Chapter 13: Financing: The Process Summary

Loan Sources

Federal Reserve sets monetary policies for the economy. The primary mortgage market originates the loans that are bought, sold and traded in the secondary mortgage market. 

The Federal Reserve System

The Federal Reserve System ("the Fed") is the nation's central bank - stabilizes the economy through the judicious handling of the money supply and credit available in the US.

• Determines the rate of growth in the money supply and attempts to match the increase with the growth in the economy.
• Regulates reserve requirements for all institutions offering checking accounts.
• Sets a discount rate of interest.
• Engages in open market operations - movement of cash through bonds. 

Primary Lenders

• Savings Associations - promote thrift and home ownership; invest some of its deposits in residential mortgage loans.
• Commercial Banks - safe depository and lender of mostly short-term loans. Rely on checking account deposits for their supply of funds to make loans.
• Fiduciary lenders (savings associations and commercial banks) - fiduciary responsibility to protect the funds of the depositors, which they invest in loans. 
• Credit Unions - provide short-term installment and home improvement loans to their member depositors.
• Insurance Companies - supply loans for very large and expensive properties.
• Investment Groups - joint ventures, such as syndicates, limited partnerships and real estate investment trusts; invest in large real estate projects.
• Mortgage Bankers - originate loans with their own money and money from their investors.
• Mortgage Brokers - locate potential borrowers and submit preliminary loan applications to the lenders for approval; do not lend money or service loans. 

Loan Brokerage

Real estate licensees can act as mortgage loan brokers and receive compensation for negotiating loans. 

Requirements - must make certain that the borrower receives a completed loan disclosure statement. CAR has a form for this called the Mortgage Loan Disclosure Statement. Must keep a copy on file for the Commissioner's inspection for three years. 

Restrictions - limits apply only to first trust deeds of under $30,000 or second trust deeds of under $20,000. (Loans above the stated amounts are not subject to these limits.) Maximum commission amounts:

• First mortgages - 5% of the principal for loans of less than 3 years; 10% for loans of 3 years or more.
• Second mortgages - 5% of the principal for loans of less than 2 years; 10% for loans of more than 2 years but less than 3; 15% for loans of 3 years or more.

Fees for making the loan cannot exceed 5%, regardless of the size of the loan. 

Secondary Mortgage Market (buys, sells and trades loans) 

Consists of holding warehouse agencies that purchase a number of mortgage loans and assemble them into packages of loans for resale to investors. 

1. Fannie Mae

The Federal National Mortgage Association (FNMA) - government-sponsored agency organized as a private corporation.

• Buys conventional, FHA and VA
• Buys mortgages from a lender in exchange for mortgage-backed securities, which then sells.
• Guarantees payment of all interest and principal on mortgage-backed securities. 

 2. Ginnie Mae

Government National Mortgage Association (GNMA) is a division of HUD.

• Administers special assistance programs and helps Fannie Mae in its activities.
• Guarantees payment on Fannie Mae's high-risk, low-yield loans, absorbing the difference between the low yield and the current market rates.
• Guarantees securities issued by private entities that are backed by a pool of VA and FHA

3. Freddie Mac

Federal Home Loan Mortgage Corporation (FHLMC) is a federal agency.

• Buys and pools mortgages.
• Sells bonds in the open market, using the mortgages as security.
• Does not guarantee payment of Freddie Mac mortgages.  

Financing the Loan – Application

Fannie Mae and Freddie Mac forms (uniform procedures) include borrower information, property information and supporting documents.

If an applicant falsifies any information on the application and the lender denies the loan because of the bad information, the applicant cannot get the application fee refunded.  

Financing the Loan – Underwriting

Underwriting - evaluating a loan application (the lender is assessing the risk of granting the loan to the buyer).

Qualifying the buyer - evaluation of the borrower’s ability to repay the loan; assessing the buyer's income, net worth and creditworthiness.

Qualify the property: Location, area zoning, value range, neighborhood, condition, etc.

Underwriting systems - Fannie Mae - Desktop Underwriter. Freddie Mac - Loan Product Advisor. 

Loan Commitment may be conditioned on the borrower meeting certain conditions, such as the sale of a current residence. But the lender has committed to lending the money. 

Financing the Loan

A mortgage has two parts: debt and security for the debt.

Must sign two documents: the note and the mortgage. The borrower - mortgagor; the lender - mortgagee.

Mortgage - mortgage document; gives the creditor the right to foreclose if necessary (the lien on the property). 

Closing the loan - By the date of the actual closing, the lender has already deposited the amount needed for the mortgage with the escrow agent, along with whatever instructions the lender has for how the funds are to be disbursed. 

Sale of a Note

If the lender used the Fannie Mae/Freddie Mac uniform procedures, the lender can sell the loan in the secondary mortgage market. To sell the loan, the original lender:

• Signs the note over to a third party investor or other mortgage company.
• Executes a document called an assignment of mortgage 

Making Payments on the Loan - Responsibilities:

• Pay real estate property taxes and keep the property repaired.
• Maintain whatever level of insurance the lender requires.
• Get the authorizations from the lender for major changes to the property.

If the grace period (for a borrower to correct any problems) expires, the lender would have the right to foreclose on the property. 

Laws Affecting Mortgage Lending 

Truth in Lending and Regulation Z - The Truth in Lending Act is implemented by Regulation Z and requires lenders to disclose to buyers the true cost of obtaining credit, so that borrowers can compare the costs of various lenders

Applies to all loans that are secured by a residence. It does not apply to commercial loans/agricultural loans over $25,000. 

Disclosure - must disclose all finance charges and the annual percentage rate (APR) of the loan.

For home mortgages - the lender must disclose the APR (but is not obligated to disclose the total interest payable over the life of the loan).

Right to Rescind - right to cancel the transaction within three days (does not apply to residential first mortgage loans, but does apply to refinancing and home equity loans). 

Any advertising is subject to Regulation Z disclosure if it contains any of the following:

• Amount of down payment; specific finance charge; number of installments; period of repayment. 

If an ad includes any of the above items, all of the following must be disclosed:

• The amount of down payment and terms of repayment.
• Annual percentage rate and if increase is possible.
• Total finance charge and number of payments and due dates. 

Penalties are twice the amount of the finance charge. Willful violation is a misdemeanor that is punishable. 

Equal Credit Opportunity Act (ECOA)

Prohibits lenders from discriminating against applicants on several aspects (race, color, sex, marital status, etc.)

Fair Housing Laws

Redlining is the practice of refusing to make a mortgage loan or restricting the number of loans in an area for reasons other than the economic qualifications of the applicant. A lender can refuse to extend a loan only on sound economic grounds 

Real Estate Settlement Procedures Act (RESPA)

Attempts to standardize settlement practices and to ensure that both buyers and sellers understand the costs involved in closing the transaction.

Applies to residential real estate purchases that will be financed by first mortgage loans. RESPA prohibits lenders from paying kickbacks and unearned fees to parties who may have referred the borrower to the lender.