Chapter 12: Financing: Loan Types Summary

Borrower Fees

• Loan Origination Fee is typically one percent of the loan amount. It covers the lender's cost for generating the loan.
• Points are a one-time service charge, paid at closing and usually equal to one percent of the loan amount.
• Discount Points (Discount Charges) are designed to offset any losses the lender might suffer when selling the loan to the secondary mortgage market. Discount points are a means of raising the effective interest rate of the loan.

Repayment Plans

• Straight Loan - also known as an interest-only loan, the monthly payments are allocated only to interest. No principal is paid off.
• Amortized Loan - a borrower makes a periodic payment of principal plus interest - loan is paid off gradually over time. Fully amortized loan - same payment amount every month. Straight amortized loan - different amount with each payment.
• Adjustable-Rate Mortgage - borrower usually pays the index rate plus a margin. An adjustment period establishes how often the lender can change the rate. Interest rate caps (periodic or overall) limit the amount of interest the borrower can be charged. A payment cap limits how much the monthly payment can increase.
• Balloon Payment Loan - long-term loan that has one large final payment due when the loan matures (partially amortized loans).
• Growing Equity Mortgage (GEM) - the growing equity mortgage is a fixed-rate loan in which payments increase by a predetermined amount each year, reducing the outstanding balance of the loan.
• Reverse Annuity Mortgage (RAM) - with a reverse annuity mortgage, the lender is making payments to the borrower.

Types of Loans

Loan-to-value ratio - the ratio of debt to the value of the property. When talking about mortgages, the value is the sale price or the appraised value, whichever is less.

1. Conventional Loans

Down payment of 20% or more, making the loan 80% or less of the property's sale price.

Conventional loans are typically uninsured. The mortgage itself provides the only security for the loan.

A borrower can get a conventional loan with a lower down payment by insuring the loan through a private mortgage insurance program (PMI). The lender will terminate the PMI payments once the loan has been repaid to a certain level.

2. FHA-Insured Loans

The FHA, overseen by HUD, provides low down-payment loans (high loan-to-value ratio loans) to qualified buyers.

FHA does not build homes or loan money directly. They insure loans made by approved lending institutions.

• FHA loans can be either fixed-rate loans or one-year-adjustable loans.
• The borrower must have cash for a down payment and closing costs.
• The borrower is charged a percentage of the loan as a premium for the insurance.
• The lender can charge points, and either the borrower or the seller (or both) can pay them.  

3. VA Loans

Available to eligible veterans and their spouses. A VA loan is guaranteed. The VA does not loan the money directly (usually) and the guarantee provides added security for the lender.

A VA loan can be used to purchase, build and improve a home.

In most cases, no down payment is required. The VA guarantees both fixed-rate and adjustable rate loans. 

• Interest rates are negotiable between the lender and the borrower.
• There is no monthly mortgage insurance premium to pay.
• Any discount points charged can be paid by either the veteran or the seller.
• The loan can be prepaid without a penalty.

VA loans are assumable - the original veteran borrower is still liable for the repayment of the loan unless the VA approves a release of liability (does not release the veteran's liability to the lender).

A veteran must apply to the VA for a certificate of eligibility to determine the eligible status and to determine the amount of the loan the VA will guarantee.

The VA requires an appraisal of the property and then issues a certificate of reasonable value (CRV).

4. CalVet Loans

The CalVet loan is actually a land contract. 

The state purchases the property and resells it to the veteran using a contract of sale. The state retains the title to the property until the loan is paid off.

• CDVA offers below market interest rates.
• CalVet loans usually have a variable interest rate.
• There is no prepayment penalty for paying off the loan early.

Other Common Financing Types

• Purchase Money Mortgage - the buyer borrows from the seller in addition to the lender. The purchase money mortgage is created at the time of the purchase and delivered at the time the property is transferred as part of the sale transaction.
• Installment Land Sales Contract (contract for deed) - the buyer does not receive legal title until the final payment is made. The seller keeps legal title until the debt is paid in full. The buyer receives equitable title until the debt is fully paid.
• Lease Purchase - a tenant enters into an agreement to purchase and a lease. The tenant agrees to purchase the property, but operates under the lease until the terms of the purchase agreement are fully satisfied.
• Lease Option - gives the tenant the right to purchase the property under specific conditions - usually at a predetermined price and within a set period of time.
• Second mortgage - owner takes out another loan for additional money, after the first mortgage.
• Blanket Mortgage - covers more than one piece of property. The partial release clause allows the borrower to obtain a release of any individual lot from the lien by repaying a certain part of the loan.
• Buydown - used to reduce the monthly payment for a borrower during the initial years of the loan.
• Construction loan - short-term loans to finance the construction of improvements to property. The lender commits to the full amount of the loan, but disburses payments over the life of the construction project. Interest rates are usually higher than on other loans because the risk is greater.
• Wraparound Loan - allows a borrower who has an existing loan to get another loan from a second lender without paying off the first loan. The second lender issues a new larger loan to the borrower at a higher interest rate. A wraparound mortgage is only possible if the original loan documents allow it.
• Package Loan - includes all the personal property and appliances that are installed on the property - used in the sale of furnished condominiums.

Other Types of Financing

• Open-end Loan- expandable loan which gives a borrower a limit up to which he or she may borrow. Each incremental advance must be secured by the same mortgage, and any advances may not exceed the original borrowing limit.
• Sale and Leaseback- typically used by commercial enterprises to free up money that has been tied up in the real estate to use as working capital in the business. The owner of the real estate sells the property and then leases it back from the buyer.
• Bridge Loan- short-term loan that covers the period between the end of one loan and the beginning of another.
• Home Equity Loan - alternative to refinancing. It can be given as a fixed amount or a line of credit. Owners have the ability to borrow against the equity they have built up in their home.
• Grant Programs (down payment assistance) - provide buyers with a "gift" of money to use toward their down payment or closing costs which never has to be paid back.