+
ESCROW 190 (Escrow I)
Spring Term 2016
Day 5
+
Chapter 6: Real Estate Financing

Key to the real estate transaction

Without financing options, every potential purchaser would
need to pay cash

Where does it all come from?
+
The Primary Market

The original source of funds in the primary market comes
from savings of individuals and businesses in the local area.

The primary market would include any individual or
institution the borrower has direct access to:

Savings and Loan

Commercial Banks

Savings Banks

Mortgage Companies

Credit Unions
+
The Primary Market: Savings and
Loan Associations

“S&Ls”

Originally created in the early 1900’s to provide financing for
single family homes

Prior to 1970’s they were the largest source of residential lending
capital in the U.S.

Obtained funds to lend from their own depositors

Serviced their own loans (30 years) and serviced their local
community

Charged higher interest than it paid on deposit accounts

The resulting “spread”, less operation costs hopefully resulted in
profit
+
The Primary Market: Commercial
Banks

Oriented toward commercial lending activity

Largest source of investment funds in the U.S.

Prior to the 1970’s government regulation restricted
commercial banks’ long term investment activity in the real
estate lending market

Today, as much as 20% of a commercial bank’s assets may be
tied up in long term mortgage loans
+
The Primary Market: Savings
Banks

Similar to S&Ls

Created to serve their local community

Obtained funds to lend from their depositors and maintained
servicing

Savings Banks tended to focus on making small personal
loans, not large residential loans

1982: Congress passed the Garn St. Germain Act allowing
Savings Banks to nationally charter

Created option of going public and selling stock

Resulting revenue boosted assets & diversity of lending activity
including residential lending
+
The Primary Market: Mortgage
Companies

Mortgage Companies (Mortgage Bankers) do not maintain
deposit accounts

Make loans by borrowing capital from other banks, or by
representing larger investors (insurance companies,
pensions funds) who don’t have resources to research local
real estate markets

Mortgage Companies serve as intermediaries, rather than a
source of lending capital

They use their capital to originate loans, but sell the loans
quickly to the secondary market
+
The Primary Market: Mortgage
Companies (continued)

Mortgage Bankers are not Mortgage Brokers

The Mortgage Broker:

Never originates a loan with own funds

Has access to a wide variety of lenders, loan rates and loan
programs

“Shops” the market for best rate and program for the client

Takes the loan application and required documentation from
client to qualify them

Submits loan package to the selected lender

Upon loan approval, steps out of the loop
+
The Primary Market: Mortgage
Companies (continued)

Mortgage Bankers are not Mortgage Brokers

The Mortgage Banker:

Works for a bank or similar lending institution which actually
provides you the money for the loan.

Is a direct lender.
+
The Secondary Market

Sets the standards for the Primary Market

National market where mortgages secured by real estate are
bought and sold

Creation of the Secondary Market helped regulate
economically disruptive cycles of local real estate markets
by moving lending capital from areas of excess to areas of
need

Investors (such as banks), are more willing to buy mortgage
loans on the Secondary Market because uniform lending
standards ensure relatively “safe” loans
+
The Secondary Market: Three
Major Players
 Fannie
Mae:
Federal National Mortgage Association
 FNMA

 Ginnie
Mae
Government National Mortgage Association
 GNMA

 Freddie
Mac
Federal Home Loan Mortgage Corporation
 FHLMC

+
Player 1: Fannie Mae

Formed in 1938, its purpose was to provide a market to buy
and sell government loans

FHA-Insured

VA-guaranteed loans

Reorganized in 1968 by Congress as a private corporation in
which the general public could purchase stock

FMNA pledged to purchase ANY residential loans that met
certain standards (“guidelines”) as provided by FNMA

FNMA acted as a conduit for packaging and selling loans to
other investors around the country
+
Player 2: Ginnie Mae

As Congress re-organized FNMA, they created the
Government National Mortgage Association to take over the
previous responsibilities of FNMA

Presently, GNMA provides government securities for large
blocks of FHA and VA loans

GNMA also purchases loans that aren’t attractive to private
investors but are socially beneficial

Low income housing loans

Loans for urban renewal projects
+
By 1980: Savings and Loans fell
into trouble

Competition in the mortgage lending space led many S&Ls to
making speculative investments which often did not pay off

S&Ls had most of their assets tied up in long-term mortgage
loans at fixed rates

The Federal Government deregulated interest rates on
deposit accounts resulting in deposit rates skyrocketing

Thus, the S&Ls were paying more money on deposit accounts
than they were making in income on mortgage loans

Many S&Ls faced bankruptcy
+
Enter Player 3: Freddie Mac

Freddie Mac was created in 1980 to help the failing S&Ls by
purchasing their conventional loans

Today, FHLMC is authorized to purchase conventional loans
from any type of lender
+
Big Mac
+
The Secondary Market: New
lending regulations

July 2010: Dodd-Frank Wall Street Reform and Consumer
Protection Act passed

In response to the recession of the late 2000s

Consumer Financial Protection Bureau (CFPB) originally
proposed in 2007 by then Harvard Law School professor,
Elizabeth Warren

Proposed CFPB supported by Americans for Financial
Reform*

*Umbrella of 250+ consumer, labor, and civil rights organizations
+
The Secondary Market: New
lending regulations (continued)

September 17, 2010 President Obama appoints Warren as
Assistant to the President and Special Advisor to the Secretary of
the Treasury, to set up the new agency

CFPB formally began operation July 21,2011, with Richard
Cordray appointed as the Director of the agency

October 3, 2015

Parties applying for a new loan for purchase or refinance of a home
now subject to new disclosures required by the CFPB
 Consumer Disclosure Form replaces the Good Faith Estimate and
Truth in Lending.
 Impact on the Escrow Agent will be discussed in Chapter 7
+
Conventional Loans

Most common type of home financing

Common term is LTV (Loan to Value)

Percentage of loan to property value

Traditionally, the mortgage and banking industry considers
80% LTV to be secure

20% equity (personal investment) makes it unlikely the
borrower will not stop making payments or abandon the
property

If a foreclosure were necessary, the property would likely sell
for a price that would cover the loan balance and foreclosure
expenses incurred by the lender
+
Conventional Loans: Processing
and approval of the loan

Basic documentation required by an underwriter for loan
approval may include the following, and is collected by the
loan processor:

A loan application by the borrower

Credit report for all borrowers

Verification of employment

Verification of the source of down payment

Appraisal of the property
+
Conventional Loans: Processing
and approval of the loan (cont.)

Loan processor submits the documentation to underwriter
for approval

Underwriter will approve a borrower and determine the final
loan amount by considering the following qualifications:

Character

Capacity

Capital

Collateral
+
Conventional Loans: Processing
and approval of the loan (cont.)
 Character:
 Refers
to a borrower’s projected willingness to
make loan payments responsibly (on time)
 The credit report is used by the underwriter to
evaluate the borrower’s character
 Good payment history is considered good
character making the borrower a good credit risk
+
Conventional Loans: Processing
and approval of the loan (cont.)
 Capacity:
 Borrower’s
ability or means to make loan payments
 Underwriter evaluates the borrower’s monthly income
to debt ratios
Example: An underwriter may not approve a loan if the
loan payment is more than 30% of the borrower’s
monthly income, and, when combined monthly debt us
more than 38% of monthly income (loan payments,
taxes, insurance child support are all considered)
+
Conventional Loans: Processing
and approval of the loan (cont.)
 Capital
Refers to the amount of down payment a borrower is
willing to invest in the property at the time of purchase
 The mortgage and banking industry has found a direct
correlation between equity invested and probability of
the borrower abandoning the property.

+
Conventional Loans: Processing
and approval of the loan (cont.)
 Collateral
Refers to the property the loan will be secured against
 Lender relies on an appraisal to determine property
value and to highlight any defects
 i.e. no power or or water = no conventional financing
 can the lender sell the house if foreclosure were
necessary?

+
Upon loan approval…

The funder will prepare documents which are forwarded to
the Escrow Agent

Borrower signs the documents

Signed loan documents are returned to the funder for review

Security documents are sent to title company to be held for
recording
+
Closing loans for the purposes
other than purchase

Conventional Loans are also given to borrower when they
already own the property (Refinance)

Refinancing for better terms

Pulling out equity for home improvement of debt consolidation

RESPA (Real Estate Settlement Procedures Act) Reg Z
provides that the borrower is entitled to additional disclosure
time when borrowing against their principal residence

This is a “Notice of Right to Cancel” and is three business
days from the date of signing.
+
Typical Conventional Loan Costs
 Loan
fees:
 Range between 1 and 3.5 points (percentage of
the loan amount)
 Fee can be broken into Origination and
Discount Fees
 “Origination” fee refers to cost to obtain the
loan
 “Discount” fee refers to the cost for the
borrower to buy down the interest rate
+
Typical Conventional Loan Costs
(cont.)
Example:
Mr. Jones is applying for an $80,000 loan. ABC Bank quotes Mr.
Jones a 7% interest rate for a total of 1 point (which is 1% or
$800). Mr. Jones decides he would prefer to “buy the rate
down” to 6.75%. Therefore, the loan will cost Mr. Jones a total
of 2 points ($1,600), the loan origination fee, plus an
additional 1% discount
Interest Rate
Loan Orig Fee
Discount Fee
Total
7%
1%
0%
1%
6.75%
1%
1%
2%
6.5%
1%
2%
3%
+
Credit Report Fee
Appraisal Fee
Tax Service Fee

Fees for these three items generally have a base rate this is
considered a usual fee

These fees can increase depending on circumstances

Out of town purchases

Additional inspections, etc
+
Document Preparation Fee
Underwriting Fee
Processing Fee

These will vary depending on the lender

Sometimes included in the loan fee
+
First year hazard insurance
premium

This can be paid directly to the insurance agent by the
borrower if the borrower can provide evidence of payment to
the lender

Usually paid through closing
+
First year hazard insurance
premium

This can be paid directly to the insurance agent by the
borrower if the borrower can provide evidence of payment to
the lender

Usually paid through closing
+
Interim Interest on the New Loan

Calculated by multiplying the loan amount by the
interest rate and dividing by 365 (or 360) to come up
with a daily interest figure (per diem).

Interest is always paid in arrears (backwards) so interest
is paid from the day of loan disbursement to 30 days
prior to the first payment on the new loan
+
Interim Interest on the New Loan
(cont.)
Example:
Susie is obtaining a loan for $100,000 at 8% interest.
Loan disbursement will occur on August 28th with first payment
due on October 1st
Since interest is paid in arrears the October 1st loan payment will
cover interest from September 1st to October 1st.
Therefore, Susie owes interim interest on the new loan from
August 28th to September 1st
+
Sellers need to be reminded that
interest is paid in arrears

Sellers will typically owe interim interest on a loan payoff

If closing is August 28th and the seller’s next payment is due
September 1, the seller will still owe interim interest on the
loan from August 1st to the date the payoff funds are receiving
by the underlying lender

This assumes all prior payments have been made
+
Reserve Accounts (aka Escrow
Accounts or Impound Account)

Reserves are required by the lender in accordance with their
lending policy

Reserves are for the purpose of establishing a separate
account to accumulate funds to pay property taxes and/or
home owner’s insurance when they come due each year

Some lenders only require property tax reserves

Others, like FHA and VA, require both property tax and home
owner’s insurance reserves
+
Reserve Requirements

Tax Reserves


In Washington State, taxes are due April 30 and October 31
Lender calculates how many months in advance deposit is
required:

How many months payments will be made before the next tax
payment is due

The subtracts 6 months

The difference is the number of months to be collected in
advance

Its typical for a lender to collect 2 additional months of reserves at
closing so there are sufficient funds in the account should taxes or
insurance
+
Reserve Requirements (cont.)
Example:
Susie’s loan will close on August 28th. Her first payment on the
new loan is due October 1st. Since second half taxes are due
October 31st, Susie will have made one payment by the time
taxes are due.
The lender will collect at least 5 months of tax reserves at the
time of closing. Most likely the lender will also collect an
additional 2 months “buffer”, bringing the total to 7 months
of tax reserves collected at closing
+ Hazard Insurance Reserves (aka Home
Owners Insurance or Fire Insurance)

For a new home purchase the lender usually requires the first
year be paid at closing plus 2 months.
Example:
Susie’s insurance premium is $400 per year. The first year
premium is paid in full at closing and 2 months insurance
reserve will be deposited into a reserve account to pay next
year’s insurance premium in full when it comes due
Therefore, the lender will collect a hazard insurance reserve
deposit of $66.66 at closing
+
Reserve Analysis

RESPA’s “Regulation X” went into affect in 1995

Lenders are now required to perform an aggregate account
analysis on all reserve accounts monthly to ensure the are not
over-collecting reserve deposits

The analysis ensures the lender is in compliance with the
regulation, and not collecting too much or too little for taxes
and/or insurance
+
Closing Insured Loans

Some borrowers do not have a 20% down payment, so
other financial options are available to them, such as:

They may qualify for a Conventional Loan of they obtain
Private Mortgage Insurance (PMI)

Secondary Financing

Government insured loan such as FHA or VA financing
+
Private Mortgage Insurance (PMI)

Protects the lender against loss if the borrower defaults on their
loan

As a rule, the less capital a borrower puts down, the greater the
risk of default

Therefore, the less capital a borrower puts down, the more
expensive the PMI premium

In terms of reserves, if the borrower chooses to pay monthly the
lender may require a year of PMI be paid at closing, or just 1
month

The difference between closing an insured loan (PMI) versus an
uninsured loan (no PMI), is the borrowers need to be approved
by the lender and the mortgage insurance company
+

FHA Insured Loans
The Federal Housing Administration (FHA) is a government
agency within the Department of Housing and Urban
Development (HUD)

Funded by Congress to enable home purchasers to acquire homes
with small down payments

Through FHA, a qualified purchaser can pay as little as 3% down
(subject to maximum loan restrictions)

The terms of the Purchase and Sale Agreement and the
Lender’s Instructions to escrow will identify what loan costs are
to be paid by the seller and buyer

Payoffs are calculated differently on an FHA loan

(instructor to describe)
+
Mortgage Insurance (MI)

Purchaser must pay for FHA mortgage insurance

FHA insurance guarantees the loan will be paid in full if the
borrower should default on the loan

Except for condo units, the mortgage insurance premium for
the life of the loan is paid at the time of closing

If the loan amount plus the mortgage insurance premium
does not exceed the maximum amount allowed, the
mortgage insurance premium can be financed
+ VA Guaranteed Loans

The Veteran’s Administration (VA) is a government department
created for the purpose of providing benefits to veterans.

On a VA loan the purchaser can’t pay certain fees, such as:













Loans closing or settlement
Document preparation
Preparation of loan documents
Conveyance documents
Attorney’s services (except title work)
Photographs
Interest rate lock-in fee
Postage/Mailing
Membership fees
Escrow fee
Notary fee
Loan processing fee
Tax Service Fee
+
VA Guaranteed Loans (cont.)

In the case of a refinance, the lender will generally pay the
escrow fee and the Escrow Agent will confirm that before
closing a VA refinance

The VA Funding fee is mandatory and is based on the loan
amount

Interest rate and discount pints can be negotiated among the
buyer, seller and lender but cannot be added to the loan
amount of VA Funding Fee

Seller may credit up to 4% of the purchase price for funding
fee, discount points, down payment and prepaid cost, without
adjustment of the down payment
+
VA Guaranteed Loans (cont.)

The VA program includes a guaranty for the down payment,
so the Veteran can purchase property with no down payment
on their principal residence all costs paid by the seller

This is called a “VA zero down” or “VA double zero”

VA zero down


VA double zero down


Veteran still pays for insurance and prepaid closing costs
Seller pays for everything including insurance and prepaid
closing costs
The veteran can only have one VA loan at a time
+
Seller Financed Transactions

Financing for the buyer comes from the seller and not an
institutional lender

The purchaser and seller may use a Real Estate Contract, a
Note and Deed of Trust, or a Note and Mortgage to outline
the terms of the loan and secure the financing
+
Real Estate Contract

A form of financing where the seller remains on title to the
property until all or a certain part of the purchase price is
paid by the purchaser

Often used when the down payment is very small

Once the purchaser has paid all sums owing under the
contract, the seller records a Statutory Warranty Fulfillment
Deed to transfer title into the name of the purchaser
+
Note and Deed of Trust

Most commonly used in seller financed transactions

Promissory Note



Written paper promising to repay a loan in accordance with
stipulated terms

Establishes personal liability for payment on the part of the
“maker” (borrower)
Deed of Trust

Security or collateral, for the personal liability

Under a Deed of Trust, title to land is transferred to a trustee as
security for a debt or other obligation
“The Deed”

Written instrument which transfers ownership form the seller to
the purchaser
+ Note and Deed of Trust (cont.)

At closing, the seller deeds title to the property to the
purchaser, who then becomes the vested owner

The purchaser then signs the Promissory Note and Deed of
Trust over to the seller

Once the Deed and the Deed of Trust have been recorded with
the County, the purchaser shows as vested owner of the
property and the seller has a lien secured against the property

The benefit to the seller of using a Deed of Trust is that they can
foreclose non-judicially (without court proceedings) if the
purchaser defaults on the loan

The Trustee (operating within WA State law), can force the sale
of the property at a foreclosure auction (or “trustee sale”) and
use the proceeds to pay off the seller’s lien
+ Note and Deed of Trust (cont.)

After closing, the seller holds the original Note and original
recorded Deed of Trust until the loan is paid in full

Upon payment in full, the seller will:

Sign a Request for Full Reconveyance,

Mark the Note as “Paid”

Send the original recorded Deed of Trust, Request for Full
Reconveyance and “Paid” Note to the Trustee (listed on the Deed of
Trust)

The Trustee is the only party who can legally prepare the
Reconveyance which removes the seller’s lien from title
+
Note and Mortgage

The only difference between a Deed of Trust and a Mortgage
is that the seller must foreclose judicially (through the courts)
if the purchaser defaults on the loan

The purchaser also has one year to make good on the loan and
reclaim the property

Again, after closing the seller holds the original Note and
original recorded Mortgage until the loan is paid in full

Upon payment in full, the seller will:

Sign a Satisfaction of Mortgage

Mark the Note as “Paid”

Send the original documents to the purchaser

The purchaser must record the Satisfaction of Mortgage to
remove the lien from the property
+ Problems with seller financing after
closing

The purchaser and seller forget to prepare a Statutory Warranty
Fulfillment Deed, Request for Full Reconveyance or Satisfaction
of Mortgage when the loan is paid off

Purchaser forgets to record the appropriate document once its
delivered (to remove the lien)

If a collection account is set up for payments, and the purchaser
loses track of the seller’s whereabouts

Seller dies without the purchaser knowing and obtaining
necessary title clearing documents


If no authorized party is identified to sign release documents then the
purchaser must sue for “quiet title” (action to establish title to real
property). Can take several months.
The seller may have deposited title clearing documents with a
collection agent who could be instructed to hold the docs until
repayment