10/11/2012
Chapter 8: Nontraditional Mortgage Products
Chapter 8
Nontraditional
Mortgage Products
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Mortgage Principles and Practices 4th Edition (02/21/2012)
Chapter 8: Nontraditional Mortgage Products
Nontraditional Mortgage Products
• SAFE Act
–Anything other than a 30-year fixed
rate mortgage
• Interagency Guidance on Nontraditional
Mortgage Product Risks
–Mortgage products that allow
borrowers to defer principal and,
sometimes, interest
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Mortgage Principles and Practices 4th Edition (02/21/2012)
Chapter 8: Nontraditional Mortgage Products
Chapter Objectives
• Describe the advantages and disadvantages of
buydown plans.
• Identify the elements that make up an adjustable
rate mortgage.
• Identify characteristics of a reverse mortgage.
• Identify factors that define a subprime loan.
• Discuss agency guidelines on lending and
subprime loans.
• Contrast various types of alternative financing.
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Chapter 8: Nontraditional Mortgage Products
Deferring Higher Interest Rate/Payment
• Growth Equity Mortgage (GEM)
– Fixed rate mortgage set up like a 30-year conventional loan
– Payments increase over time with predictable and scheduled
escalation
– Good for borrower with expected increases in income
– 100% of scheduled payment increases reduce principal
balance
• Reduction Option Mortgage
– Fixed rate loan with limited opportunity to reduce interest rate
– Avoids certain refinancing costs, such as for an appraisal
• Shared Appreciation Mortgage (SAM)
– Lender charges below-market interest in exchange for a share
of the gains the borrower realizes when the property is
eventually sold
– Shared risks/rewards, especially on commercial projects
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Chapter 8: Nontraditional Mortgage Products
Buydown Plans
• Point = 1% loan amount
• Discount points: Paid upfront to lower interest rate
• Buydown may be paid by:
– Borrower
– Seller
– Interested third party
• If borrower, appears on GFE as borrower charge
• Advantages:
– Lower monthly payment
– May allow qualification on reduced payment
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Chapter 8: Nontraditional Mortgage Products
Case in Point
• Borrower financing $180,000
• Quoted 6.5% interest rate for 30-year conventional
loan
• Payments would be $1,137.72 per month
• At 6.25% for the same $180,000 30-year loan,
payments would be only $1,108.29
• Paying discount points up front to buy down the
interest rate 1/4%, buyer saves $29.43 / month
• May help borrower qualify for the home loan
• Makes mortgage payments more attractive
• 2 points cost approximately $3,600
• 123 months to recapture upfront discount points
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Chapter 8: Nontraditional Mortgage Products
Buydown Plans: Paid by Seller
•
•
•
•
•
Less money to seller
May help close the deal
Buydown amount subtracted from loan proceeds
Reflected on HUD-1 as charge to seller
Buyer signs note for full amount
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Chapter 8: Nontraditional Mortgage Products
Permanent Buydown
• Points paid to lender to reduce the interest
rate and loan payments for the entire life of
the loan
• Interest rate written into promissory note
• Nominal rate (or coupon rate) stated in the
note will be the actual reduced interest rate
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Chapter 8: Nontraditional Mortgage Products
Temporary Buydown
• Funds deposited at closing to supplement
monthly payment
• Short-term discount
• Lender receives full payment
– Borrower’s discounted payment
– Supplemented by “deposited” funds
• When “deposited” funds run out, borrower
makes full payment
• Underwriters generally consider payments using
fully indexed rate, not starting rate
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Chapter 8: Nontraditional Mortgage Products
Temporary Buydown: Level
• Level payment reduction plan: Constant throughout
buydown period
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Chapter 8: Nontraditional Mortgage Products
Temporary Buydown: Graduated
• Payments increase every year, as per note, until
sufficient to amortize loan
– 2-1 buydown: Subsidized for 2 years
– 3-2-1 buydown: Subsidized for 3 years
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Chapter 8: Nontraditional Mortgage Products
Buydowns: Fannie / Freddie Limits
• Limits interested party contributions (IPCs) to % of
sale price or appraised value, whichever is less
• Excessive contributions deducted from maximum
loan amount
• Contributions from employers or immediate family
members usually not subject to limits
Property Type
LTV/CLTV
Investment
All CLTV ratios
Principal residence Greater than 90%
or second home
75.01% to 90%
Less than 75%
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Max. IPC
2%
3%
6%
9%
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Chapter 8: Nontraditional Mortgage Products
Buydowns: FHA / VA Limits
• FHA:
– Will not underwrite at temporary buydown rate
– Unless permanent, borrower must qualify at note
rate
– Reduction limited to 2% below note rate
– Allows maximum interest party contribution of 6%
• Proposed reduction to 3%
– Excess contribution deducted from maximum loan
amount
– Excludes family and employer contributions
• VA has no set limits
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-1
A borrower wants to buy a $150,000
home, and is going to make a $15,000
down payment. The borrower is seeking
a conventional loan, but doesn’t want to
pay more than 6 1/2% interest. The
lender agrees to 6 1/2% interest if the
loan has three discount points and the
loan origination fee is 2%.
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-1
1. What’s the total amount of points (in dollars and
percentage) that the lender will receive for making
this loan?
–
–
–
–
Points are based on the loan amount, in this case,
$135,000 ($150,000 - $15,000 down).
The lender is charging a total of 5 points, or 5% of
the loan.
Discount points total $4,050 ($135,000 x .03) and
the loan origination fee is $2,700 ($135,000 x .02).
The total the lender will receive in points is $6,750
($4,050 + $2,700).
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-1
2. If the seller agrees to pay the discount
points, how much will the seller net from the
transaction? (Assume the seller pays no
other costs.)
– The seller net is the sale price minus any
seller-paid points, so the seller will net
$145,950 ($150,000 - $4,050).
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-1
3. What will the borrower’s note state as the
interest rate on the loan? What dollar
amount will the note say was borrowed?
– The loan note rate will be 6.500% since this
is not a temporary buydown.
– The amount on the note equals the loan
amount, not the sale price, so it’s $135,000
($150,000 - $15,000).
– The note amount does not reflect the sellerpaid points.
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-1
4. Can the lender sell this loan to Fannie Mae
or Freddie Mac on the secondary market?
Why or why not?
– Yes, the lender should be able to sell this
loan to Fannie Mae/Freddie Mac on the
secondary market because it has less than
the 6% seller assistance limit that the
programs allow with a 90% LTV.
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Chapter 8: Nontraditional Mortgage Products
Adjustable Rate Mortgages (ARMs)
• Frees lender from being locked into fixed rate
• Interest rates may adjust to reflect fluctuations
in cost of money
• May allow borrower to qualify more easily
• Allows lenders to pass risk on to borrowers
• Lenders may charge lower starting interest
rate than for fixed
• Must adhere to guidelines of appropriate
regulatory agency, Fannie Mae/Freddie Mac,
FHA, and private mortgage insurers
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Mortgage Principles and Practices 4th Edition (02/21/2012)
Chapter 8: Nontraditional Mortgage Products
ARM Elements
•
•
•
•
•
•
•
•
Index
Margin
Rate adjustment period
Mortgage payment adjustment period
Interest rate cap/floor (if any)
Mortgage payment cap (if any)
Negative amortization cap (if any)
Conversion option (if any)
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Chapter 8: Nontraditional Mortgage Products
ARM Elements: Index
• Statistic consumer can examine
• Generally reliable indicator of cost of money, e.g.:
– Average One-Year Treasury Constant Maturity Index
(TCM)
– Cost of Funds Index (COFI) (used by Fannie Mae)
– London Interbank Offered Rate (LIBOR)
• Interest rate adjustments based on up / down
movement of index
• Index must be:
– Independent of lender
– Affected by market conditions
– Regularly listed in major publication
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ARM Elements: Margin
• Difference between index value and interest rate
charged (margin + index = interest rate)
• Generally remains fixed; negotiated with lender
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Chapter 8: Nontraditional Mortgage Products
ARM Elements: Adjustment Periods
• Rate adjustment period: Length of time between at
which interest rate changes
– Often every six months or 1 year
• Payment adjustment period: Length of time
between payment adjustments
– Can range from months to several years
• May be adjusted parallel to rate adjustment
• May be adjusted less frequently than rate
adjustment
– Negative amortization: Interest paid insufficient
to pay interest accrued from previous month
– Excess interest paid may be applied to principal
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Mortgage Principles and Practices 4th Edition (02/21/2012)
Chapter 8: Nontraditional Mortgage Products
ARM Elements: Interest Rate Cap
• Discounted indexed rate or teaser rate
– Start rate lower than fully indexed rate
– Makes ARMs more attractive to borrowers
– Could result in significant payment shock
• Interest rate caps limit % points rate can increase
• May be shown as 2 numbers, such as 2/6:
– 1st number: Max. increase at adjustment
– 2nd number: Max. lifetime increase
• May be shown as 3 numbers, such as 5/2/6:
– 1st number: Max. increase at 1st adjustment
– 2nd number: Max. increase at subsequent adjustments
– 3rd number: Max. lifetime increase
• May also limit how much interest rate can decrease
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Chapter 8: Nontraditional Mortgage Products
ARM Interest Rates
• 1-year ARM loan for $100,000 for 30 years
• 5/2/6 interest rate cap
• Current index rate is 4.5%; margin is 3%;
discounted start rate is 4%.
9%
7%
9%
10%
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Chapter 8: Nontraditional Mortgage Products
ARM Elements: Interest Rate Caps
•
•
•
•
Fannie Mae: 2% per year / 6% lifetime
Freddie Mac: 2% per year / 5% lifetime
FHA: 1% per year / 5% lifetime
VA:
– 1% per year / 5% lifetime on traditional
ARMs (adjusts annually)
– 2% per year / 6% lifetime on hybrid ARM
(fixed for at least five years)
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Chapter 8: Nontraditional Mortgage Products
ARM Elements: Payment Cap
• Protects a borrower from large payment
increases
• Limits magnitude of payment changes with
interest rate adjustments
• Some lenders only use interest rate caps;
others use both rate and payment caps
• Could allow for negative amortization if
current interest rate exceeds payment cap
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Chapter 8: Nontraditional Mortgage Products
ARM Elements: Negative Amortization Cap
• Negative amortization: Loan balance grows
because payments don’t cover the accrued
interest due on the loan
– Most likely to occur with frequent rate changes
and less frequent payment adjustments
• Cap limits growth of loan balance beyond a
certain point
• Maintains manageable LTV
• May require readjustment (recast) of monthly
payments
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Chapter 8: Nontraditional Mortgage Products
ARM Elements: Conversion Option
• Gives the borrower the right to convert from
an adjustable rate loan to a fixed rate loan
• Conversion option note normally includes:
– Higher interest rate
– Limited time to convert
– Conversion fee
• If sold to the secondary market, terms would
have to be honored by purchaser
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Chapter 8: Nontraditional Mortgage Products
ARM Standardization
• Most lenders follow secondary market guidelines
• Loan-to-value a consideration
– May not make higher LTV if chance of negative
amortization
– Higher LTV generally requires occupancy
• Fannie Mae / Freddie Mac require occupancy
for all ARM loans
– Credit scores may be considered
• Appraisal must not be influenced by financing
concessions
• May use smaller housing expense and debt-toincome ratios for qualifying
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Chapter 8: Nontraditional Mortgage Products
ARM Disclosures
• Disclose APR to comply with TILA (Reg Z)
• CHARM Handbook discloses (as appropriate):
• Index / where to find it
• How interest rate and
payment are determined
• Suggestion to ask about
current margin / interest
rate
• Initial discount rate and
suggestion to ask about
amount of discount
• Rate / payment adjustment
periods
• Rate and payment caps
• Statement payment caps may
result in negative amortization
• Statement if loan has demand
provision
• Description / time of adjustment
notice
• Availability of other ARM loan
disclosures
• Maximum interest rate / payment
• Initial interest rate / payment
• Conversion option details
• Example based on $10,000 loan
• Advance notice of change in payment / interest rate
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Chapter 8: Nontraditional Mortgage Products
ARM: Annual Percentage Rate
• Annual percentage rate (APR): Relationship
between the cost of borrowing money and the total
amount financed, represented as a percentage
• Disclosure cannot be made based solely on ARM’s
initial rate
• Must reflect the finance charges and fees as well
as the composite annual percentage rate
– Based on initial payment rate and fully indexed
rate that could exist for the remaining loan term
– Lets consumers comparison shop for rates
among lenders
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Chapter 8: Nontraditional Mortgage Products
ARM: Payment Option
• Allows borrowers to pick a payment option each
month
– Traditional payment of principal and interest
• Reduces the amount owed
– Interest only payment
• Pays interest due but does not reduce principal
– Minimum (or limited) payment
• May be less than the amount of interest due
• Balloon payment may be required
• Built-in recalculation period, e.g., every 5 years
– New minimum payment amortizes loan
• Uncommon today; could result in negative
amortization
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Chapter 8: Nontraditional Mortgage Products
ARM: Hybrid ARM
• Loan has a fixed rate for a specified number of
years, then interest rate adjusts regularly for
remainder of loan term according to note
• May be designated by:
– Number years fixed and adjustable:
• 2/28 or 3/27 ARM – fixed for first 2 or 3 years;
interest rate adjusts at predetermined point
– Number of years fixed and adjustment period:
• 3/1, 5/1, 7/1, or 10/1 ARM -- fixed for first 3, 5, 7,
or 10 years with annual adjustment after
CAUTION: Be careful when using the term “fixed”
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Mortgage Principles and Practices 4th Edition (02/21/2012)
Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-2
• A borrower received a 30-year ARM mortgage loan
for $120,000.
• The start rate was 3.50% and the loan adjusts
every 12 months for the life of the mortgage.
• Rate caps are 3/2/6.
• The index used for this mortgage is the LIBOR. For
this exercise, let’s say it was:
– 3.00% at the start of the loan
– 5.00% at the end of the first year
– 4.50% at the end of the second year
• The margin on the loan is 3.00%.
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-2
1. What’s the initial rate (start rate) and what is the
interest rate after the first year?
–
–
–
The start rate is 3.50%. The fully indexed rate after
the first year is 8.00% (5.00% index + margin of
3.00% = 8.00%).
BUT, the periodic maximum rates caps (in this
example, annual) have to be taken in consideration
also. In this mortgage, the maximum rate increase
the first year is 3.00% (2.00% in all other years).
So 3.50% + 3.00% = 6.50%, which will be the
interest rate after the first adjustment.
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-2
2. What is the fully indexed rate after the
second year?
– The fully indexed rate is 7.50% (LIBOR rate
of 4.50% + 3.00% margin).
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-2
3. What is the borrower’s interest rate after the
second adjustment?
– The borrower’s interest rate after the first
adjustment period was 6.50%.
– Adding the periodic maximum adjustment
cap of 2.00% = 8.50%.
– However, the borrower’s interest rate would
be the LOWER of the two interest rates,
which is 7.50%.
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-2
4. What is the maximum interest rate this loan
could have?
– The maximum interest rate equals the start
rate of 3.50% + the life of the loan cap of
6.00%, so the maximum interest rate this
loan could have is 9.50%.
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Chapter 8: Nontraditional Mortgage Products
Mortgage Exercise 8-2
5. What would the LIBOR have to be to obtain
that interest rate?
– In order for this loan to get to that rate, the
LIBOR would have to increase 2.00% from
its current rate of 4.50% to 6.50%:
– 9.50% (maximum lifetime rate) – 3.00%
(margin) = 6.50% (LIBOR)
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Mortgage Principles and Practices 4th Edition (02/21/2012)
Chapter 8: Nontraditional Mortgage Products
ARM: Be Prepared to Answer
1.
2.
3.
4.
What will my interest rate be?
How often will my interest rate change?
How often will my payment change?
Is there any limit to how much my interest rate can
be increased?
5. Is there any limit to how much payments can be
increased at any one time?
6. What is the probability of runaway negative
amortization?
7. Can my ARM be converted to a fixed rate loan?
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Chapter 8: Nontraditional Mortgage Products
Advantages & Disadvantages
Advantages
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Disadvantages
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Chapter 8: Nontraditional Mortgage Products
Advantages & Disadvantages
Advantages
Disadvantages
• Lower initial interest rate and
payments
• May be easier to qualify for
loan
• Leverage buyer into a higherpriced home
• Payments may decrease over
time
• May be converted to a fixedrate loan
• Good in times of low inflation
or for short-term ownership
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Mortgage Principles and Practices 4th Edition (02/21/2012)
Chapter 8: Nontraditional Mortgage Products
Advantages & Disadvantages
Advantages
• Lower initial interest rate and
payments
• May be easier to qualify for
loan
• Leverage buyer into a higherpriced home
• Payments may decrease over
time
• May be converted to a fixedrate loan
• Good in times of low inflation
or for short-term ownership
Disadvantages
• No interest rate guarantees
• No payment guarantees
• Buyer’s financial situation
may change
• Buyer may over-leverage
• Possibility of negative
amortization
• May have to pay a fee to
convert even if you choose
not to convert
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Chapter 8: Nontraditional Mortgage Products
Subprime Loans
• Riskier than conforming loans
– Less creditworthy borrowers (also called B-C
loans)
– Less documentation provided
• Rely on equity in property to offset credit risk, so
may require larger down payment
• Requires experienced / specialized underwriter
• Allows lenders to charge higher interest / fees
• Borrowers showing good credit/payment history
may be able to refinance at more favorable terms
• Rare in today’s market
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Chapter 8: Nontraditional Mortgage Products
Interagency: Nontraditional Products
• Interagency Guidance on Nontraditional Mortgage
Product Risks
• Mortgage products that allow borrowers to defer
principal and, sometimes, interest, for example:
– Interest only (IO) feature
– Potential for negative amortization
• Qualifying standards/guiding principles:
– Recognize potential impact of payment shock
– Nontraditional loans may not be appropriate for high
LTV, high DTI, and low credit scores
– Analysis should consider fully indexed rate
– Avoid over-reliance on credit scores
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Chapter 8: Nontraditional Mortgage Products
Interagency: Nontraditional Products
• Avoid collateral-dependent loans
• Compensate risk layering with risk mitigating features
• Reduced documentation – acceptable only if other risk
mitigating features available
• Simultaneous seconds – minimal equity loans should
not allow delayed / negative amortization
• Teaser rates – minimize early or disruptive recastings
or extraordinary payment shock
• I/O feature – should evaluate ability to repay by final
maturity at fully indexed rate
• Negative amortization – analysis should consider initial
loan amount + balance increases
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Chapter 8: Nontraditional Mortgage Products
Interagency: Statement on Subprime
• Promote consumer protection standards,
particularly on ARMs offered to subprime borrowers
that have:
– Very high / no limits on payment amount / interest
rate increases
– Limited / no income documentation
– Features leading to frequent refinancing
– Prepayment penalties:
• Substantial
• Extend beyond initial fixed rate period
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Interagency: Statement on Subprime
• Provides consumer protection through
disclosure:
– Payment shock potential
– Prepayment penalties and how calculated,
imposed
– Balloon payments
– Cost of reduced documentation loans
– Responsibility for taxes and insurance
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Chapter 8: Nontraditional Mortgage Products
Interagency: Statement on Subprime
• Defines predatory lending as:
– Making loans based on foreclosure /
liquidation value of collateral rather than on
borrower’s ability to repay
– Inducing borrower to repeatedly refinance in
order to charge high points and fees (“loan
flipping” or “equity skimming”)
– Engaging in fraud or deception to conceal the
true nature of the obligations from
unsuspecting or unsophisticated borrower
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Chapter 8: Nontraditional Mortgage Products
Reverse Mortgages
• Allows borrower to convert equity in home
without selling or making payments
• Funds may be used for virtually anything
• Also called reverse equity mortgage or
reverse annuity mortgage (RAM)
• FHA’s Home Equity Conversion Mortgage
(HECM) most popular
• Balance of loan rises as equity shrinks
(rising debt, falling equity)
• At end of loan, all equity could be gone
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Chapter 8: Nontraditional Mortgage Products
Reverse Mortgages: Eligibility
• No income requirements (must be able to pay
continuing obligations related to property)
• All individuals with ownership interest must be
at least 62 years old
• Generally, single-family homes, including
condos and PUDs
– Mobile homes / co-ops not generally eligible
• Homeowner’s insurance at replacement value
• Principal residence with little or no mortgage
balance
• Required pre-loan counseling
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Chapter 8: Nontraditional Mortgage Products
Reverse Mortgages: Amount
• Many factors:
– Appraisal of home value
– Amount of equity
– Payment options
– Interest rate
– Fees
• Age of borrower
– Older can borrow more
– Age of youngest borrower determines
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Chapter 8: Nontraditional Mortgage Products
Reverse Mortgages: Payment
• Payment options:
– Fixed monthly payments
– Lump sum
– Line of credit as needed
– Combination
• Spending options: Virtually anything
• Tax implications:
– Generally not considered income
– Interest deducted only at loan conclusion
– Could affect eligibility for other programs
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Reverse Mortgages: Repayment
• If not in breach, due when last surviving borrower:
– Dies
– Sells the home
– Ceases to live in home for 12 consecutive months
• Total amount due (interest, insurance, fees, etc.)
• Any remaining equity belongs to estate
• Lender generally may not sell home during loan
term
• Non-recourse
– Cannot claim other assets
– Borrower cannot owe more than fair market value
• Repayment could be accelerated under some
circumstances
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Chapter 8: Nontraditional Mortgage Products
Seller Financing / Purchase Money
• Seller extends some or all credit to purchase
property
– Buyer may not be able to get traditional financing
– Allows seller to enhance marketability
• Alienation (due on sale) clause gives lender
certain rights upon transfer of some interest in
property
• Purchase money mortgage - given to seller by
buyer
• Sellers not bound by institutional policies
– Can take any form, e.g., fixed, adjustable, etc.
– Cannot violate laws, e.g., usury laws
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Chapter 8: Nontraditional Mortgage Products
Seller Financing
• Assumption: One party agrees to take over payments of
another party’s debt, with terms of the note staying
unchanged
– FHA / VA loans require approval of lender
– Buyer becomes primarily liable but lender may have
recourse against seller upon default without release
• Wraparound financing: Seller retains existing loan on the
property while giving the buyer a second loan
– Buyer pays seller full amount; seller pays original lender,
keeps excess
– Original mortgage must:
• Be assumable with lender approval or
• Not have an alienation clause
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Chapter 8: Nontraditional Mortgage Products
Land Contracts
• Installment agreement where buyer pays seller for
right to occupy and use property
– Also called land installment contracts, installment sales
contracts, land sales contracts, real estate contracts
• No deed or title is transferred until all, or a
specified portion, of the payments have been made
• Seller (vendor) holds legal title to property as
security
• Buyer/debtor (vendee) may possess and enjoy
land, but is not legal owner (equitable title)
• No institutional loan qualifying standards
• Cannot be sold to Fannie Mae / Freddie Mac
• Generally require vendor to provide annual
statement
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Lease / Option
• Property lease for specific term with option to buy at a
predetermined price during lease term
– Lease: Rent in exchange for possession of real estate
– Option: Contract giving right to do something within a
designated time period, without obligation
– Optionee: Prospective purchaser
– Optionor: Property owner
• May credit any portion of rent that is above established
market for comparable property toward:
– Down payment
– Loan amount
– Sales price
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Lease / Purchase
• Seller leases property for specific term;
tenant agrees to buy property at set price
during or following the lease term
• Equivalent of a sale where purchase
agreement:
– Locks in a predetermined price
– Sets date for sale transaction
• Reasons for lease / purchase include buyer:
– Needs time to acquire cash
– Will qualify once circumstances change
– Will take advantage of rent credit
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Equity Exchanges
• Value in one property traded for another
• Also called tax-deferred or tax-free
exchange, like-kind exchange, Section 1031
• Properties must be:
– Exchanged, or qualify as delayed exchange
– Like-kind property (real estate for real estate)
– Held for use in a trade, business, or investment
• Seller defers paying tax until profit is realized
from transaction
• Legal and tax advice should always be
consulted
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Participation Plans
• Partnership between buyer and another
investor (or seller, lender, etc.)
• Investor provides cash; receives percentage
of equity in lieu of or in addition to interest
• Buyer pays principal (or it is deferred)
• Things to negotiate:
– Loan application
– Equity calculation
– Investor’s equity percentage
– Investor repayment
– Handling improvements
– Responsibility for taxes and insurance
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Homebuyer Assistance Programs
• May provide:
– Down payment assistance
– Subsidized mortgage interest rates
– Help with closing costs
• Offered by government, non-profits, lenders
• Program funding usually limited
• Lender programs developed to provide
financing flexibility
– First time homebuyer
– Community homebuyer
• Positive: Help get people into homes
• Negative: Potential for default
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Chapter 8: Nontraditional Mortgage Products
Key Term Review
• Adjustable Rate
Mortgage (ARM)
• Buydown
• Caps
• Equity Exchange
• Estoppel
• Index
• Land Contract
• Lease/Option
• Lease/Purchase
•
•
•
•
•
Margin
Option
Participation Plan
Points
Rate Adjustment
Period
• Reverse Mortgage
• Subprime Loan
• Teaser Rate
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Summary
1. Nontraditional mortgage products
– Defined by the SAFE Act as anything other
than 30-year fixed rate loans.
– Defined by Interagency Guidance on
Nontraditional Mortgage Products as mortgage
products that allow borrowers to defer principal
and, sometimes, interest.
– Such products can help buyers qualify for
larger loans or help them reach other financial
goals.
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Summary
2. Buydowns are additional money (discount points)
paid to the lender at the start of a loan to lower
interest rate and payments.
–
–
–
–
–
Make up the difference between the market interest
rate and the rate a borrower gets in the note.
A permanent buydown (for life of loan) has a reduced
rate stated in the note.
A temporary buydown (early in loan) can be level
payment or graduated payment.
Buyer can qualify 2% below market rate. FHA requires
buyers to qualify at note rate, not buydown rate.
Fannie Mae, Freddie Mac, and FHA limit points and
other interested party contributions (IPCs) that can be
paid.
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Summary
Adjustable rate mortgages (ARMs)
Borrowers select index (statistical report reflecting cost of money),
lenders add a margin (spread) = fully indexed rate paid on the
loan.
–
Loan documents must state: Rate, index, margin, and payment
adjustment period; caps (if any) on rate, payments or negative
amortization; conversion option (if any).
–
Rates that change more frequently than payments may create
negative amortization (payments insufficient to cover interest
due).
–
Caps keep loans from growing out of control.
–
Lenders periodically readjust or recast the loan by recalculating
payments based on the loan balance at specific interval.
–
Conversion options allow buyers to convert to fixed rate.
–
Lenders/MLOs must provide CHARM booklet to borrower in
addition to other mandated disclosures, including the annual
percentage rate (APR). For ARMs, it is a composite rate that
reflects the lower rate for certain number of years and the higher
rate for later years. Lenders cannot disclose only initial low rates.
3.
–
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Summary
4. Reverse mortgages provide monthly income, a lump sum of cash, or a
line of credit to borrowers aged 62 or older, based on the equity in their
homes
– Loan generally repaid when the borrower dies, moves out of the
house for 12 months, or sells the house (assuming no breach).
5. Structured mortgages help borrowers reach other financial goals.
– Growth equity: Fixed rate, but payments increase to pay off faster.
– Reduction option: Buyer can reduce rate one time, with fewer
refinancing costs.
– Shared appreciation: Lender shares equity in commercial project.
6. Subprime loans (B-C loans, low-doc, stated income) have more risk
than what is allowed by the conventional market. Borrower risk factors
determine interest rate and terms. A-minus loans are riskier than prime
loans, less risky than subprime loans.
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Summary
Seller financing is when seller extends credit to buyer to
finance the purchase of property. Seller can extend all or
partial credit.
7.
–
–
–
–
Can help buyer who doesn’t have enough cash to buy a property,
can’t qualify for a conventional loan, or wants or needs a lowerthan-market interest rate. Seller gets the benefit of a home that’s
easier to sell, and often a better price by offering terms.
A purchase money mortgage or seller-held mortgage is given
by buyer to the seller to secure part or all of the money borrowed
to purchase property. Unencumbered property with no liens is best
for this transaction; encumbered property with liens needs
assumption or wraparound.
Assumption has the buyer take responsibility for the mortgage,
but the seller must get a release from the lender.
A seller-wraparound mortgage has the seller retain existing
mortgage (the buyer makes one larger payment; the seller pays
the lender and keeps difference).
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Summary
8. A land contract is a real estate installment
agreement.
–
–
–
–
Buyer (vendee) makes payments to seller (vendor) for
right to occupy land, but no title is transferred until all,
or part of, payments are made.
Buyer has equitable title under a land contract. States
differ in how they treat land contracts.
Problems for the buyer include difficulty in borrowing
against equity with a land contract and protecting equity
if land contract is not recorded.
Lender may consent to deal using an estoppel letter.
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Summary
9.
Other alternative financing:
–
–
–
–
A lease/option has the seller (optionee) lease to a tenant
(optionor) who has the right (but not the obligation) to buy the
property at a set price within a certain time. An option can be used
for profit, speculation, investment, comparison, or to give the
optionor time to acquire cash, to qualify, or credit rent toward
purchase price.
A lease/purchase combines a lease with a purchase contract.
An equity exchange (tax-deferred exchange, Section 1031) is
property traded for value in other property. Properties must be
exchanged (or delayed exchange), like kind, and held for trade,
business, or investment. Capital gains tax is deferred, but boot
(unlike property added to balance value) is taxed. Tax-free
exchanges are not available for residential property.
Participation plans have investors share equity of the property
instead of or in addition to receiving interest.
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Summary
10.Homebuyer assistance programs:
–
–
–
–
Down payment assistance programs (DAP)
Subsidized mortgage interest rates
Help with closing costs (or combination)
Programs can be offered by government or
non-profit groups, or by lenders
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Chapter 8: Nontraditional Mortgage Products
Chapter 8 Quiz
1. A borrower is purchasing a home for
$100,000. The LTV on the loan is 80%. If the
borrower pays a total of 6 points on the loan,
how much will the points cost him?
A. $2,400
B. $3,400
C. $4,800
D. $6,000
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Chapter 8 Quiz
2. A buydown plan can reduce the
borrower’s payments
A. early in the loan only, but requires a large
balloon payment.
B. early in the loan or for the entire life of the
loan.
C. for the entire life of a loan, but with an
automatic prepayment penalty.
D. with gradual payment decreases throughout
the life of the loan.
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Chapter 8 Quiz
3. Which statement is true about interest
rate buydowns on FHA loans?
A. Borrowers may qualify at the buydown
rate.
B. Borrowers must qualify at the note rate.
C. FHA does not allow builder-paid
buydowns.
D. FHA does not allow seller-paid
buydowns.
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Chapter 8: Nontraditional Mortgage Products
Chapter 8 Quiz
4. Which of the following is NOT an
element of an ARM?
A.index
B.margin
C.positive amortization cap
D.rate
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Chapter 8 Quiz
5. What is the adjustable number used
to compute the interest rate on an
ARM called?
A.cap
B.index
C.margin
D.prepayment
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Chapter 8 Quiz
6. With an ARM, the index is added to
the ______ to determine the
_________ .
A.APR / cost of funds
B.home value / amount borrowed
C.margin / interest rate charged
D.qualifying ratio / maximum monthly
mortgage payment
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Chapter 8: Nontraditional Mortgage Products
Chapter 8 Quiz
7. Negative amortization occurs
when
A. a borrower suffers payment shock.
B. each mortgage payment is adjusted
more frequently than is the interest
rate.
C. the payment made does not cover the
interest due for that period.
D. all of the above
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Chapter 8 Quiz
8. How are subprime loans different from
conforming loans?
A. They allow for lower interest rates.
B. They allow for more risk.
C. They are only offered by banks.
D. They are sold in the secondary market.
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Chapter 8 Quiz
9. Which scenario best describes a land
contract?
A. A buyer makes payments to the seller in exchange
for the right to occupy, use, and enjoy the property,
but no deed or title transfers until a specified portion
of payments have been made.
B. A buyer takes over primary liability for the loan of a
seller, usually implying no change in loan terms.
C. A seller keeps the existing loan and continues to pay
on it while giving the buyer another loan.
D. A seller leases the property with the provision that
part of the rent payments be applied to the sale price
if the tenant decides to purchase before the lease
expires.
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Chapter 8: Nontraditional Mortgage Products
Chapter 8 Quiz
10.An equity exchange may be treated as a
tax-free exchange when property is
A. for profit and of like kind.
B. held for sale by a dealer only.
C. owner-occupied.
D. rental only.
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Chapter 8 Quiz
11.In which federal law would you find the
definition of a nontraditional loan?
A. Homeowners Equity Protection Act
B. Real Estate Settlement Procedures Act
C. Secure and Fair Enforcement for
Mortgage Licensing Act
D. Truth in Lending Act
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Chapter 8 Quiz
12.During the life of a typical reverse
mortgage, which of the following factors
is decreased?
A. debt
B. equity
C. interest
D. monthly payments
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Chapter 8: Nontraditional Mortgage Products
Chapter 8 Quiz
13.According to the Interagency Guidance
on Nontraditional Mortgage Products,
nontraditional mortgage loans may be
LEAST risky for borrowers with
A. high debt-to-income ratios.
B. high loan-to-value.
C. low credit scores.
D. low debt-to-income ratios.
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Chapter 8 Quiz
14.Each of these are characteristics that
could make a loan nontraditional
EXCEPT
A.15-year term.
B.adjustable rate.
C.fixed rate.
D.temporary buydown.
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Chapter 8 Quiz
15.A borrower has a ARM with a 5/2/6
interest rate cap. The start rate is 4%,
the current index is 3%, and the margin
is 3%. What is the borrower’s interest
rate if the index rises to 5% at the time of
the first adjustment?
A. 5%
B. 6%
C. 8%
D. 9%
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