Conventional Financing PDF

Conventional 10 Financing Learning Objectives After completing this lesson, students should be able to… Distinguish between conforming and nonconforming loans List the key features found in most conventional loans Understand confo...

Conventional 10 Financing Learning Objectives After completing this lesson, students should be able to… Distinguish between conforming and nonconforming loans List the key features found in most conventional loans Understand conforming loan limits and why they are important Summarize the concept of risk-based loan fees Explain when private mortgage insurance is needed and when it can be canceled Discuss the restrictions commonly placed on secondary financing Calculate the debt to income ratio and housing expense to income ratio List compensating factors that may justify loans with higher ratios Describe ways to make a loan more affordable, such as buydowns and accelerated payment plans Suggested Lesson Plan 1. Give students Exercise 10.1 to review the previous chapter, “Qualifying the Property.” 2. Provide a brief overview of Chapter 10, “Conventional Financing,” and review the learn- ing objectives for the chapter. © 2018 Rockwell Publishing  Financing Residential Real Estate Instructor Materials 3. Present lesson content: Conforming and Nonconforming Loans Conventional Loan Characteristics – Property types and owner-occupancy – Loan amounts – Repayment periods – Amortization – Loan-to-value ratios – Loan fees and interest rates – Private mortgage insurance – Secondary financing EXERCISE 10.2 Conventional loan characteristics Qualifying Standards – Evaluating risk factors – Credit reputation – Income analysis – Available funds EXERCISE 10.3 Qualifying standards Buydown Plans – Types of buydown plans – Buydowns and qualifying rules – Limits on buydowns and other contributions Conventional Low-Downpayment Programs – Features and requirements – Affordable housing programs – Lender contributions EXERCISE 10.4 Buydowns and low-downpayment programs 4. End lesson with Chapter 10 Quiz. Chapter 10 Outline: Conventional Financing I. Conforming and Nonconforming Loans A. Conforming loans: loans that comply with Fannie Mae and Freddie Mac underwriting guidelines 2  Chapter 10: Conventional Financing B. Nonconforming loans: loans that don’t follow secondary market guidelines and can’t be sold to either GSE, except by special arrangement II. Conventional Loan Characteristics A. Property types and owner-occupancy 1. Fannie Mae and Freddie Mac will purchase loans secured by residential properties, including site-built homes, manufactured homes, townhouses, condos, and co-ops 2. The loan may be for a principal residence (with up to four units) or a second home (with no more than one unit) 3. Fannie Mae and Freddie Mac also buy investor loans, which are for properties that will be rented out to tenants; these loans are underwritten differently B. Loan amounts 1. Conforming loan limits are set annually; limits are higher in Alaska, Guam, Ha- waii, the Virgin Islands, and other high-cost areas 2. Jumbo loans are loans that exceed conforming loan limits; they typically have stricter qualifying standards and may have higher interest rates and fees C. Repayment periods: can range from 10 to 40 years; 30 years is standard D. Amortization: most conventional loans are fully amortized E. Loan-to-value ratios 1. The traditional loan-to-value ratio (LTV) for conventional loans is 80%, but bor- rowers may find loans with LTVs up to 97% 2. Fannie Mae and Freddie Mac require private mortgage insurance on loans with LTVs over 80% 3. Lenders usually charge higher interest rates and fees for high-LTV loans and im- pose stricter qualifying standards F. Loan fees and interest rates 1. Conventional loan sold to GSE is subject to risk-based loan-level price adjust- ment (LLPA); generally, the riskier the loan, the higher the LLPA 2. Varies based on borrower’s credit score and proposed LTV 3. Certain types of riskier loans (investor, ARMs) may be charged an LLPA in addi- tion to the one based on credit score and LTV G. Private mortgage insurance (PMI) 1. PMI is issued by private companies instead of a government agency, to protect lenders from the greater risk of high-LTV loans 2. PMI typically covers 25% to 30% of the loan amount rather than the whole amount 3. If borrower defaults, lender may (at insurer’s option) either foreclose on the prop- erty or relinquish it to the insurer and submit a claim for actual losses up to the policy amount 4. PMI premiums are paid by the borrower a. Payment could be a flat annual premium 3  Financing Residential Real Estate Instructor Materials b. Or there may be an initial premium (paid at closing) plus annual renewal premiums (which are usually paid on a monthly basis) c. Or there may be a one-time premium (paid at closing or financed over the loan term) 5. Homeowners Protection Act requires lenders to cancel PMI at the borrower’s request when the loan is paid down to 80% of the property’s original value, or au- tomatically when it reaches 78% of the original value or the loan period reaches the midway point (if borrower’s payments are current) H. Secondary financing 1. Lenders usually allow secondary financing regardless of the source, but impose a number of restrictions to reduce risk of default 2. Examples of rules concerning secondary financing: a. Borrower must qualify for the combined monthly payment for both loans b. Borrower must make a minimum downpayment c. Payments must be regularly scheduled d. Second mortgage can’t require a balloon payment until at least five years after closing e. If the first mortgage has variable payments, the second mortgage must have fixed payments f. Negative amortization and/or prepayment penalties may not be allowed 3. Piggyback loans: using secondary financing to avoid paying for private mortgage insurance or to avoid having the loan designated as a jumbo loan EXERCISE 10.2 Conventional loan characteristics III. Qualifying Standards A. Evaluating risk factors 1. Fannie Mae’s comprehensive risk assessment approach uses primary risk factors and contributory risk factors 2. Two primary risk factors determine the level of review applied to the rest of the application: a. credit reputation, and b. proposed loan-to-value ratio 3. Contributory risk factors include the other aspects of the application, such as income ratios and cash reserves B. Credit reputation 1. Credit reputation is based on credit score from one or more of the three credit agencies; also known as indicator score, underwriting score, or representative score 2. Good credit score can offset weaknesses in other areas, but a low score may pre- vent loan approval 4  Chapter 10: Conventional Financing 3. Underwriters typically use lower of two scores, or middle of three 4. When two people apply for a loan, lowest of the two indicator scores used C. Income analysis 1. Debt to income ratio: total recurring obligations generally should not exceed 36% of stable monthly income; higher ratio allowed for strong applicants and loan underwritten by AUS 2. Recurring obligations include housing expense (PITI), installment debts (such as car loans), revolving debts (such as credit cards), and other debts (such as ali- mony and child support) 3. Housing expense to income ratio: proposed housing expense (PITI) generally should not exceed 28% of stable monthly income (required only by Freddie Mac for manually underwritten loans) 4. Ratios aren’t strict maximums; compensating factors such as a large downpay- ment or substantial net worth may give the lender a reason to allow higher ratios 5. ARM borrowers may receive greater scrutiny because of the risk of payment shock; lenders may require borrowers to qualify under the maximum interest rate that could be in effect at the end of the loan’s introductory period D. Available funds 1. Reserves a. Reserves can be an important compensating factor b. Borrowers should have at least two months’ payments in reserve after paying downpayment and closing costs c. Some loan programs require more, up to six months 2. Gift funds can be used for most of the downpayment and closing costs, but borrowers generally must pay at least 5% of the sales price out of their own re- sources EXERCISE 10.3 Qualifying standards IV. Buydown Plans A. Buydown lowers interest rate permanently or temporarily 1. Temporary buydown may have level or graduated payments 2. Fannie Mae and Freddie Mac limit how much a seller or other interested party can contribute for the buyer V. Conventional Low-Downpayment Programs A. High-LTV conventional loans may be available B. Affordable housing programs base eligibility on income, property location, or job C. Lender may make limited contributions to closing costs EXERCISE 10.4 Buydowns and low-downpayment programs 5  Financing Residential Real Estate Instructor Materials Exercises EXERCISE 10.1 Review exercise To review Chapter 9, “Qualifying the Property,” have students answer these questions. 1. A property is sold for $495,000. It appraises for $499,000. Which figure will the lender base the maximum loan amount on? 2. What are the three main methods appraisers use to appraise real estate? 3. What are the three types of depreciation? Answers: 1. The sales price in this case, because it’s less than the appraised value 2. Sales comparison, replacement cost, and income 3. Physical deterioration, functional obsolescence, and external obsolescence EXERCISE 10.2 Conventional loan characteristics Discussion Questions: 1. Angela agrees to buy a house for $410,000, which is the appraised value as well as the price. She’s going to put 15% down and take out a conventional loan for the remainder of the purchase price. Will private mortgage insurance be required? Why or why not? If Angela is required to obtain 25% coverage, what is the policy amount for the mortgage insurance? What would that mean in the event that Angela loses her house to foreclosure? 2. Continuing with the scenario in the previous question: suppose that instead of defaulting, Angela has been making her loan payments dependably for about five years, and she’s paid her loan down to $323,900. The original value of the property was $410,000; it has appreciated to $460,000. Is the PMI automatically canceled at this point? Will it be canceled at Angela’s request? 6  Chapter 10: Conventional Financing Answers: 1. It’s very likely that private mortgage insurance will be required. A 15% down­ payment means the loan-to-value ratio is 85%, and PMI is generally required for any conventional loan with an LTV over 80%. (Fannie Mae and Freddie Mac won’t buy loans with LTVs over 80% without PMI.) With 25% coverage, the policy amount will be $87,125: $410,000 × 0.85 = $348,500 loan amount $348,500 × 0.25 = $87,125 policy amount If Angela eventually defaulted on the loan, the lender foreclosed, and the net fore­ closure sale proceeds weren’t enough to pay off the remaining balance, then the mortgage insurance company would pay the lender the difference, up to the policy amount. (Any shortfall in excess of $87,125 would be a loss for the lender.) 2. A PMI policy must be canceled automatically when the loan’s principal balance is paid down to 78% of the property’s original value. It must be terminated at the borrower’s request when the balance reaches 80% of the property’s original value. In this case, Angela’s principal balance is $323,900, which is 79% of the property’s original value: $323,900 ÷ $410,000 = 0.79. So the policy doesn’t have to be canceled automatically at this point, but it does have to be terminated if Angela formally requests it. (Note that these rules apply only to loans secured by a single-family dwelling that is the borrower’s principal residence.) EXERCISE 10.3 Qualifying standards Discussion Prompt: Melinda would like a loan with monthly PITI payments of $1,400. Her stable monthly income is $5,000. She also has a monthly student loan pay­ ment of $300 and a monthly auto loan payment of $200. Assume that the lender is going to manually underwrite the loan, applying the standard maximum income ratios for a conventional loan. Would she qualify for this loan based on her housing expense to income ratio? Would she qualify based on her debt to income ratio? What compensating factors might help Melinda qualify for the loan? Analysis: Yes, she qualifies as far as the housing expense ratio is concerned. The standard maximum housing expense ratio for a manually underwritten loan is 28%, and that’s exactly what Melinda’s would be with this loan: $1,400 ÷ $5,000 = 0.28 7  Financing Residential Real Estate Instructor Materials No, she doesn’t qualify under the debt to income ratio. The standard maximum for a manually underwritten loan is 36%, and Melinda’s is 38%: $1,900 ÷ $5,000 = 0.38. Compensating factors: excellent credit reputation; large downpayment; sub­ stantial liquid assets; education or job training indicating potential for greater earnings; short-term income not counted as stable monthly income; rent from a relative who will share home; demonstrated ability to carry a higher housing expense; significant energy-efficient features in the house. EXERCISE 10.4 Alternatives for conventional financing Match the type of loan to its description. Permanent buydown Affordable housing program Temporary buydown ______ 1._Borrower’s payments are subsidized for the first three years of the loan term. ______ 2._Borrower makes a smaller downpayment to buy home in lower-income neigh­ borhood ______ 3._Borrower’s payments are lowered for the duration of the loan term. Answers: 1. Temporary buydown 2. Affordable housing program 3. Permanent buydown 8  Chapter 10: Conventional Financing Chapter 10 Quiz 1. A loan that complies with Fannie Mae and 6. Which of the following is an example of an Freddie Mac guidelines, which can be sold on installment debt that would be considered part the secondary market, is a: of an applicant’s total monthly obligations? A. conforming loan A. A car loan with six $100 monthly payments B. conventional loan remaining C. jumbo loan B. A credit card balance D. nonconforming loan C. A student loan with five years of monthly payments remaining D. Court-ordered child support payments 2. If a loan is for an amount greater than the conforming loan limits set by Fannie Mae and Freddie Mac, it is known as a/an: 7. Loan-level price adjustments (LLPAs): A. conforming loan A. reflect risk levels B. conventional loan B. are charged by Fannie Mae and Freddie C. investor loan Mac D. jumbo loan C. may be charged for investor loans or ARMs D. All of the above 3. Which of these loans would present the greatest level of risk to a lender? 8. Fannie Mae and Freddie Mac require private A. 97% LTV mortgage insurance on all loans with loan-to- B. 95% LTV value ratios over: C. 90% LTV A. 80% D. 80% LTV B. 90% C. 95% D. 97% 4. According to the Homeowners Protection Act, a lender must terminate private mortgage in- surance automatically when the loan balance 9. If a seller makes a lump sum payment to the reaches _____ of the property’s original value. lender in order to lower the buyer’s interest A. 70% rate, this is known as a/an: B. 75% A. accelerated payment plan C. 78% B. buydown D. 80% C. gift fund D. wraparound 5. Piggyback loans are used to: A. avoid having to pay private mortgage 10. In this type of temporary buydown, the amount insurance of the actual monthly payment will increase B. avoid the higher interest rate associated each year during the buydown period: with a jumbo loan A. graduated payment buydown C. give the buyer a low initial interest rate, B. growing equity buydown with a rate that will adjust upward later C. level payment buydown D. Either A or B D. seller-financed buydown 9  Financing Residential Real Estate Instructor Materials 11. The lender will use _____ to qualify a buyer using a temporary buydown on a fixed-rate loan. A. the bought-down rate B. the note rate C. an intermediate rate between the bought- down and note rates D. the note rate or the fully indexed rate, whichever is greater 12. All of the following would be compensating factors that might enable an underwriter to ap- prove a loan with a high debt-to-income ratio, except: A. borrower has held same job for ten years B. borrower’s education indicates potential for higher earnings C. energy-efficient features in subject property D. substantial liquid assets 13. Affordable housing programs involving con- ventional loans often have: A. biweekly payments B. maximum income limits C. accelerated payment plans D. buydown requirements 14. A low-downpayment mortgage would be ap- propriate for: A. a buyer with poor credit scores B. first-time buyers with little savings C. buyers who plan to pay off their loan in less than ten years D. All of the above 15. Fannie Mae and Freddie Mac prohibit a lender from contributing to a borrower’s closing costs if the contribution: A. exceeds the total closing costs B. is part of the downpayment C. must be repaid separately from the mort- gage D. Any of the above 10  Chapter 10: Conventional Financing Answer Key 1. A. A conforming loan is made in compli- 9. B. In a buydown arrangement, a seller or ance with Fannie Mae and Freddie a third party pays the lender a lump Mac underwriting guidelines. sum at closing to lower the interest rate on the buyer’s loan. 2. D. A jumbo loan has a loan amount ex- ceeding the conforming loan limit set 10. A. A graduated payment buydown is a by Fannie Mae and Freddie Mac. temporary buydown where the month- ly payment will increase each year 3. A. A higher loan-to-value ratio (or LTV) during the buydown period. At the end indicates a smaller down payment rela- of the buydown period, the buyer will tive to the sales price. This creates a be paying the note rate. higher risk for the lender. 11. B. For a fixed-rate loan, Fannie Mae and 4. C. The law requires that lenders cancel pri- Freddie Mac require the borrower to vate mortgage insurance automatically be qualified using the note rate. at 78% of the property’s original value, or upon the borrower’s request at 80%. 12. A. Stable employment by itself is not a compensating factor unless it suggests 5. D. Piggyback loans are secondary financ- the likelihood of higher earnings in the ing used to keep the loan’s LTV below future. 80% (and thus avoid PMI) or to keep the loan amount below the conforming 13. B. Most affordable housing programs loan limit. offer loans that are easier for buyers to qualify for and often have reduced 6. C. An installment debt has a fixed begin- cash requirements. Eligibility for these ning and ending date. An underwriter programs is often based on the buyers’ will not include installment debts that income. will be paid off in ten months or less. 14. B. A low-downpayment mortgage would 7. D. Loan-level price adjustments (LLPAs) be a good choice for first-time buyers are risk-based loan fees charged by who have steady and reliable income, Fannie Mae and Freddie Mac. Ad- but little savings for a downpayment ditional LLPAs may be charged for and closing costs. certain types of loans considered to present more risk. 15. D. Fannie Mae and Freddie Mac allow lender contributions to closing costs, but 8. A. For a loan that is going to be sold to restrictions apply. Fannie Mae or Freddie Mac, PMI will be required if the LTV is over 80%. 11  Financing Residential Real Estate Instructor Materials PowerPoint Thumbnails Use the following thumbnails of our PowerPoint presentation to make your lecture notes. Financing Residential Real Estate Lesson 10: Conventional Financing © 2018 Rockwell Publishing Introduction This lesson will cover: ⚫ conforming and nonconforming loans ⚫ characteristics of conventional loans ⚫ qualifying standards ⚫ alternatives for conventional financing © 2018 Rockwell Publishing Introduction Loans made by mortgage lenders can be divided into two main categories: ⚫ conventional loans ⚫ government-sponsored loans © 2018 Rockwell Publishing 12  Chapter 10: Conventional Financing Introduction Conventional loan: any institutional loan that isn’t insured or guaranteed by government agency. © 2018 Rockwell Publishing Conforming & Nonconforming Loans Most conventional loans comply with underwriting guidelines set by Fannie Mae and Freddie Mac. Conforming loan: complies with those guidelines. Nonconforming loan: doesn’t comply. © 2018 Rockwell Publishing Conventional Loan Characteristics Fannie Mae/Freddie Mac underwriting guidelines: ⚫ widely followed in mortgage industry ⚫ lenders want to be able to sell loans on secondary market ⚫ many of the rules covered here are based on Fannie/Freddie guidelines © 2018 Rockwell Publishing 13  Financing Residential Real Estate Instructor Materials Conventional Loan Characteristics Topics: ⚫ property types and owner-occupancy ⚫ loan amounts ⚫ repayment periods and amortization ⚫ loan-to-value ratios ⚫ risk-based loan fees ⚫ private mortgage insurance ⚫ secondary financing © 2018 Rockwell Publishing Conventional Loan Characteristics Property types and owner-occupancy Fannie Mae and Freddie Mac buy loans secured by residential property, including: ⚫ detached site-built houses ⚫ townhouses ⚫ condominium units ⚫ cooperative units ⚫ manufactured homes © 2018 Rockwell Publishing Conventional Loan Characteristics Property types and owner-occupancy Borrowers may intend to occupy property as: ⚫ principal residence ⚫ second home Fannie Mae/Freddie Mac also willing to purchase investor loan: borrower purchasing property to rent not occupy. © 2018 Rockwell Publishing 14  Chapter 10: Conventional Financing Conventional Loan Characteristics Property types and owner-occupancy Conventional loan may be secured by: ⚫ Principal residence ⚫ Up to four dwelling units ⚫ Second home ⚫ No more than one dwelling unit ⚫ Investment property ⚫ Up to four dwelling units © 2018 Rockwell Publishing Conventional Loan Characteristics Loan amounts Conforming loan limits: set annually by Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac. ⚫ GSEs won’t buy loan that exceeds limits. ⚫ Loan limits vary based on area median home prices, and whether loan is for one-, two-, three-, or four-unit dwelling. © 2018 Rockwell Publishing Conventional Loan Characteristics Loan amounts 2018 conforming loan limits for one-unit dwellings: ⚫ in most areas: $453,100 ⚫ in high-cost areas: based on area median house price, up to a maximum of $679,650 ⚫ higher limits for Alaska, Hawaii, Guam, and Virgin Islands © 2018 Rockwell Publishing 15  Financing Residential Real Estate Instructor Materials Conventional Loan Characteristics Loan amounts Jumbo loan: exceeds conforming loan limit. ⚫ Usually can’t be sold to Fannie Mae or Freddie Mac. ⚫ Underwritten using stricter standards. ⚫ May have higher interest rates and loan fees than conforming loans. © 2018 Rockwell Publishing Conventional Loan Characteristics Repayment periods Repayment periods can range from 10 to 40 years. ⚫ 30-year loans are standard. ⚫ Fannie and Freddie won’t buy loan if over 30 years ⚫ 15-year loans also popular. © 2018 Rockwell Publishing Conventional Loan Characteristics Amortization Standard conventional loan is fully amortized. ⚫ Fannie Mae and Freddy Mac generally won’t buy partially amortized or interest- only loans. © 2018 Rockwell Publishing 16  Chapter 10: Conventional Financing Conventional Loan Characteristics Loan-to-value ratios Traditional conventional loan LTV: 80%. ⚫ During subprime boom, higher LTVs were common: 97% or even 100%. ⚫ Now less common. ⚫ Loans above 90% harder to get, too. © 2018 Rockwell Publishing Conventional Loan Characteristics Loan-to-value ratios Higher LTV loans usually have: ⚫ higher interest rates and fees, and ⚫ stricter underwriting rules. © 2018 Rockwell Publishing Conventional Loan Characteristics Combined loan-to-value ratios If there are other mortgages against property, lender will be concerned with the combined loan-to-value ratio (CLTV). ⚫ Should not exceed usual LTV limit, but in some cases a higher CLTV allowed. © 2018 Rockwell Publishing 17  Financing Residential Real Estate Instructor Materials Conventional Loan Characteristics Risk-based loan fees Loan-level price adjustments (LLPAs): risk- based loan fees. ⚫ Charged by Fannie Mae and Freddie Mac when buying loans from lenders. ⚫ Riskier loans usually equal higher LLPAs. © 2018 Rockwell Publishing Conventional Loan Characteristics Risk-based loan fees LLPA varies based on borrower’s credit score and LTV ratio. ⚫ Borrower with 650 credit score and 95% LTV might be charged 1.25% LLPA. ⚫ But borrower with 710 credit score and 80% LTV might be charged only 0.5%. Additional LLPAs may be charged if loan is riskier (ARM, investor loan). © 2018 Rockwell Publishing Conventional Loan Characteristics Private mortgage insurance Private mortgage insurance (PMI): helps protect lenders from risk of high-LTV loans. ⚫ Required for conventional loans if LTV over 80%. ⚫ Makes up for reduced borrower equity. © 2018 Rockwell Publishing 18  Chapter 10: Conventional Financing Private Mortgage Insurance How PMI works Private mortgage insurance company assumes only portion of risk of default and foreclosure loss. ⚫ PMI covers upper portion of loan. ⚫ Typically 25% to 30% of loan amount. © 2018 Rockwell Publishing Private Mortgage Insurance How PMI works In event of default and foreclosure, lender (at insurer’s option) will either: ⚫ sell property and make claim for reimbursement of losses up to policy amount, or ⚫ relinquish property to insurer, and make claim for actual losses. © 2018 Rockwell Publishing Private Mortgage Insurance How PMI works Insurers have own underwriting standards, which have been influential in mortgage industry. © 2018 Rockwell Publishing 19  Financing Residential Real Estate Instructor Materials Private Mortgage Insurance PMI premiums Mortgage insurance company charges risk- based premiums for coverage. Variety of payment plans include: ⚫ flat annual premium ⚫ initial premium at closing, plus renewal premiums ⚫ financed one-time premium © 2018 Rockwell Publishing Private Mortgage Insurance Cancellation/termination of PMI Under federal Homeowners Protection Act, loan servicers must cancel loan’s PMI when: ⚫ loan has been paid down to 80% of property’s original value (upon borrower request); or ⚫ loan reaches 78% of property’s original value (automatic termination). © 2018 Rockwell Publishing Private Mortgage Insurance Cancellation/termination of PMI If PMI hasn’t been canceled or terminated already, it must be terminated at midpoint of loan term. Homeowners Protection Act applies only to loans on single-family dwellings occupied as primary residence. © 2018 Rockwell Publishing 20  Chapter 10: Conventional Financing Secondary Financing Lenders generally allow secondary financing in conjunction with conventional loan. ⚫ Most impose some restrictions to minimize increased risk of default on primary loan. © 2018 Rockwell Publishing Secondary Financing Restrictions Examples of restrictions lenders may impose: ⚫ Borrower must qualify for payments on both first and second mortgages. ⚫ Borrower must make minimum downpayment. ⚫ Scheduled payments due on regular basis. © 2018 Rockwell Publishing Secondary Financing Restrictions ⚫ Second mortgage can’t require balloon payment less than 5 years after closing. ⚫ If first mortgage has variable payments, second mortgage must have fixed payments. ⚫ No negative amortization. ⚫ No prepayment penalty in some cases. © 2018 Rockwell Publishing 21  Financing Residential Real Estate Instructor Materials Secondary Financing Piggyback loans Secondary financing is sometimes referred to as a piggyback loan, especially when it is used to either: ⚫ avoid paying private mortgage insurance, or ⚫ avoid jumbo loan treatment. Popular during subprime boom, but no longer widely used. © 2018 Rockwell Publishing Secondary Financing Piggyback loans With piggyback loan, LTV of primary loan isn’t over 80%. ⚫ So PMI requirement doesn’t apply. With piggyback loan, loan amount for primary loan doesn’t exceed conforming loan limit. ⚫ So higher costs and stricter rules for jumbo loans don’t apply. © 2018 Rockwell Publishing Summary Conventional Loan Characteristics Conventional loan Conforming loan Nonconforming loan Conforming loan limits Jumbo loan Loan-level price adjustment (LLPA) PMI Piggyback loan © 2018 Rockwell Publishing 22  Chapter 10: Conventional Financing Conventional Qualifying Standards Evaluating risk factors Fannie Mae and Freddie Mac each have their own automated underwriting system (AUS). ⚫ Fannie and Freddie encourage lenders to use automated underwriting whenever possible. ⚫ AUS is more flexible; can weigh risk factors more precisely than manual underwriters. © 2018 Rockwell Publishing Conventional Qualifying Standards Evaluating risk factors Fannie Mae prescribes “comprehensive risk assessment” to evaluate risk factors. Two primary risk factors: ⚫ applicant’s credit reputation, and ⚫ applicant’s cash investment (LTV). © 2018 Rockwell Publishing Conventional Qualifying Standards Evaluating risk factors Contributory risk factors: other aspects of application, such as debt to income ratio and cash reserves. © 2018 Rockwell Publishing 23  Financing Residential Real Estate Instructor Materials Conventional Qualifying Standards Evaluating risk factors Freddie Mac’s underwriting guidelines similar but terminology differs: ⚫ considers “overall layering of risk” ⚫ main issues: credit reputation, capacity to repay, collateral (the property being purchased) ⚫ weakness in one component can be outweighed by strength in another © 2018 Rockwell Publishing Conventional Qualifying Standards Evaluating risk factors Both GSEs consider borrower’s overall financial picture, with positive factors offsetting negative ones, and vice versa. © 2018 Rockwell Publishing Conventional Qualifying Standards Credit reputation Credit scores central factor in conventional underwriting. ⚫ Excellent score can offset weaknesses in other aspects of application. ⚫ Poor score may doom application. ⚫ Fannie Mae won’t buy loan if borrower’s score is under 620. ⚫ For many loan types, 680 is minimum. © 2018 Rockwell Publishing 24  Chapter 10: Conventional Financing Conventional Qualifying Standards Credit reputation Credit scores from three main credit bureaus usually vary somewhat for given borrower. Credit score used for underwriting (indicator score) is: ⚫ lower of two scores, or ⚫ middle of three scores. © 2018 Rockwell Publishing Conventional Qualifying Standards Credit reputation When two people apply for loan together: ⚫ lower score used for underwriting ⚫ not average © 2018 Rockwell Publishing Conventional Qualifying Standards Income analysis Stable monthly income: meets lender’s tests of quality, durability. Durable income: income that is expected to continue for at least 3 years after loan is made. © 2018 Rockwell Publishing 25  Financing Residential Real Estate Instructor Materials Income Analysis Debt to income ratio Lenders consider income adequate for conventional loan if total monthly obligations don’t exceed a specific percentage of stable monthly income. ⚫ Limit may be 36 - 50% depending on credit scores, LTVs, additional compensating factors Total monthly obligations: ⚫ proposed housing expense ⚫ other recurring obligations © 2018 Rockwell Publishing Income Analysis Debt to income ratio Housing expense includes PITI: ⚫ principal ⚫ interest ⚫ property taxes ⚫ hazard insurance ⚫ special assessments, mortgage insurance, homeowners association dues (if applicable) © 2018 Rockwell Publishing Income Analysis Debt to income ratio Total monthly obligation includes recurring debts. ⚫ Installment debts: fixed beginning, ending date (car loan). ⚫ Revolving debts: open-ended line of credit with minimum monthly payments (credit cards). ⚫ Other: alimony, child support. Debts paid by others may be excluded. © 2018 Rockwell Publishing 26  Chapter 10: Conventional Financing Income Analysis Housing expense to income ratio Housing expense to income ratio: ⚫ proposed housing expense should not exceed 28% of stable monthly income ⚫ less important than debt to income ratio ⚫ Fannie Mae no longer uses; Freddie Mac only uses for manually underwritten loans © 2018 Rockwell Publishing Income Analysis Compensating factors Fannie Mae and Freddie Mac may allow income ratios to exceed “maximums” if compensating factors such as: ⚫ excellent credit reputation ⚫ large downpayment ⚫ substantial liquid assets ⚫ strong potential for increased earnings ⚫ additional short-term income © 2018 Rockwell Publishing Income Analysis Compensating factors Even with compensating factors, income ratios shouldn’t exceed standard ratio by too much. ⚫ For manually underwritten loans, Fannie Mae and Freddie Mac allow AUS to accept ratio up to 50% with strong compensating factors. © 2018 Rockwell Publishing 27  Financing Residential Real Estate Instructor Materials Income Analysis Factors that increase risk Some applications have factors that pose increased risk to lender. ⚫ Lender might not accept high debt to income ratio if, for example, LTV also high or loan is an ARM. © 2018 Rockwell Publishing Income Analysis ARMs ARM loans have same underwriting standards as fixed-rate loans. ⚫ But borrower must usually qualify at a higher “qualifying rate” than note rate. ⚫ often the note rate plus 2% © 2018 Rockwell Publishing Conventional Qualifying Standards Available funds – reserves General rule: ⚫ conventional borrower should have at least 2 months of mortgage payments in reserve after closing ⚫ smaller amount weakens loan application, more strengthens © 2018 Rockwell Publishing 28  Chapter 10: Conventional Financing Available Funds Gift funds Fannie Mae and Freddie Mac set limits on use of gift funds. Donor must be: ⚫ borrower’s relative, fiancé, or domestic partner ⚫ borrower’s employer ⚫ municipality or public agency ⚫ nonprofit religious or community organization © 2018 Rockwell Publishing Available Funds Gift funds Borrower may be required to make a downpayment of at least 5% of sales price out of her own resources. © 2018 Rockwell Publishing Summary Conventional Qualifying Standards Comprehensive risk assessment Primary risk factors Contributory risk factors Overall layering of risk Credit score Debt to income ratio Housing expense to income ratio Compensating factors Reserves Gift funds © 2018 Rockwell Publishing 29  Financing Residential Real Estate Instructor Materials Buydowns Buydown: seller or third party pays lender lump sum at closing to lower interest rate on buyer’s loan. ⚫ Increases lender’s upfront yield. ⚫ Lowers buyer’s monthly payment. ⚫ Lowers interest rate. © 2018 Rockwell Publishing Buydowns Buydown plans Buydown can be permanent or temporary. ⚫ Permanent buydown: borrower pays lower interest rate for entire loan term. ⚫ Temporary buydown: borrower pays lower interest rate for first few years of term. © 2018 Rockwell Publishing Buydowns Permanent buydowns Permanent buydown: ⚫ reduces note rate (rate stated in promissory note) ⚫ cost calculated in terms of points (percentage of loan amount) © 2018 Rockwell Publishing 30  Chapter 10: Conventional Financing Buydowns Temporary buydowns Two types of temporary buydown plans: ⚫ level payment plans ⚫ graduated payment plans © 2018 Rockwell Publishing Buydowns Temporary buydowns Level payment plan: calls for interest rate reduction that stays same throughout buydown period. Graduated payment plan: calls for largest payment reduction in first year, progressively smaller reductions each remaining year. © 2018 Rockwell Publishing Buydowns Buydowns and qualifying rules Permanent buydown: lender qualifies buyer at bought-down interest rate. Temporary buydown: depends on program, but fixed-rate loan borrower generally must be qualified using note rate. © 2018 Rockwell Publishing 31  Financing Residential Real Estate Instructor Materials Buydowns Limits on buydowns Fannie Mae and Freddie Mac set limits for interest rate buydowns. Both limit amount of rate reduction. © 2018 Rockwell Publishing Buydowns Limits on buydowns Limits also apply to other contributions from seller or another interested party, such as real estate agent or builder. ⚫ But usually don’t apply to someone not in transaction, such as employer or family member. © 2018 Rockwell Publishing Summary Buydowns Permanent buydown Temporary buydown Level payments Graduated payments Qualifying rate Contribution limits © 2018 Rockwell Publishing 32  Chapter 10: Conventional Financing Low-Downpayment Programs Secondary market entities have developed low-downpayment programs for first-time buyers and others who tend not to have much money saved. © 2018 Rockwell Publishing Low-Downpayment Programs LTVs and downpayment rules Examples of low-downpayment programs: ⚫ Loan with 97% LTV and: ⚫ 3% downpayment from borrower’s own funds ⚫ Loan with 97% LTV and: ⚫ 3% downpayment from alternate source ⚫ No minimum contribution from borrower's own funds © 2018 Rockwell Publishing Low-Downpayment Programs Alternate sources of funds Alternate sources of funds may include gifts, grants, or unsecured loans from: ⚫ relative ⚫ employer ⚫ public agency ⚫ nonprofit organization ⚫ private foundation © 2018 Rockwell Publishing 33  Financing Residential Real Estate Instructor Materials Low-Downpayment Programs Affordable housing programs Many low-downpayment programs are targeted at low- and moderate-income buyers. ⚫ Buyers qualify if stable monthly income doesn’t exceed median income of area. ⚫ Debt to income ratio rules are relaxed. ⚫ Income limit may be waived for buyers purchasing homes in low-income or rundown neighborhoods. © 2018 Rockwell Publishing Low-Downpayment Programs Affordable housing programs Other low-downpayment programs are offered to specific groups such as: ⚫ teachers ⚫ police officers ⚫ firefighters © 2018 Rockwell Publishing Low-Downpayment Programs Lender contributions Lender may make contribution to help borrower with closing costs, but contribution cannot: ⚫ exceed total closing costs; ⚫ fund any portion of downpayment; ⚫ be subject to repayment requirement; ⚫ change rates, points, or fees; or ⚫ be passed to lender from a third party. © 2018 Rockwell Publishing 34  Chapter 10: Conventional Financing Summary Low-Downpayment Programs Low-downpayment programs Affordable housing programs Alternate sources of funds Lender contributions © 2018 Rockwell Publishing 35