• Legal title• Equitable title• Forfeiture
© 2011 Rockwell Publishing
Types of Mortgage Loans
Different types of mortgage loans are used in various circumstances or designed to serve particular functions.
In spite of term “mortgage loan,” deed of trust would almost always be used in Washington.
© 2011 Rockwell Publishing
Types of Mortgage LoansFirst or second
First mortgage: Loan against a property that has higher lien priority than any other loans.
Loans against same property with lower priority are second mortgage, third mortgage, and so on.
© 2011 Rockwell Publishing
Types of Mortgage LoansSenior or junior
First mortgage is senior to second mortgage.
Second mortgage is junior to first mortgage, but senior to third mortgage.
Lien priority determines order in which loans will be paid off in foreclosure.
© 2011 Rockwell Publishing
Types of Mortgage LoansPurchase money
Purchase money mortgage: In general, any mortgage loan used to buy the property that will serve as security for the loan.
But also used more narrowly to refer to mortgage in seller-financed transaction.Seller extends credit to buyer and
“carries back” mortgage.Buyer pays seller in installments.
© 2011 Rockwell Publishing
Types of Mortgage LoansSoft or hard money
Soft money mortgage: When seller gives buyer credit in exchange for mortgage.
Another term for purchase money mortgage in narrower sense.
Hard money mortgage: When lender gives borrower cash in exchange for mortgage.
May be purchase money mortgage in broader sense, unless borrower already owns security property.
© 2011 Rockwell Publishing
Types of Mortgage LoansBudget
Budget mortgage: When borrower’s monthly payment includes prorated share of property taxes and insurance in addition to principal and interest.
Lender holds funds in reserve account, pays taxes and insurance when due.
Reserve account is aka impound account.
© 2011 Rockwell Publishing
Types of Mortgage LoansPackage
Package mortgage: When single loan is used to purchase personal property along with real property.
Example: Buyer purchases commercial ovens, freezers, and other equipment along with restaurant property.
© 2011 Rockwell Publishing
Types of Mortgage LoansConstruction
Construction loan: Temporary loan used to finance construction of improvements on land. Aka interim loan.
Take-out loan: Permanent financing of construction debt, replacing interim loan after construction completed.
© 2011 Rockwell Publishing
Types of Mortgage LoansConstruction
Construction loans are risky: borrower could exhaust loan funds before construction finished.
To prevent that, construction lenders have various ways of disbursing funds, such as:Fixed disbursement plan: Borrower
receives obligatory advances at various stages in construction process.
Lender may also hold back 10% or more for mechanic’s lien claims.
© 2011 Rockwell Publishing
Types of Mortgage LoansBlanket
Blanket mortgage: When several pieces of property secure a single loan.
Common in subdivision development.Partial release clause: Requires lender to
release some parcels from blanket lien once certain portion of loan repaid.
© 2011 Rockwell Publishing
Types of Mortgage LoansParticipation
Participation mortgage: Lender entitled to portion of security property’s earnings, in addition to interest on principal.
Most common on large commercial projects.
Lender is insurance company or other large investor.
© 2011 Rockwell Publishing
Types of Mortgage LoansShared appreciation
Shared appreciation mortgage: Lender entitled to portion of security property’s appreciation in value.
Part of increasing equity will belong to lender rather than borrower.
Equity: Difference between property’s market value and liens against it.
© 2011 Rockwell Publishing
Types of Mortgage LoansWraparound
Wraparound mortgage: New loan to buyer that “wraps around” seller’s existing first loan.
Buyer makes payment on wraparound to seller.
Seller uses portion of buyer’s payment to make payment on underlying loan.
Underlying loan:can’t have alienation clauseshould be paid off before wraparound is
© 2011 Rockwell Publishing
Types of Mortgage LoansOpen-end
Open-end mortgage: Allows borrower who has paid off part of loan to reborrow funds without arranging new loan.
Can reborrow up to the amount originally borrowed.
Loan usually has variable interest rate.Often used by builders and farmers.
© 2011 Rockwell Publishing
Types of Mortgage LoansGraduated payment
Graduated payment mortgage (GPM): Borrower allowed to make smaller payments in early years of loan, then steps up to larger payments.
Good for borrowers who expect income to increase.
© 2011 Rockwell Publishing
Types of Mortgage LoansSwing
Swing loan: Temporary loan to buyer who needs funds to close purchase of new property because old property hasn’t sold yet.
Secured by equity in old property.Paid off when sale of that property
closes.Aka gap loan or bridge loan.
© 2011 Rockwell Publishing
Types of Mortgage LoansHome equity
Home equity loan: Loan secured by borrower’s equity in home she already owns.
Usually a second mortgage, junior to existing purchase money loan.
May be used for remodeling or other improvements, or for expenses unrelated to property.
HELOC: Home equity line of credit; works like credit card, but secured by equity in home.
© 2011 Rockwell Publishing
Types of Mortgage LoansReverse
Reverse mortgage: Provides source of income for elderly person who owns home free and clear, by converting equity into cash.
Owner receives monthly payment from lender in return for mortgaging home.
Mortgage typically paid off when home sold after owner’s death.
© 2011 Rockwell Publishing
Types of Mortgage LoansSubprime
Subprime loan: Loan made to borrower who doesn’t qualify for traditional (prime) mortgage loan.
Credit scores or income ratios don’t meet usual standards.
Or may be unable or unwilling to provide standard documentation.
Subprime lenders charge higher interest rates and fees to compensate for higher risk.
© 2011 Rockwell Publishing
Types of Mortgage LoansRefinancing
Refinancing: New loan used to pay off existing loan secured by same property.
May be from same lender or new lender.Common reasons for refinancing:
to take advantage of lower interest ratesto make balloon payment on old loan
Cash-out refinancing: New loan is for more than amount needed to pay off old loan.
© 2011 Rockwell Publishing