University of North Carolina Wilmington
Cameron School of Business
Department of Economics &Finance
REAL ESTATE
FINANCE 331
LECTURE NOTES AND STUDY GUIDE
Phase 2: Chapters 7 - 11
To Accompany Ling & Archer’s
Real Estate Principles: A Value Approach
4th Edition (2012), McGraw-Hill Irwin
Prepared by Dr. David P. Echevarria
 ALL RIGHTS RESERVED
1
Chapter 7
Valuation Using the Sales Comparison and Cost Approaches
I.
MARKET VALUE, INVESTMENT VALUE, AND TRANSACTION PRICES
A. Appraisals
1. An unbiased written estimate of the fair market value of a property
a. Appraiser’s final estimate of property value
b. Data upon which the estimate is based
c. Assumptions and calculations used to arrive at the particular estimate
2. Why Do We Have To Estimate Market Value?
a. To get an estimate of the probable selling price under current market conditions
b. Lenders require an estimate of market value to make a reasonable mortgage
decision
c. Real estate markets are assumed to reflect near perfect competition; the
implication is that transaction occur at or very near true (or intrinsic) values
d. Question: Are we all price takers?
B. The Appraisal Process: Uniform Standards of Professional Appraisal Practice (USPAP)
1. Identify the appraisal problem
a. Client & intended uses of appraisal
b. Date of valuation
c. Rights to be valued (fee simple, etc.)
d. Type of value to be estimated: market, insurance, or taxable value?
e. Important assumptions or conditions
2. Determine the required scope of work
a. Time & personal requirements
b. Outline of proposed appraisal report
c. Data & procedures used to complete required tasks
3. Collect data and describe property
a. Market area data: Characteristics of region, city, and neighborhood
b. Subject property data: Site, building, & locational characteristics
c. Comparable property data: Key to Appraisal?
4. Perform data analysis
a. Market analysis: Effects of demand & supply
b. Highest & best use; use which is legally/physically/financially permissible
c. Highest & best use as though vacant: considers any possible use
d. Highest & best use as improved: must consider any cost of demolition
2
5. Determine value of land: Important to value separately from improvements
6. Apply 3 Approaches to Valuation
a. Sales comparison approach
b. Cost approach
c. Income approach
7. Reconcile indicated values from 3 approaches
a. Weight based on relative reliability of the three approaches
8. Report final value estimate
a. Report writing is an extremely important function
b. Must meet requirements of 1 of 3 reporting options
Self-contained report: full narrative description of process
Summary report: summary of conclusions, principal points of process
Restricted report: minimal discussion, limited to use by client
II.
SALES COMPARISON APPROACH TO ESTIMATING MARKET VALUE
A. Sales Comparison Approach
1. Basic Idea: Value of RE can be determined by analyzing the sale prices of similar
properties
2. Why? In a competitive market, close substitutes should sell for similar prices
3. Major difficulty? How many truly close substitutes exist & how many of these have
sold recently?
B. Selecting Comparable Sales
1. Must be properties that prospective buyers would consider substitutes
2. Should be arms-length transactions
a. Fairly negotiated prices that occurred under “normal” conditions
b. For example, not a distressed sale
3. Select to minimize required physical and locational adjustments
C. Data Sources
1. Public records (e.g., county property tax assessor)
2. Multiple listing service
3. Private vendors (title companies, others): CoStar for commercial properties
D. Adjustments to Comparable Sale Prices
1. Convert characteristics of each comparable to an approximation of subject
2. Sequence of adjustments
a. Transactional adjustments: nature of the deal (see list top of page 171)
b. Property adjustments: unique feature of property (ditto)
3. Recent price trends
3
III.
COST APPROACH TO ESTIMATING MARKET VALUE
A. Procedure
1. Estimated reproduction cost of improvements
− Estimated accrued depreciation
= Depreciated cost of building improvements
+ Estimated value of site
= Indicated value by the cost approach
2. The Major Assumption?: Cost of creating a property is related to its market value
B. Two concepts of cost:
1. Replacement cost: Cost to create something of equal utility (functionality)
2. Reproduction cost:
a. Cost of an exact physical replica
b. Complication in application?
C. Methods to estimate replacement cost
1. Quantity survey method
2. Cost per square foot or cubic foot
3. Unit in place
D. Sources replacement cost estimates
1.
2.
3.
4.
R.S. Means www.rsmeans.com
Marshall and Swift www.marshallswift.com
Consulting firms
Builders/contractors
E. Special Issue of Accrued Depreciation – Commercial Property
1. Difference between replacement cost & market value of improvements
2. Types of accrued depreciation that must be considered:
a. Physical deterioration: Loss in market value due to aging, decay & ordinary use
b. Functional obsolescence: Loss in value due to changes in tastes, preferences,
technological innovations, or market standards
c. External (economic) obsolescence: loss of value due to neighborhood changes
IV.
HOMEWORK ASSIGNMENT
A. Key terms: Accrued depreciation, Appraisal, Comparable properties, Market value,
Property adjustments, Replacement cost, Reproduction cost, Restricted appraisal report,
Transactional adjustments
B. Study questions: 2, 3, 4, 7, 8, 12
4
Chapter 8
Valuation Using the Income Approach
I.
THE INCOME APPROACH TO APPRAISAL
A. Rationale: Value = present value of future income
1.
2.
3.
4.
Income capitalization: converting future income into a present value
The present value is a function of the capitalization rate
The capitalization rate reflects investor requirements for return on investments
ROIs are adjusted for riskiness of investment
B. Two Approaches To Income Valuation
1. Direct capitalization using a single overall cap rate
2. Discount all expected future cash flows (CFs) at a discount rate
C. Direct capitalization
1. Find value as a multiple of first year net income (NOI)
2. “Multiple” is obtained from sales of comparable properties
3. Similar in spirit to valuing a stock using a price/earnings multiple
D. Discounted cash flow (DCF)
1. Project net CFs for a standard holding period (say, 10 years).
2. Discount all expected future CFs at required return (IRR)
3. DCF valuation models require:
a. Estimate of typical buyer’s expected holding period
b. Estimates of net (annual) CFs over expected holding period, including net income
from expected sale of property
c. Appraiser to select discount rate (required IRR)
II.
ESTIMATING NET OPERATING INCOME
A. Potential gross income (PGI)
1. Rental income assuming 100% occupancy
2. Sometimes referred to as potential gross revenue (PGR)
3. Should forecast of PGI be based on contract rent (signed leases) or current market
rents?
B. Types of Commercial Leases
1.
2.
3.
4.
Straight lease: “level” lease payments
Step-up or graduated lease: Rent increases on a predetermined schedule
Indexed lease: Rent tied to an inflation index; ex., consumer price index
Percentage lease: rent includes percentage of tenant’s sales
5
C. Effective Gross Income
1. VC-vacancy & collection loss is based on:
a. Historical experience of subject property
b. Competing properties in the market
c. “Natural vacancy” rate: Vacancy rate that is expected in a stable or equilibrium
market
2. Miscellaneous income
a. Garage rentals & parking fees
b. Laundry & vending machines
c. Clubhouse rentals
D. Operating Expenses
1. Ordinary & regular expenditures necessary to keep a property functioning
competitively
2. Fixed: Expenses that do not vary with occupancy (at least in the short-run)
a. hazard insurance,
b. local property taxes
3. Variable: Expenses that tend to vary with occupancy
a. Utilities
b. Maintenance & supplies
4. OE do not include: mortgage payments, tax depreciation, capital expenditures
E. Net Operating Income equals Effective Gross Income minus Operating Expenses
1.
2.
3.
4.
5.
6.
NOI is property's "dividend“: Why is it not investor’s dividend?
Projected stream of NOI is fundamental determinant of property’s value
NOI must be sufficient to:
service the mtg debt and
provide equity investor with an acceptable return on equity
Be careful of NOI vs. NCF (net cash flow)
F. Sources Of Industry Expense Data
1.
2.
3.
4.
Institute of Real Estate Management www.irem.org
Building Owners and Managers Association www.boma.org
International Council OF Shopping Centers www.icsc.org
Urban Land Institute www.uli.org
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III.
FIRST INCOME VALUATION METHOD: DIRECT CAPITALIZATION
A. Basic Value Equation: V = NOI ÷Ro
1. Where: Ro is a capitalization rate NOT a discount rate
2. A Cap Rate is defined simply as: Net Operating Income1 ÷ Sale Price
3. See Exhibit 8-5 for an example of how cap rates are estimated
Note that the NOI is the expected or anticipated first year net operating income
B. Effective Gross Income Multiplier
1.
2.
3.
4.
EGIM = sale price ÷ effective gross income
Quick indicator of value for smaller rental properties
Requires no operating expense information
Critical assumptions
a. Roughly equal operating expense percentages across subject and comparable
properties
b. Assumes market rents are paid
5. Best used for properties with short-term leases (apartments & rental houses)
C. Problems with Valuation by Direct Capitalization
1. Inadequate data on comparable sales due to:
a. Above- or below-market leases
b. Differing length of leases and rent escalations
c. Comparable vs. subject
d. Differing distributions of operating expenses between landlord and tenant
2. Differing prices between institutional and private investors for similar properties
3. Result: Discounted cash flow (DCF) analysis can be preferable
IV.
APPRAISAL WORK REQUIRES ANALYTICAL AND PEOPLE SKILLS
A. Developed a network of data contacts
B. Collect, read, interpret, and organize data and reports
C. Be skilled in data analysis and report production
D. Be able to meet tight deadlines
V.
HOMEWORK ASSIGNMENT
A. Key terms: Capital Expenditures, Direct capitalization, effective gross income, effective
gross income multiplier, capitalization rate, natural vacancy rate, net operating income,
operating expenses
B. Study Questions: 1, 4 - part a, 5, 6, 8 (Some calculations are required for 4a, 5, & 6.)
7
Chapter 9
Real Estate Finance: The Laws and Contracts
I.
GENERAL CHARACTERISTICS OF REAL ESTATE CONTRACTS
A. Most real estate transactions involve debt financing
B. Most businesses prefer to have their cash in the bank rather than tied up in real estate
C. Most investors leverage their investments in order to increase their returns on equity
D. Mortgage debt financing is a major aspect of real estate decisions
E. Mortgage lending is a major industry in United States and many other countries
F. A mortgage loan creates documents: a note and a mortgage or deed of trust
G. Debt financing also has tax advantages
II.
THE NOTE
A. Interest rates interest charges
1. Interest rates may be fixed or variable
2. Mortgages are amortized
a. Payments consist of principal and interest
b. The principal portion increases over time
c. The interest portion decreases over time
B. Adjustable Rate Mortgages
1.
2.
3.
4.
Adjustable-rate mortgages generally use an index
The index might be U.S. Treasury constant maturity rates (10-year) or the LIBOR
As the index changes the adjustable rates change
All adjustable-rate mortgages have floors and caps
a. A floor is the lowest rates can go
b. A cap Is the highest rates can go
5. Margin is the lenders markup above the index rate
6. Teaser rates: a reduced interest rate for a short period of time
8
C. Payments
1.
2.
3.
4.
5.
6.
Payments are made at the end of the month
Loans may be fully or partially amortized
Loans may also have a balloon payment
Some loans may be interest only
Some loans may involve negative amortization in the early years
Terms may be shortened by adding additional principal to each payment
a. All “conforming” and FHA/VA loans
b. Home equity credit lines
7. Loans with restricted right of prepayment
c. Subprime home loans
d. “Jumbo” home loans
e. Most income property mortgage loans
f. Lender may impose prepayment penalties
D. Other Terms
1. Nonrecourse loan: No personal liability
a. Exculpatory clause
b. Single-purpose, single asset, bankruptcy remote entity for borrower
2. Demand clause: Right of lender to require prepayment
3. Inclusion of mortgage clauses by reference
III.
THE MORTGAGE (DEED OF TRUST)
A. Mortgagor: Borrower
B. Mortgagee: Lender
C. Title vs. lien theory
1. Title theory: Mortgage a temporary transfer of title
2. Lien theory: Mortgage a lien
3. Historic difference was lender’s claim to rents and possession in case of default
D. Some Important Mortgage (DOT) Clauses
1.
2.
3.
4.
5.
6.
7.
Description of the property
Insurance clause
Escrow clause
Acceleration clause
Due-on-sale clause
Hazardous substances clause
Preservation and maintenance clause
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IV.
DEFAULT
A. Failure to meet requirements of the note or mortgage
1. Technical default: Any violation of terms
2. Substantive default: Three missed payments (90 days)
B. Non-Foreclosure Responses to Default
1.
2.
3.
4.
5.
Counseling and consumer debt reorganization
Temporary reduction of payments
Assisted sale
Short sale
Deed in lieu of foreclosure
a. Advantages: quick, quiet, cheap
b. Disadvantages: other liens remain; bankruptcy cannot nullify and wipe out
mortgage
C. Foreclosure
1. Legal process of terminating all claims of ownership and all liens inferior to
foreclosing lien
2. Negatives
a. Risk of failing to notify a claimant
b. Presence of superior liens
c. Costly and time consuming
d. Distressed sale
3. Importance of lien priority
4. Recourses of the defaulted mortgagor
a. Equity of redemption
b. Statutory right of redemption
5. Deficiency judgment: Judgment against mortgagor for unrecovered balance
Example:
a. Net foreclosure auction price: $100,000
b. Remaining loan balance:
c. Deficiency :
$120,000
$20,000
6. Judicial foreclosure vs. power of sale
a. Judicial foreclosure: Court-administered public auction
b. Power of sale: Public auction conducted by trustee or mortgagee (preferred by
lenders)
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V.
BANKRUPTCY
A. Three forms of bankruptcy
1. Chapter 7: Liquidation
2. Chapter 11: Court supervised “workout”
3. Chapter 13: Wage-earner’s proceeding
B. No form of bankruptcy can set aside a mortgage lien
C. Chapters 11 and 13 can result in delays
VI.
REGULATION OF HOME MORTGAGE LENDING
A. Equal Credit Opportunity Act: no discrimination (protected classes)
B. Federal Truth-in-Lending Act (TILA): full disclosure
C. Real Estate Settlement Procedures Act (RESPA): Standard HUD forms/requirements
D. Other laws
1. Home Ownership and Equity Protection Act
2. Home Mortgage Disclosure Act
3. Community Reinvestment Act
E. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
1. Given oversight and enforcement power for:
a. All federal consumer financial protection laws
b. Anti-discrimination laws in consumer finance
c. To restrict unfair, deceptive or abusive practices
d. Receive consumer complaints
e. Promote financial education
f. Power to monitor emerging consumer financial risks
2. Centralizes a multitude of regulators within one for home mortgage lending
VII.
HOMEWORK ASSIGNMENT
A. Key terms: Adjustable-Rate Mortgage, Balloon Loan, Contract For Deed, Deed Of Trust,
Default, Foreclosure, Libor, Negative Amortization, Nonrecourse Loans, Recourse Loans,
Short Sale, Term To Maturity
B. Study Questions: 1, 4, 6 - parts a, b, c, d
11
Chapter 10
Residential Mortgage Types and Borrower Decisions
I.
PRIMARY AND SECONDARY MORTGAGE MARKETS
A. The primary mortgage market is the loan origination market
B. Numerous institutions supply capital to borrowers
C. Mortgage originators can either hold loans in their portfolios or sell them in the
secondary mortgage market
D. The principal buyers in the secondary mortgage market are Fannie Mae and Freddie
Mac
II.
PRIME CONVENTIONAL MORTGAGE LOANS
A. Fixed-rate level payment mortgage
B. Over 85% of loans in 2011 were conventional mortgages
C. Conventional mortgages typically require 20% down (0.80 loan to value)
D. Conforming conventional loan: meets requirements for purchase in secondary markets
for Fannie Mae or Freddie Mac
E. Nonconforming Loans
1. Exceed loan limits (currently $417,000 for most areas of the continental US)
2. May require private mortgage insurance (PMI
F. Adjustable Rate Mortgages (ARM): rates reflect changes in lending rates over time
III.
FHA MORTGAGES (FEDERAL HOUSING ADMINISTRATION)
A. Primary Objective of 1949 Act: provide good housing
1. FHA is a loan insurance program
a. Loans made by private lenders
b. Mortgage payment includes insurance premiums (included in loan)
c. FHA insures 100% of loan and makes payments if borrower defaults
d. If foreclosed, title passes to HUD
e. Various types of mortgages covered by FHA programs
2. Veterans Administration has similar program
12
IV.
OTHER MORTGAGE TYPES
A. Purchase money mortgage: Mortgage given to a property buyer simultaneous with
receipt of title
1. Among real estate brokers: refers to a second mortgage loan from a seller to reduce
the buyer’s down payment (Amounts to installment payments with interest)
2. Among government agencies: any loan that finances a purchase
B. Piggyback loan:
1. A second mortgage paired with an underlying 1st mortgage
2. Keeps the 1st below 80 percent LTV, thus avoiding required mortgage insurance
C. Home Equity Loans (HEL)
1.
2.
3.
4.
5.
Some home equity loans are closed-end, fixed-term loans
Mostly open-end or line-of-credit loans (HELOC)
Interest is Tax deductible
Strength of the house as security provides favorable rate and longer term
Usually limited to total mortgage debt (sum of all mortgage loans) of 75% to 80% of
value
D. Reverse Mortgage
1.
2.
3.
4.
5.
6.
7.
Many older households are income constrained
Over 80% own their home
Most have little or no mortgage debt
Most do not want to sell
Converts home equity into income
Owners not be forced to move except if owner fails to maintain insurance & taxes
Two major problems:
a. Owner may outlive cash flows
b. Loans may exceed value of home (if property values decline over time)
E. Interest-Only:
1. No amortizing of principal.
2. Frequently involves a balloon payment
F. Sub-Prime Loans
1. Extending credit to high risk borrowers
2. High default rates due to poor or no creditworthiness background checks
3. Serious problems occurred for borrower when rates adjusted (always up)
G. Alt-A Loans
1.
2.
3.
4.
Minimal or no down payments
Very weak credit scores
Bank not required to verify information provided by borrowers
The “NINJA” loans
13
V.
LOAN COST MEASURES
A. Annual Percentage rate (APR)
1. APR converts regular interest expense and up-front loan fees into a single equivalent
interest expense
2. APR is far superior to interest rate alone in comparing the cost of loans
3. APR has a bias for most applications:
a. APR assumes that up-front fees are spread over the full maturity of the loan
b. Since most loans are prepaid before maturity, APR will tend to understate the
true cost of borrowing when up-front fees are charged
4. Final APR affected by prepayments
B. Motives for Refinancing
1.
2.
3.
4.
5.
6.
VI.
Lowering loan costs (lower APR)
Reduce the term of the loan (30 to 20 or 15 year mortgage)
Lower total amount of interest paid
Net Benefit = Total Savings – Cost of Refinancing
Lower rate results in lower interest deduction – slightly higher tax due
Spread should be ~ 2%: Old – new: Recoup costs over 18 to 24 months
HOMEWORK ASSIGNMENT
A. Key terms: Alt-A Loan, Conforming Conventional Loan, Conventional Mortgage, Fannie
Mae, Freddie Mac, FHA, GSE, Home Equity Loan, Jumbo Loans, Primary Mortgage
Market, Secondary Mortgage Market, Reverse Mortgage, Subprime Loan
B. Study questions: 1, 2, 3, 4, 6
14
Chapter 11
Sources of Funds for Residential Mortgages
I.
THE MARKET FOR HOME MORTGAGE LOANS
A. Mortgage borrowers must compete to borrow funds in the credit markets
B. Total mortgage debt at the end of 2011 approached $13.6 trillion
C. There are four major types of mortgage debt (Exhibit 11-1)
1. Residential (1 to 4 family) $10,336
2. Multifamily apartments
76%
$841 6%
3. Commercial $2,249 17%
4. Farm $133 1%
$13,559
II.
100%
THE EVOLUTION OF MORTGAGE FINANCE
A. Thrifts and Savings and Loans
1. Dominated mortgage lending: 50% or more y mid 1970s
2. Extremely localized market
3. Fatal flaw: Funded long-term loans with short-term savings
4. Cocoon of regulations restricted ability to adapt to changing market conditions
5. Disintermediation in financial markets led to widespread Thrift/S&L failures
B. Banking Deregulation and Consolidation
1. Effects of the Depository Institutions Deregulation and Monetary Control Act
a. Money center banks begin to enter the mortgage business
b. Many create mortgage banking subsidiaries
2. Mortgage Bankers originate mortgage loans, provide processing services, package
mortgages and sell in secondary markets
a. Servicing is core profit center
Collects monthly payments, remits to investor
Collects and remits payments for property taxes, hazard insurance and mortgage
insurance
Manages late payments, defaults, foreclosures
Receives fee of .25% to .44% (25 to 44 basis points: 1 bp = 0.01%)
Typically accept loss at origination of a loan to obtain servicing rights
15
b. Three-step process:
Issue mortgage commitment to potential borrower
Close or originate loan (funding loan)
Sell loan
3. Mortgage Brokers bring borrowers and lenders together but do not own the loans or
fund them (charge fees for services)
III.
PIPELINE RISK: SIGNATURE RISK OF MORTGAGE BANKING
A. Pipeline risk: Risk between loan commitment and loan sale
1. Two components
a. Fallout risk: Risk that loan applicant backs out
b. Interest rate/price risk: Risk that closed loans will fall in value before sold
2. Mortgage bankers highly leveraged
a. Very sensitive to pipeline risk
b. Hedging necessary for survival
B. Management Tools for Pipeline Risk
1. Good pipeline information
2. Forward commitment: Sale of loan at a preset price for future delivery
a. Price set now
b. Delivery and payment are, 60 to 90 days away
c. Analogous to futures contract
3. Standby forward commitment: Optional forward sale
a. Same as “forward commitment” except that mortgage banker has option to use or
not
b. More costly than forward commitment
IV.
SECONDARY MORTGAGE MARKET
A. Mortgage-Backed Securities (MBS)
1. Multiple mortgage loans in a single pool or fund
2. Security entitles investor to pro rata share of all cash flows
3. Loans in a given pool will be similar:
a. FHA/VA; conventional
b. Same vintage (new or recent loans)
c. Similar interest rates
16
4. Nearly two-thirds of all new home loans have been securitized in recent years
B. Fannie Mae (Federal National Mortgage Association, 1938)
1. Secondary market for FHA/VA
2. Funded through both debt issues and mortgage securitization
3. Has securitized and sold, or owns, about 23% of outstanding home loans
4. Taken into conservatorship by U.S. in 2008
C. Ginnie Mae (Government National Mortgage Association, 1968)
1. Created first major pass-through MBS program
2. Does not buy mortgages
3. Guarantees timely payment of interest and principal to holders of GNMA securities
4. Guarantees only securities based on FHA/VA loans
D. Freddie Mac (Federal Home Loan Mortgage Corporation, 1970)
1. Chartered by Congress to expand secondary market for mortgages
2. Deals exclusively in conventional loans
3. Securitized all loans purchased until recent years
4. Financially similar to Fannie Mae
5. Has securitized and sold, or owns, about 15% of outstanding home loans
6. Taken into conservatorship by U.S. in 2008
E. Importance of Fannie Mae and Freddie Mac
1. Have brought about standardization in:
a. Mortgages and mortgage notes
b. Appraisal forms and practices
c. Underwriting procedures and standards
d. Also, influence practices and standards in nonconforming mortgage markets
2. Have increased liquidity of mortgage markets
a. No interstate differentials in mortgage interest rates
b. No home lending disruptions when interest rates rise
c. New sources of mortgage funds in security investors
3. Heavily influence what type loans lenders make
F. Major Problems with Fannie and Freddie
1. Not capitalized to withstand declining home values
17
2. Said to wield too much political influence
3. Said to unsuccessfully mix private enterprise with housing subsidy programs
4. Said to divert the benefits of their efficiency advantage into the pockets of their
management
5. Said to be unnecessary in a financial world now dominated by a few giant banks
6. Said to be part of an unnecessary mortgage lending system – for the level-payment
fixed rate mortgage
G. Private Mortgage Conduits
1. Primarily a conduit for jumbo (nonconforming) loans
2. Briefly active in sub-prime loan market
H. US Mortgage System basically has 4 Channels
1. Local depository lending (very limited)
2. FHA/VA – GNMA securitization process
3. Conforming conventional – GSE process
4. Non-conforming conventional – private security process
V.
LENDERS’ UNDERWRITING DECISIONS
A. Underwriting: Process of determining whether the risks of a loan are acceptable
B. Three “Cs” of traditional underwriting:
1. Collateral: importance of Uniform Residential Appraisal Report (URAR)
2. Creditworthiness: Credit report – FICO score
3. Capacity: Ability to pay (payment ratios)
18
C. Computing Payment ratios for Underwriting (manage risk)
1. Housing Expense Ratio = PITI/GMI (~ Front-end ratio)
a. PITI is principal, interest, (property) taxes and insurance
b. GMI is gross monthly income
2. Recent convention set maximum at:
a. 28% for conventional loans
b. 29% for FHA
3. Total Debt Ratio = (PITI + LTO) ÷ GMI (~Back-end ratio)
a. LTO is long-term obligation
b. Recent convention set maximum at:
36% for conventional loans
43% for FHA
D. Recent Underwriting Failures
1. Problems were due not adhering to procedures and standards described above
a. Half of sub-prime loans had limited documentation
b. Most of Alt-A loans had limited or no documentation (Came to be called “liar
loans”)
c. Private securitization firms widely suppressed loan underwriting
2. Underwriting focuses on comparative risk among borrowers
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VI.
EMERGING MORTGAGE CLASSIFICATIONS
A. Qualified Mortgage
1. Fully amortizing (generally)
2. No longer than 30 years
3. Fees of no more that 3 percent (generally)
4. Debt-to-income ratio no more than 43 percent
5. Strong verification of borrower income and assets
6. If ARM, must underwrite to highest possible rate in first five years
7. Gives lender legal advantage in case of default
VII.
HOMEWORK ASSIGNMENT
A. Key terms: Collateral, Credit Scoring, Disintermediation, Housing Expense ratio,
Interest rate Risk, Loan Underwriting, Pipeline Risk, Qualified Mortgage, Total Debt
Ratio
B. Study Questions: 1, 2, 4, 9 (all parts)
20