Financing Residential Real Estate Lesson 7: The Financing Process

Loan Costs Primary consideration for most buyers in choosing lender is how much loan will cost.

Loan Costs Primary consideration for most buyers in choosing lender is how much loan will cost. In addition to interest rate, cost of loan may include:  loan origination fee,  discount points,  miscellaneous charges, and  mortgage broker’s fee.

Loan Costs Point = percentage point 1 point = 1% of loan amount Points

Loan Costs Point = percentage point 1 point = 1% of loan amount Usage issue:  Some lenders use “points” to refer to origination fee and discount points together.  Others use “points” to refer only to discount points. Points

Loan Costs Origination fee pays for lender’s expenses, such as staff compensation, facilities costs, and other overhead.  Charged in almost every mortgage transaction.  Typically around 1% of loan amount.  Paid at closing, usually by borrower. Loan origination fee

Loan Costs Discount points are a lump sum paid at closing to increase lender’s upfront yield (profit) on loan.  In exchange for upfront payment, lender charges borrower lower interest rate.  May save borrower money in long run, depending on how long she owns home. Discount points

Loan Costs How many discount points lenders charge varies depending on market conditions and other factors.  Might charge 4 to 6 points for 1% interest rate reduction. Discount points

Loan Costs Example: Market rate for mortgage: 5.25% Lender charges 4 points for 1% rate reduction $300,000 Loan amount x 4% 4 points $12,000 Cost of discount If lender is paid $12,000 up front, will charge borrower only 4.25% interest on loan. Discount points

Loan Costs Discount points may be paid by buyer or seller. Buydown = Paying lender discount points to “buy down” buyer’s interest rate. Discount points

Loan Costs Discount points may be paid by buyer or seller. Buydown = Paying lender discount points to “buy down” buyer’s interest rate. When buyer pays points, pays lender in cash at closing. When seller pays points, amount is withheld from loan amount and deducted from seller’s proceeds at closing. Discount points

Loan Costs In addition to an origination fee and discount points, lenders often charge borrowers other fees, such as:  application fee  document preparation fee  underwriting fee Miscellaneous fees

Loan Costs In addition to an origination fee and discount points, lenders often charge borrowers other fees, such as:  application fee  document preparation fee  underwriting fee These vary widely from one lender to another. Borrower should ask loan originator if any can be reduced or waived. Miscellaneous fees

Loan Costs Buyers working with mortgage broker are generally charged a mortgage broker’s fee. May be separate fee or included in points quote for loan. Mortgage broker’s compensation

Loan Costs Buyers working with mortgage broker are generally charged a mortgage broker’s fee. May be separate fee or included in points quote for loan. Shouldn’t make loan more expensive than one obtained without a broker’s help.  Broker gets loan at wholesale price, marks it up to retail price, keeps overage as fee. Mortgage broker’s compensation

Loan Costs Controversy over another form of mortgage broker compensation: yield spread premium (YSP). Mortgage broker’s compensation

Loan Costs Controversy over another form of mortgage broker compensation: yield spread premium (YSP). Broker persuades borrower to accept a loan at “above par” (higher-than-market) interest rate. Mortgage broker’s compensation

Loan Costs Controversy over another form of mortgage broker compensation: yield spread premium (YSP). Broker persuades borrower to accept a loan at “above par” (higher-than-market) interest rate. Lender pays broker YSP based on difference between market rate and borrower’s rate. Mortgage broker’s compensation

Loan Costs Controversy over another form of mortgage broker compensation: yield spread premium (YSP). Broker persuades borrower to accept a loan at “above par” (higher-than-market) interest rate. Lender pays broker YSP based on difference between market rate and borrower’s rate. Practice gives mortgage brokers incentive to steer borrowers to more expensive loans. Mortgage broker’s compensation

Comparing the Cost of Loans The various fees charged in addition to interest make it hard to compare loans offered by different lenders. Truth in Lending Act (TILA): federal consumer protection law that requires lenders to disclose the cost of a loan using certain figures and terminology, to make comparison easier. Truth in Lending Act

Most important TILA disclosure: annual percentage rate (APR). APR expresses relationship between all of the financing charges and the amount borrowed as a percentage. To determine which of two loans is more expensive, compare APRs, not just interest rates. Annual percentage rate

Truth in Lending Act Another key TILA disclosure: total finance charge. Total finance charge includes:  interest,  origination fee,  discount points paid by borrower,  mortgage broker’s fee,  finder’s fee,  service fee, and/or  mortgage guaranty or insurance fees. Total finance charge

Truth in Lending Act Total finance charge does NOT include:  title insurance costs,  credit report charges,  appraisal fee, or  discount points paid by seller. Total finance charge

Loan Costs Some lenders offer no-fee loans or low-fee loans. No major lender charges such as origination fee or discount points. Only (or almost only) financing charge is interest. Interest rate often much higher than rate for loan with standard fees. Helpful for buyers with little cash for closing. No-fee or low-fee loans

Summary Loan Costs and Financing Options  Origination fee  Discount points  Buydown  Mortgage broker’s fee  Truth in Lending Act  APR  Total finance charge  No-fee or low-fee loan  Home buyer counseling

Summary Lesson 14:  Fair Lending and Consumer Protection

Consumer Protection Laws Federal consumer protection laws that apply to mortgage loan transactions:  Truth in Lending Act  Real Estate Settlement Procedures Act

Consumer Protection Laws Truth in Lending Act (TILA) – 1968 Implemented by Federal Reserve Board’s Regulation Z.  Requires disclosure of finance charges.  Regulates advertising of consumer credit. Truth in Lending Act

TILA applies only to consumer loans. Consumer loan = a loan used for personal, family, or household purposes. Consumer loan is covered by TILA if it is to be repaid in more than four installments (or is subject to finance charges) and is either:  for $25,000 or less, or  secured by real property. Loans covered by TILA

Truth in Lending Act Thus, TILA applies to any mortgage loan used for personal, family, or household purposes, such as:  buying or remodeling a home,  consolidating personal debt, or  sending kids to college. Loans covered by TILA

Truth in Lending Act TILA only applies to loans made to natural persons. Loans exempt from TILA

Truth in Lending Act TILA only applies to loans made to natural persons. Doesn’t apply to: 1) loans made to corporations or organizations; 2) loans made for business, commercial, or agricultural purposes; or 3) loans > $25,000 not secured by real property. Loans exempt from TILA

Truth in Lending Act TILA only applies to loans made to natural persons. Doesn’t apply to: 1) loans made to corporations or organizations; 2) loans made for business, commercial, or agricultural purposes; or 3) loans > $25,000 not secured by real property. Most seller financing is also exempt. Loans exempt from TILA

Truth in Lending Act Lender must give mortgage loan applicant disclosure statement with estimates of loan costs within 3 days of receiving written application. Disclosure requirements

Truth in Lending Act Lender expected to use best info reasonably available in preparing TILA disclosure statement. If estimates later prove incorrect, revised disclosures required. Disclosure requirements

Truth in Lending Act Two most important disclosures: Total finance charge  “Dollar amount your credit will cost you” Annual percentage rate (APR)  “Cost of your credit as a yearly rate” Disclosure requirements

TILA Disclosure Requirements For mortgage loan, these expenses would be included in total finance charge, if applicable:  Interest  Origination fee  Points paid by borrower  Finder’s fee  Service charge  Mortgage insurance premiums  Guaranty fee  Mortgage broker’s fee Total finance charge

TILA Disclosure Requirements Application fee Appraisal fee Document prep fee Notary fee Credit report fee Survey fee Title report fee Title insurance premiums Pest inspection fee Flood inspection fee Impounds Points paid by seller Late payment fees Fees charged on default Total finance charge Not part of total finance charge for mortgage loan:

TILA Disclosure Requirements TILA disclosure statement must also show:  Lender’s identity  Amount financed  Payment schedule  Total payments  Any prepayment penalty  Late charges  Assumption policy Other disclosures

TILA Disclosure Requirements APR for ARM can’t be calculated in same way as APR for fixed-rate loan, because total amount of interest to be charged is unknown at outset.  When calculating APR for ARM, lender may use loan’s initial interest rate.  Must state that APR is subject to increase after closing. ARMs

TILA Disclosure Requirements Numerous special disclosures required for ARM secured by principal dwelling. CHARM booklet: “Consumer Handbook on Adjustable-Rate Mortgages.” ARMs

TILA Disclosure Requirements Numerous special disclosures required for ARM secured by principal dwelling. CHARM booklet: “Consumer Handbook on Adjustable-Rate Mortgages.” Specific disclosures about ARM program(s) the applicant is considering, such as:  how interest rate and payment may change;  index used to determine ARM’s interest rate. ARMs

TILA Disclosure Requirements For ARM secured by principal dwelling, lender must notify borrower each time interest rate is being adjusted. Notice explains effect of adjustment on payment, loan balance, other aspects of loan. If payment amount will change, adjustment notice must be sent at least 25 days, but no more than 120 days, before change. ARM adjustment notice

Truth in Lending Act If security property is borrower’s existing principal residence, borrower has right of rescission. Right of rescission

Truth in Lending Act If security property is borrower’s existing principal residence, borrower has right of rescission. May rescind loan agreement any time within 3 days after:  signing agreement,  receiving disclosure statement, or  receiving notice of right of rescission. Right of rescission

Truth in Lending Act If borrower doesn’t receive statement or notice, right of rescission doesn’t expire for 3 years. Right of rescission

Truth in Lending Act Right of rescission applies to:  home equity loans  refinancing with a new lender Doesn’t apply to purchase loans. Right of rescission

Truth in Lending Act TILA advertising rules apply to anyone who advertises consumer credit, not just lenders. Advertising under TILA

Truth in Lending Act TILA advertising rules apply to anyone who advertises consumer credit, not just lenders. Rules prohibit:  Bait and switch tactics.  Misleading ads that feature only most attractive terms and disguise true cost of loan. Advertising under TILA

Truth in Lending Act It’s legal to state cash price or APR in ad. But if particular “trigger” terms (such as downpayment, interest rate, or monthly payment) are stated, the rest of the terms must also be stated. Advertising under TILA

Summary Truth in Lending Act  Regulation Z  Consumer loan  Annual percentage rate  Total finance charge  ARM disclosures  CHARM booklet  Adjustment notice  Right of rescission  Advertising rules  Bait and switch

Consumer Protection Laws Real Estate Settlement Procedures Act – 1974 Affects how closing is handled in most residential mortgage transactions. RESPA

RESPA has two main goals: to provide borrowers with information about all financing fees and closing costs; and to eliminate kickbacks and referral fees that increase borrowers’ costs. Purpose of law

RESPA RESPA applies to all federally related loan transactions.  Category includes most residential mortgage loans. Covered transactions

RESPA Loan is federally related if both 1 and 2 apply: 1. Loan is secured by residential property with up to four dwelling units.  Or loan will be used to finance construction of dwelling with up to four units. 2. Lender is federally regulated, has federally insured accounts, sells loans to secondary market agency, or makes more than $1 million in real estate loans per year. Covered transactions

RESPA RESPA doesn’t apply to: loan to purchase 25 acres or more; loan primarily for business, commercial, or agricultural purpose; loan to purchase vacant land, unless it will have dwelling built on it or mobile home placed on it; temporary financing (construction loan); assumption where lender’s approval not required or obtained. Exemptions

RESPA Requirements and Restrictions 1. Within 3 days of written application, lender must give loan applicant: booklet about settlement procedures good faith estimate of closing costs mortgage servicing disclosure statement Disclosures to loan applicant

RESPA Requirements and Restrictions 2. When referring a party to another provider, a settlement service provider must disclose any affiliated business arrangement. Settlement service provider = lender, mortgage broker, title company employee, real estate agent. Affiliated business arrangement = referring provider has more than a 1% ownership or beneficial interest in the business the party is being referred to. Affiliated business arrangements

RESPA Requirements and Restrictions 3. Closing agent must itemize loan settlement charges on Uniform Settlement Statement form.  Completed form must be available for inspection by borrower, upon request, at least one day before closing.  Form has special sections for buyer and seller information; copies given to both parties at closing. Uniform Settlement Statement

RESPA Requirements and Restrictions 4. If borrower required to make deposits into an impound account, lender can’t require excessive deposits.  Excessive = more than necessary to cover expenses when due.  Cushion of more than two months’ worth of payments generally considered excessive. Impound account deposits

RESPA Requirements and Restrictions 5. Lender or settlement service provider may not:  give or receive kickbacks or referral fees;  accept unearned fees; or  charge a document preparation fee for required disclosures (Uniform Settlement Statement, impound account statement, or TILA disclosures). Kickbacks and unearned fees

RESPA Requirements and Restrictions 6. Property seller may not require buyer to use a particular title insurance company. Choice of title company

RESPA Requirements and Restrictions In 2010, lenders will be required to start using new standardized form for good faith estimate (GFE) and new version of Uniform Settlement Statement. RESPA rule changes in 2010

RESPA Requirements and Restrictions New rules will also: Encourage lenders to give applicants GFE earlier in process, to facilitate comparison shopping. Place strict limits on cost increases between time of GFE estimates and closing. Require disclosure of more information about trade-offs between interest rate and other loan costs (such as yield spread premiums for mortgage brokers). RESPA rule changes in 2010

Summary Real Estate Settlement Procedures Act  RESPA  Federally related loan transaction  Settlement service provider  Affiliated business arrangement  Kickback or referral fee  Unearned fee  Good faith estimate of closing costs (GFE)  Uniform Settlement Statement