The Loan and the Consumer Sources of Financing

Nightly Trivia Q) In what real estate market are more than 90% of home sales cash transactions? A) Palm Beach, home to princes, politicians, and CEO’s, has homes from 2,000 sq ft condos to 56,000 sq ft estates

The Loan and the Consumer Truth-in-Lending Application and Approval

The Truth-in-Lending Act Went into effect in 1969 Requires that lenders disclose to borrowers BEFORE closing the transaction all details of cost in both dollar and percentage Important term – APR – Annual Percentage Rate – the interest rate plus other costs of a loan combined to show the true annual cost of borrowing

When to Disclose? Five trigger terms: The amount of down payment The amount of any payment The number of payments The period of repayment The dollar amount of any finance charge

Triggers Need Disclosure 5 disclosures if any one of the triggers is present The cash price or the amount of the loan The amount of down payment or a statement that none is required The number, amount, and frequency of the payments The annual percentage rate The deferred payment price or total payments

Disclosures Prominently displayed information: The amount financed The finance charge The annual percentage rate The total payments

Many More Disclosures Identity of the lender Payment schedule Prepayment penalties and rebates Late payment charges Any insurance required Any filing fees Any required deposits Whether the loan can be assumed The demand feature, if the note has one Total sales price of the item being purchased if the seller is also the creditor Any adjustable rate features of the loan Itemization of the amount financed Reference to any terms not shown on the disclosure statement but which are shown on the loan contract

Compliance Who – anybody that makes loans on a regular basis Examptions Credit for business, commercial, or agricultural purposes Credit over $25,000 secured by personal property unless it is the principal residence of the borrower

Fines and Penalties $10,000 fine per day once an advertiser has been told to cease running an ad by the FTC Disclosure failure when credit is extended carries fines of: Twice the amount of the finance charge, min $100, max $1000 Court costs Attorney fees Actual damages Fine of up to $5,000 and one year imprisonment

Lemon Law The borrower has three business days (including Saturdays) to back out after signing the loan papers !!! Does not apply to credit used for the acquisition or initial construction of one’s principal dwelling

Uniform Residential Loan Application Type of mortgage and terms of the loan Property and proposed financing Analysis of the borrower(s) Job stability Amount and sources of income Housing payments past vs. future Housing expense vs. income

More Application Info Source of funds for closing and emergency funds (liquid assets) Life insurance values, cash value and face amount Existing debts and liabilities Net worth calculation Credit references

Fair Lending Redlining – the past practice of refusing to make loans in certain neighborhoods Lenders are no longer allowed to make decisions based on age or location of property, neighborhood income level, or race, religion, or ethnic composition

Sources of Financing Primary Market Secondary Market Government Agencies Availability of Funds

Primary Market Primary mortgage market – lenders originate loans Regulated and unregulated markets – based on government control Primary mortgagers often sell mortgages on the secondary market – larger than the entire U.S. corporate bond market

Types of Markets Regulated: Commercial banks, S&L’s, savings banks Subject to federal regulators Pay risk-based premiums on insurance Restricted LV ratios Nonregulated: Commercial finance companies, investment bankers, life insurance companies, finance companies

Savings and Loan Companies Based on building societies in Europe and the U.S. Required to hold 80% of assets in residential loans Rapid inflation caused problems and ultimately failure of many S&L’s in the 1980’s

The S&L Problem Disintermediation – depositors take money out of their savings accounts and invest in government securities S&L’s took short-term deposits and made long-term loans During periods of high inflation, the interest rates of these instruments do not support each other

FIRREA Financial institutions reform, recovery, and enforcement act of 1989 Created 7 new regulatory authorities Done in response to S&L failures and other problems experienced by the financial markets in the ’80’s

Types of Financing Institutions Commercial banks Life insurance companies Mortgage companies Mortgage brokers Computerized loan origination Municipal bonds Other lenders

Commercial Banks 1 dollar in 6 goes to real estate lending Maintaining multiple loan accounts for an investor in one portfolio provides a market advantage Attracts customers Broadens opportunities Financial Services Modernization bill (FSM) of 1999 allowed banks to become one-stop financial conglomerates

Life Insurance Companies Large-scale investments are the specialty Usually purchased in the secondary mortgage market Participation loans – a percentage of payments on the mortgages and profits from rentals goes to the company, offers a hedge against inflation

Mortgage Companies Originates the loan and then sells it on the secondary market Usually earn 1%-3% of the amount of the loan on origination Earn ¼ to ½ of 1% of the outstanding balance each year for the life of the loan

Mortgage Brokers Work like any other broker – bring together buyers and sellers Neither lends money nor services loans Fees are paid in points on the mortgage

Computerized Loan Origination A computer links offices to lenders’ computers Provides: Informaiton on current mortgage loan terms and loan types available on the market Conveys loan application information electronically Monitors the loan approval process

Municipal Bonds Municipal bonds pay tax-free interest Mortgage borrowers will save approximately 2% using this form over others Used by cities to encourage growth and renewal of specific areas

Other Lenders Pension and trust funds are placing more money into real estate loans than in the past Finance companies are investing in second mortgages Credit unions are expanding mortgage activity Commercial finance companies can operate in the mortgage market without the regulatory restrictions placed on banks

Secondary Market Why? Delivery systems Standardization FNMA GNMA FHLMC Farmer MAC

Why a Secondary Market? Provides a place for lenders to sell a loan Permits investment in loans without all the other loan requirements Works as a pipeline for money

Secondary Market Delivery Systems The borrower obtains a loan from a loan originator Investments are made by: Portfolio purchasers looking for initial investments with a return Poolers looking for long-term stable return

Standardization Traditionally, there were many ways to originate and make loans Standardizing applications, appraisals, terms, etc. makes these loans tradable It is standardization that allows the secondary market to exist

FNMA “Fannie Mae” – originated in 1938 to buy loans from lenders and encourage loan growth In 1968 changed to a private division Buys FHA, VA, and conventional loans Focus is on the mid-range housing prices Max LV ratio of 80%

Fannie Mae, Cont. Trades in mortgage-backed securities – allows securities markets (NYSE, etc.) to generate funds for the organization Test-marketing $1000 increments for individual investors and IRA’s Works to facilitate loans for low- to moderate- income borrowers

GNMA “Ginnie Mae” – split from Fannie Mae in 1968 Federal agency of HUD Underwrites only HUD/FHA, VA, and some other loans Accounted for 10% of all residential loans in 2001

FHLMC “Freddie Mac” – created in 1970, deals primarily in conventional mortgages Issues securities Accounts for almost 17% of all outstanding loans in residential lending

Participation Certificates Freddie Mac can acquire all or only a part of a mortgage Freddie Mac provides the guarantee of payment for these mortgages This is possible by very strict loan qualifications plus mortgage insurance Individuals can invest in PC’s for a minimum of $25,000

Farmer Mac Established by the Agricultural Credit Act of 1987, began work in 1989 Established a secondary market for farm real estate loans Purchases loans directly from originators

Computerization This makes a very complex transactional environment possible Data can be easily and quickly transmitted among all participants in primary and secondary markets All parts of all accounts can be tracked and recorded

Availability of Money The money transferred in the mortgage markets must come from somewhere Savings from businesses and individuals are real savings Government money is fiat money The government can increase money in circulation, but risks inflation

Usury and Price to the Borrower Usury laws put a ceiling on interest rates charged to borrowers Not an issue in low interest rate environments As a rule, calculate loan rates as: savings interest + 2% for expenses + ½% for profit