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THE
IMPORTANCE OF REAL ESTATE FINANCE
The
field of Real Estate Finance deserves a special place in the scheme of
national economics. While
the importance of all types of credit finance cannot be minimized, the
Real Estate lending field affords us funds to acquire an asset that
most us could not afford otherwise.
Most homes have to be financed. Most commercial
projects have to be financed.
Over
fifty five percent of the basic assets of this great American nation
are in Real Estate. Minerals,
metals, stocks, bonds, commodities and other securities comprise the
other forty five percent of this nations assets.
This fact alone emphasizes the importance of Real Estate
Finance.
Certainly
auto sales have to be financed and are a good barometer for the
national economy, but housing starts and sales is one of the main
financial arteries of this nation.
Those housing starts could not be made if Real Estate financing
was not available to make it all happen.
Of
equal importance is the giant volume of refinance that goes on in the
real estate market. Equity
builds up in owner held real estate and a refinance loan will free
that equity and translate it into cash for movement throughout the
free enterprise system. So
the ripple effect from Real Estate loans is difficult to be measured
in a capitalistic society.
Real
Estate Finance plays such an important part in our national economy
when we see Real Estate prosper we can see the entire national economy
prosper. When we see a
sharp decline in Real Estate sales, housing starts and refinance we
generally can expect a recession to follow-if not a depression.
Many
important factors operate upon a healthy Real Estate lending activity
in our economy. Bank
deposits and investment capital is closely tied to the Real Estate
market. Financial institution growth can be greatly measured in terms
of mortgage loans in force in this nation.
Last
but not least is the concept of private ownership of the mass of Real
Estate in the United States. Our
system of private capital sources for Real Estate Finance encourages
and emphasizes the ownership of all types of properties by private
owners. This concept
leaves little government control in Real Estate ownership-which is as
it should be. Certainly
the government has a role but it is largely a cooperative role with
private lending institutions with the government offering insurance
and guarantees to help protect private capital.
It
is important that we have the proper appreciation and respect for the
part that Real Estate and Real Estate Finance plays in our lives and
the free enterprise system.
Such an appreciation will give us a greater understanding of
how our economy works, what the problems are and how to correct them.
Perhaps most importantly we will have a better understanding
that the heart of the capitalistic system is centered in all types of
Real Estate-owned and controlled by private parties.
THE
PLAYERS IN REAL ESTATE FINANCE
Many
players are required in the Real Estate Finance field.
Commercial banks, Mutual Savings banks, Savings and Loan
associations and Insurance companies head up the list of institutional
lenders. Mortgage
companies, investment trusts, commercial finance corporations, pension
funds, credit unions, private investors and other private lenders
round out the player roster in Real Estate Finance.
In
a cooperative role is a player whose presence is felt in no small way
in Real Estate Finance. The
Federal Government agencies offering guarantees, insurance and a
secondary market is a boon to the private lending sector.
Heading that list is the Federal Housing Administration and the
Veterans Administration. At
the primary Real Estate Finance level you will find these government
agencies sharing the risk with private lenders through guarantees,
insurance, lowered credit requirements and minimum property standards.
Leaving the primary lending level again you will find
government agencies playing an important role in the secondary market.
Here these agencies provide an important market for private
lenders to sell their mortgages to and in turn keep their capital
revolving for new Real Estate loans.
At the front of this list of government agencies you will find
the Federal National Mortgage Association, Government National
Mortgage Association and the Federal Home Loan Mortgage Corporation.
The Farm Home Administration and its services to the farmer and
the rural homebuyer is another important government source of Real
Estate money and low interest loans.
In
a final player profile is the individual lender, which we call the
private investor. A big
factor in Real Estate Finance is the owner carried contract or
mortgage. Many real estate owners do own their property free of any
liens or mortgage. These
individuals will often sell their property and carry their own
mortgage or contract affording the buyer of the property private
financing. Many
individuals will also invest their accumulated capital in other Real
Estate and in Real Estate financing for other individuals-mirroring
their institutional counterpart lenders.
SPECIALIZED
MORTGAGE LOANS FOR EVERY PURPOSE
Nowhere
in the field of credit finance is there a larger selection of loan
types and choices than in the field of mortgage lending for Real
Estate properties. Basically
all of these loan types fit under the category of Purchase or
Refinance.
If
you are buying a property and seek a loan to finance that purchase,
that loan will be called a "purchase money mortgage".
If you already own the property and are seeking a loan for
whatever reason, it will probably be referred to as a "refinance
mortgage loan".
Lets
review first some of the mortgage loan programs available to the
borrower seeking a purchase money mortgage.
Below we have listed some of the types of programs available
with some definition and considerations for each;
l.
FIXED RATE MORTGAGE: This is the most traditional and the
safest from the standpoint of the borrower.
The interest rate is fixed for the life of the loan, usually
long term for fifteen to thirty years.
The monthly payments of principal and interest are equal and
will remain the same until the loan is paid in full.
Some of the important considerations on a fixed rate mortgage
are: (l) The loan payments are stable (2) Interest rates may be higher
than the adjustable rate mortgages (3) The loan may not be assumable
because of increasing interest rates over the life of the loan.
2.
ADJUSTABLE RATE MORTGAGE:
There are a variety of loans now available under this category.
All however have one thing in common, the interest rate can
change and usually does over the life of the loan.
Generally these types of loans start out lower than the fixed
rate loans in order to be more attractive.
Your monthly payments of principal and interest can change
periodically. The term of these loans are also fifteen to thirty years.
If a loan of this type is your choice be sure that the interest
rate is tied to something such as the "Treasury Bill" or
"Prime" so that you can follow a likely change.
Also insist that there be a "cap" by year and loan
life. Generally the cap
is l and 5, meaning the loan cannot be increased more than l% in
interest rate per year or more than 5% during the lifetime of the
loan. Some of the
important considerations on an adjustable rate mortgage are; (l) The
lower interest rate might help you qualify for a loan where you could
not otherwise do so-on a higher fixed rate (2) Project a payment with
the cap increase and see if you can handle it as called for at the
time of the likely increase. (3) Look for a program of this type with
a convertible option, meaning at some future point you have the option
to convert to a fixed rate loan. (4) This is a good loan type if it
appears the interest rates are going to remain the same or decrease.
(5) Sometime these loans will have more points out front and this
should be considered a cost factored back into the interest rate.
Watch out for the fine print in these types of loans.
3.
RENEGOTIABLE RATE MORTGAGE:
This may be a compromise type loan between the fixed rate and
the adjustable rate. In
this loan your principal and interest payments will remain the same
for a number of years with a possible change after a set amount of
years. Term is generally fifteen to thirty years.
The interest rate will likely be somewhere between the fixed
rate mortgage and the adjustable rate mortgage.
Some of the considerations are; (l)The terms offered in the
interest rate change (2) Points charged out front, factoring these
costs back into the interest rate (3) The loan offers some stability
in fixed principal and interest payments for a period of time.
4.
GRADUATED PAYMENT MORTGAGE:
This type of mortgage loan could be the lowest monthly payment
of principal and interest you can find at the front end of any
mortgage loan. It is not
a bad loan program if your income is expected to increase as your
payment graduates. Most
of these programs will start with a low monthly payment and gradually
increase for five to ten years and then level off for the balance of
the loan. It is usually
tied to some index and can change even after the leveling off period
but not in a graduated fashion. Some
of the considerations are;
( l)
The beginning interest rate as compared to other programs
(2)
A low monthly payment that might help the borrower qualify for
a purchase money mortgage where it would not be possible in other
higher interest rate programs.
(3)
An ideal program for the borrower who can project an income
increase for five or ten years.
(4)
Check the cost of points out front as a cost to be factored
back into the interest rate
(5).
BALLOON MORTGAGE: This is a mortgage that can give the borrower an interest
rate payment only for a set period of time and then the entire
principal amount of the loan comes due.
An interest rate payment only would be lower than amortizing
interest and principal together, which would result in a low payment
over a long term such as fifteen years. Some of the considerations
are; (1) The borrower will gain no equity until the balloon is paid
because he will only be paying interest and no principal (2) At the
end of the balloon period, the entire principal must be paid or
possibly refinanced, this offers some obvious risk (3) If at the end
of the balloon period interest rates have climbed the borrower could
end up with a more costly loan if refinance of the principal is
necessary.
There
are a variety of other loan devices to finance a property purchase,
perhaps not as popular as the mortgage loans we have named.
Some of those devices are;
l.
ASSUMABLE MORTGAGE: Buyer
simply assumes the existing mortgage on the property from the seller.
2.
SELLER CONTRACT: Seller owns his property free and clear and offers to carry a
contract of sale for the borrower.
3.
WRAPAROUND CONTRACT; Seller has a mortgage or contract and
creates a new contract for the buyer, continuing to make his original
payment and accepting payment for his equity on a seller carried
contract. The second
contract is wrapped around the first contract or mortgage. This
sometime results in a lower interest rate for the borrower.
4.
BUY-DOWN: A
developer or builder of a new home will buy down the interest rate for
the borrower or buyer so the interest rate will be more attractive and
qualifying will be easier.
5.
LEASE OR RENT OPTION; The
buyer will pay an option fee and start to rent or lease the property
from the seller for a designated period of time.
At the end of the designated period the buyer must exercise the
terms of the option to purchase.
6.
REAL ESTATE OR LAND CONTRACT:
Here the property is sold on a contract and the seller holds
back the mortgage. No
transfer of title is made until the contract is paid.
Up
to this point we have discussed mortgage loan programs for
"purchase money mortgages" in the acquisition of a property
for the first time. Now
lets look at some of the loan programs available for borrowers seeking
a "refinance" loan, assuming the property is already in
title with the borrower;
1.
1ST MORTGAGE REFINANCE: This
occurs when the borrower wants to pay off his existing mortgage or
contract with a new 1st mortgage or he wants to place a new mortgage
on his already free and clear property.
The borrower may be prompted to do this to get a better
interest rate or to capture some of his equity or to consolidate his
existing payments for a smaller payment.
2.
CASH OUT MORTGAGE: This can be a 1st or 2nd mortgage to cash out some of the
borrowers equity for whatever need.
If the 1st mortgage is small with a good interest rate, the
borrower is wise to keep that mortgage and create a 2nd mortgage at
the higher rate.
3.
2ND MORTGAGE: This is the placement of a 2nd mortgage on the property
behind the existing first, similar to the explanation in (2) above.
4.
3RD MORTGAGE: This is identical to the procedure of 2nd mortgage placement
except this mortgage will be in third position behind the 1st and 2nd.
5.
REAL ESTATE CONTRACT: Some
private investors prefer to lend small amounts around $10,000 to
$30,000 against a property on a real estate contract.
The reason for this is the ease with which a property can be
foreclosed in the event of default. To claim a property in default on a real estate contract by a
lender usually requires only a letter and a
transfer of deed being held in escrow as opposed to a lengthy
process of foreclosure in the courts where a mortgage is foreclosed.
6.
SALE LEASEBACK: This type of refinance device is used more frequently in
commercial properties. The
borrower or owner sells the property to the finance source and in turn
leases it back with an option to purchase at the end of the lease.
This results in cash to the property owner and is a form of
refinance.
Interest
rates are generally higher for refinance loans with exception of 1st
mortgages. This often
results because of the smaller amounts borrowed on shorter term
requiring a higher yield for
the lender.
The
information given here is a broad overview of the types and choices of
loans available to the real estate borrower.
It should be obvious that with this many programs there will be
a large volume of lenders and a very competitive market for the
borrower. Given the
information offered here the borrower can only define the type of loan
and terms suited to his income. Beyond
that the following rules should apply when the borrower goes shopping
for a Real Estate loan-regardless of the type.
FOLLOW
THESE RULES FOR MORTGAGE LOANS
l.
If you are purchasing a home direct from the seller, negotiate
with the seller and explore the possibility of a seller carried
mortgage or contract.
2.
If you are shopping the market for a Real Estate loan, ask
questions about the fine points of the loan.
3.
Always request an estimated closing statement on the loan,
which will show all the loan costs including points and origination
fee.
4.
Call around to different mortgage lenders and ask for their
current rate on fixed and adjustable rate mortgage loans.
5.
Bargain for the deal, which best suits, your financial
capabilities.
6.
When seeking an adjustable rate mortgage, always consider the
possibility of a rate increase and larger payment.
Be sure the caps are spelled out and the interest rate is tied
to a common index which you can follow.
7.
Look at the possibility of two mortgages; the rates and terms
could outweigh the value of one mortgage.
8.
If you have trouble qualifying because of credit record, debt
ratio or other factor that prevents you from securing a prime purchase
money mortgage-consider changing your purchase choice and look for a
no qualifying existing mortgage offered by the seller.
QUESTIONS
AND ANSWERS ABOUT MORTGAGE LOANS
Q.
Will my mortgage payment be cut in half if I get a thirty-year
mortgage rather than a fifteen-year mortgage?
A.
NO! In fact your
mortgage payment will be reduced by less than 30% and your interest
rate will be greatly increased. A fifteen-year mortgage is the best
bet if you can handle the payment.
Q.
I frequently see advertising for a real low rate mortgage do
these rates really exist?
A.
Yes and most of them are for (ARM) loans, which are adjustable
rate mortgage loans. They
start with a low rate but after the first six months or a year they
can be increased on a regular basis.
Q.
What is meant by debt ratio?
A.
This is two percentage numbers.
The first is the percentage of debt the borrower has to income
for his housing payment expense and the second is the total debt to
income including the housing payment expense.
If you are seeking a prime 1st purchase money mortgage those
figures will probably be no more than 28/36%.
Some lenders offering higher interest rates will raise the
ratio to 33/49%.
Q.
What is meant by loan to value?
A.
Value means the price you are paying for the Real Estate or the
current appraisal, whichever
is lower. On a purchase
money mortgage most lenders will do a loan to value of 90% meaning if
the value is $l00,000, the loan will be $90,000. Refinance loans are
generally 80% or less.
Q.
Are discount points charged on all mortgage loans?
A.
Yes on most mortgage loans but the points charged will differ. Sometime no points will be charged but an origination fee of
l point or more will be charged.
A point is equivalent to l% of the loan amount.
Sometimes a lower interest rate will be offset by higher
discount points.
Q.
If a borrower is turned down for a loan by one mortgage lender
will he be turned down by all the others?
A.
NO! It will depend
upon the reason however. If
it is heavy debt ratio, you may be turned down everywhere.
If it is credit you may find a lender who will qualify you at a
higher rate of interest and shorter term.
If it is lack of provable income and you are self-employed you
need to find a lender offering a "no income qualifier
mortgage". If you
have trouble with
qualifying with three or more lenders, seek out a reputable mortgage
broker for consultation, he may know of a source out of your area that
will take your type of loan.
Q.
Will the borrower be charged a fee before being approved for a
mortgage loan by a lender?
A.
YES! Many lenders will require the borrower to pay in advance
for a property appraisal, credit report and possibly a title search.
This could cost from $300 to $500 and more for commercial
loans.
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