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UGA / Real Estate / REAL 4000 / What makes notes troublesome at times when it comes to mortgage loans?

What makes notes troublesome at times when it comes to mortgage loans?

What makes notes troublesome at times when it comes to mortgage loans?

Description

● How to create a mortgage loan?


What makes notes troublesome at times when it comes to mortgage loans?



○ Note-​ contract that legally establishes that you have received the loan and will pay back ■ Issues regarding the note

● Late fees

● Recourse loans-​ during foreclosure, lenders can go to borrowers’ other assets and get recovered from the loss

● Nonrecourse loans-​ lenders can only go to the one property borrower pledged to

● Demand clause-​ bank can “call” the loan and require immediate repayment of all outstanding principal even if the borrower is in good standing with their

payments

○ Applies when there is a deterioration of the creditworthiness of the

borrower

○ Only applies to commercial, not residential


Why do lenders hate fixed-rate mortgage?



○ Mortgage- ​document pledges property as security of the loan, compounded monthly ■ Fixed-rate mortgage​- interest rate is stated and does not change during the life of the loan

● Lenders hate this, bc they will need to carry all of the interest risks We also discuss several other topics like What makes bill clinton an effective president?

■ Adjustable-rate mortgage-​ interest rate changes with respect of the current market ● Index rate + Margin = Annual interest rate 

● Lenders and borrowers share interest rate burden

● Higher interest rate savings than fixed-rate mortgage

● Borrowers can “lock in” their interest rate for a certain amount of time, but the longer the lock is, the smaller the interest rate savings is

● Index rate-​ determined by the market and is beyond the control of either the borrower or the lender; the starting point of the interest rate


What refers to the limit on how much the interest can change at any one time?



● Margin-​ fixed throughout the entire life of a loan; lender’s markup and reflects the risk of a loan

● Markup-​ the interest rate matches up with the rate of return

● Teaser rate-​ an initial interest rate that is temporarily reduced to some value below index + margin

○ When the rate expires, jump right back to index + margin

○ Lenders created it during the Housing Boom to attract more borrowers

since teaser rate lowered the qualification to take out a loan Don't forget about the age old question of How does cognitive autonomy affect transformation in religious thinking?

● Payment caps-​ a limit on how much the interest rate or payment can change at any one time

● Lifetime caps​ limits how much the payment or interest rate can change in total during the life of the loan

○ Caps apply to both upwards and downwards changes in rates and Don't forget about the age old question of How does pka and camp influence the calcium cycling part of this?

payments

■ Important clauses

● Insurance clause-​ requires the borrower to insure the property in case a fire destroyed the property, borrowers can still pay off the loan

● Escrow clause-​ since lenders are required to pay property premium and property tax, they require borrowers to pay 1/12 as part of their monthly

payment

● Acceleration clause-​ allows lenders to declare borrowers to immediately pay off all outstanding principal in the event of default

○ Important step in initiating foreclosure process

● Due-on-sale clause-​ if the property securing the loan is sold, lenders can require the loan to be paid off

● Preservation and maintenance clause-​ cannot intentionally destroy the property

○ Loan Payments

■ Fully amortizing loan-​ pay interest and partial principal every month; all principal will be paid off by the end of the loan’s term

■ Partially amortizing loan​- pay interest every month but there is still principal outstanding when the loan reaches maturity We also discuss several other topics like What do cells do before division?

● Common for commercial mortgages

■ Nonamortizing loan-​ pay interest every month, but principal payment is not required ● Risky when the property value goes down, and borrower has zero equity of the property

○ Prepayment-​ paying off a loan earlier to refinance to a lower interest rate loan or sell the property

■ The note says nothing about prepayment. Some states allow the lender to charge a prepayment penalty and some do not.

● GA forbids a prepayment penalty unless stated in the contract

■ This is why lenders do not like fixed-rate mortgages, bc borrowers can simply change to a lower interest rate loan

■ Prepayment penalties are common for:

● Jumbo mortgages​ (large residential mortgage, bc loans are too large) ● Subprime mortgages​ (loans to borrowers with bad credit or inability to document income)

○ Higher prepayment penalties for these people

● Most commercial mortgages

■ Types of prepayment penalties

● Lockout provisions-​ forbidden for refinancing for the first certain # of years ● Yield maintenance- i​ nvestors attain the same yield as if the borrower made all scheduled mortgage payment until maturity Don't forget about the age old question of How the hebrew scriptures are incorporated into the quran?

● Defeasance-​ instead of paying cash to the lender, borrower can exchange another cash flowing asset for the original collateral for the loan

○ Lenders are better off, bc the new collateral is less risky

○ Borrowers use this when the new interest rate is significantly low

○ Used by business people

○ Why is it difficult to observe the market value of a property?

■ No two properties are alike

■ Infrequent transactions

■ Immobility, meaning market value is strongly affected by local market trends ○ Real estate appraisal-​ formal estimate of the value of a piece of real estate by estimating market value and using information on transaction price

■ Used by lenders, courts, buyers and sellers

■ Market value-​ most probable selling price under normal market conditions (estimate) ■ Investment value-​ how much is that investor willing to pay for a property ■ Both market value and investment value are just concepts.​ We can never estimate the true value If you want to learn more check out Who was opposed to the new deal?

■ Transaction prices-​ the amount actually paid for a property in a completed transaction

■ The appraisal process is guided by the Uniform Standards of Professional Appraisal Practice

● Step 1: Identify the problem

● 2: Determine the scope of the work

○ Who will use the appraisal? What will it be used for?

● 3: Collect data on property, market, comparable property, and investment market characteristics

● 4. Perform data analysis

○ Highest and best use analysis-​ legally permissible, physically possible (the property can support the use), financially feasible (profitable to use

the property that way), and maximally productive

■ First pretend it is vacant, then take in consideration of what is

already there

● 5. Estimate the value of the land

○ Pretend the property is vacant and calculate the highest market value

○ Take in consideration of what is already there

● 6. Application of the three valuation methods

○ The sales comparison approach-​ determine the sale prices by

analyzing the value of similar comparable properties that have sold

recently

■ Preferred method, bc it is most directly tied to marketplace

■ Step 1: Identify the elements of comparison (location, size, style,

age) and value adjustment (property right, location, physical

characteristics)

● Comparable has three rooms, but subject property has

four. What is the adjustment?

■ Step 2: Make adjustment: after making all the adjustments,

appraisers average all three comps and get a sales adjustment

value

○ The cost approach a​ pplies to special buildings, such as schools and

churches, since they were not sold frequently, it is difficult to get an

estimation of the value

■ Disadv.: does not take in consideration of demand (if anyone would buy the property)

● Step 1: Estimate the value of the land

● 2: Estimate the cost of the structure as new

○ Replacement cost 

○ Reproduction cost: what is the cost to exactly

reproduce the building?

● 3: Deduct accrued depreciation

○ Physical depreciation:​ old properties

○ Functional depreciation:​ features of the building

do not line up with what current users want

○ Curable vs. Incurable

■ Curable- something that can be fixed

○ External depreciation​: spillover

○ The income approach

■ Potential Gross Income (PGI)​- the amount of rental income the property will generate if it is fully leased for the entire year, and all of the tenants pay their rent in full and on time

■ Effective Gross Income (EGI)-​ the amount of total income the property is actually expected to generate; two adjustments: ● Vacancy and collection losses

● Other income, such as parking fees

■ Operating expenses-​ ordinary and regular expenses that are necessary to maintain the functionality of the property

● Ex. utilities

■ Capital expenditures-​ expenditures that extend the life of the property or increase its value

● Ex. new AC

■ # units x Average rent ($/unit/month) = PGI 

■ PGI - Vacancy and collection losses + Other income = EGI ■ EGI - Operating expenses - Capital expenditure = Net Operating Income 

■ For rent: Make sure it is $/unit/MONTH

■ How do we use this info to estimate the market value of the property?

● Direct capitalization: M​ arket value = Expected year 1 NOI / capitalization rate 

○ Capitalization rate- a ratio indicating how market

participants are valuing the income from

properties

■ Can use published Cap rate if the property

is generic enough

■ Or compute one for ourselves if we are in

a small market and no published data is

available

■ The smaller the cap rate is, the bigger the

market value is, meaning buyers are

paying more for the property

■ Hotels > Apartments > Other commercial

real estates

■ Hotels have the highest Cap rate bc it can

feel the economy the fastest

● Discounted cash flow-​ estimate the NOI for every year,

Net sales proceeds from the sale at the end of the

holding period, and calculate the NPV

Year 1 Year 2 Year 3 Year 4 Year 5

Number of Units 200 200 200 200 200

Average Rent ($/unit/month)

$1,000 1,000 x 104% $1,040

$1,082 $1,125 $1,170

Potential Gross

Income (Number of Units x Market Rent x 12)

Vacancy and Collection Losses

$2,400,000 $2,496,000 $2,595,840 $2,699,674 $2,807,661

5% 5% 5% 5% 5% ($120,000) ($124,800) ($129,792) ($134,984) ($140,383)

Other Income ($/unit/month)

$5 5 x 103% $5.15

$5.30 $5.46 $5.63

Effective Gross

Income

Operating Expenses (% of EGI)

Capital Expenditures (% of EGI)

$12,000 $12,360 $12,731 $13,113 $13,506 $2,292,000 $2,383,560 $2,478,779 $2,577,803 $2,680,784

40% 40% 40% 40% 40%

($916,800) ($953,424) ($991,512) ($1,031,121) ($1,072,314) 3% 3% 3% 3% 3%

($68,760) ($71,507) ($74,363) ($77,334) ($80,424)

Net Operating Income $1,306,440 $1,358,629 $1,412,904 $1,469,348 $1,528,047 ○ Future selling price = Year 6 NOI / Going-Out Cap rate

○ 1,589,902 / 6.5% = $24,447,562

○ Net sale proceeds= Future selling price - Selling expenses

○ $24,447,562 - (24,447,562 * 5%) = $23,225,184 (the price of selling the

property)

○ NSP + Year 5 NOI = C05

○ Market value = NPV @ 8% = $21.42 million

● 7. Reconcile indicated value from the three approaches to get an indicated 

value for the market value of the property

● 8. Report final value estimate, can be done as a:

○ Full appraisal report (commercial, 30-50 pages)

○ Summary appraisal report (residential, short and concise)

○ Simple report of value (for the court)

● Default-​ any failure to live up to the terms of the note or mortgage

○ Technical default-​ violations of upholding some other aspect of the loan terms, not a failure to make payments

■ Ex. failed to keep up with property maintenance or repairs

■ Usually does not lead to foreclosure

○ Substantive default-​ failing at least 3 payments behind

■ Step 1 of foreclosure

○ Non-foreclosure responses to default

■ Credit counseling-​ for people who do not know who to spend money wisely ■ Consumer debt reorganization-​ come up plans to help people pay off debts ■ 1 & 2 are for people who have the income but having trouble paying back

■ Loan modification-​ lender will lengthen the amortization period to decrease monthly payment

■ Short sale-​ happens when the borrower owes more than the house actually worth, so he finds another buyer who is willing to purchase the property

■ Deed in Lieu of foreclosure-​ happens with a powerful commercial company; the borrower writes a deed and transfers ownership of the property to the bank, then lenders cancel the borrower debts

■ Keep in mind that lenders try to eliminate foreclosure, bc 60-70% of foreclosure loans do not get recovered

● Foreclosure-​ legal process of terminating all of the borrower’s ownership claims and liens inferior to the foreclosing lien

○ Goal is to have a property that the lender can sell with clean title in order to recover the debt ○ Equity of redemption-​ what borrower can do to stop the foreclosure process and retain ownership of the property

■ Foreclosure can be stopped up to the day of the foreclosure sale if the borrower pays the amount owed and all foreclosure costs

■ Statutory right of redemption-​ some states allow claim of ownership after the foreclosure sale

● Alabama (within 1 year), Iowa (farms, 5 years)

● GA has NO statutory right of redemption

○ Acceleration clause-​ ​ lenders can demand the borrower to pay back all of the loan amount ○ Deficiency judgement-​ sue the borrower when the lender failed to recover everything from foreclosure

■ GA gives lenders 30 days to pursue a deficiency judgement

■ Rarely

○ Foreclosure process follows…

■ Judicial foreclosure-​ courts handle the foreclosure, very long process

■ Power of sale-​ lenders handle the foreclosure sale, quick

● Mortgage Market

○ Primary mortgage market-​ where lenders and borrowers meet to create mortgage ○ Secondary mortgage market-​ where lenders sell the loans that they have originated to other investors

■ Fannie Mae and Freddie Mac​ are the largest purchasers of residential mortgages ● Similarities:

○ Both are private shareholders corporation with charter from the federal

government

○ Both purchase mortgages originated by private lenders

● Differences:

○ Fannie is a bigger than Freddie

○ Fannie is the sole purchaser of FHA and VA loans

○ Freddie securitized everything while Fannie held a mortgage portfolio

● Created a national mortgage markets instead of a group of connected local

markets

● Mortgage Types

○ Prime Conventional mortgages

■ Prime mortgages- ​loans to borrowers with good credit records and who are able to document their incomes and assets

■ Conventional mortgages-​ loans that are not guarantee from a U.S. governmental agency

● Need to have PMI-​ purchased by the borrower to protect lender from default losses

○ If you make a down payment less than 20%, then you will need to

purchase PMI

● PMI Cancellation Rules

○ Cancellation may be allowed when the loan balance falls below 80% of

the current home value

○ Borrower has the right to terminate when the loan balance falls below

80% of the original home value

○ Insurer must terminate the policy when the loan balance falls below

78% of the original home value

■ Most common: fixed-rate conventional mortgage

○ Conforming loan-​ one that meets Fannie and Freddie’s standard for them to purchase the loan

■ Adv: make the loan more liquidity, bc loan owners know there will always be a buyer ○ The National Housing Act of 1949-​ made it a national goal to help those who cannot get access to prime conventional through private mortgage markets

■ The Federal Housing Administration default insurance program ( FHA)- f​ or those who have the income to make monthly payment, but do not have enough savings to make a down payment

● Does not make loans

● If a borrower makes a loan through FHA, the Federal housing provides default insurance to lenders

● Requires a downpayment of 3.5% instead of the 5-10% for conventional

mortgages

● Disadv.: size of loan is limited

■ Veteran’s Affairs loan guarantee program (VA)

○ Interest-only balloon mortgage-​ paying only interest every month and pay off the entire principal at the end of the term

○ Interest-only amortizing mortgage (30 years)-​ 15 years of only monthly interest payment; at the end of 15 years the loan converts to a fully-amortizing 15 mortgage

■ Therefore, payment jumps in the next 15 years, hopefully your income jumps in the next 15 years

○ Hybrid Adjustable Rate mortgage (Hybrid ARM)-​ interest rate is fixed for the 2,3,5, or 10 years, then it changes to adjustable rate

■ Initial rate is lower than that on a fixed-rate mortgage

○ Option ARM (worst)-​ every month, borrower can choose among fully amortizing, interest-only, and minimum monthly payment

○ Subprime loan-​ adjustable-rate mortgages with very low introductory payment (use as teaser rate), but a large jump in payment amount at some point

○ Alt-A loans-​ conventional loans with less stringent underwriting requirements ■ Lower credit scores

■ Reduced documentation of income or assets

○ NINJA loan-​ lenders do not ask for income verification, do not verify employment, and do not document assets

● Lenders

○ Depository lenders​- traditional lenders; characteristics:

■ They are financial intermediaries-​ poor small amounts of savings and channel them to large-scale uses for the people who need it

■ They are portfolio lenders-​ originator of loans and holders of the portfolio of their loans instead of selling them off

■ Main types of depository lenders:

● Savings associates- ​ S&Ls, savings banks; dominated residential mortgage lending)

○ Suffered and died out in the late 1970s when the U.S. was fighting

inflation and unemployment

○ Government allowed interest rate to go up to fight inflation, but most

mortgages are fix-rate mortgages

○ 70% had disappeared by 2001

● Commercial banks: dominated construction lending, bc construction lending tends to be 6 months to 2 years which commercial banks prefer it, bc it does

not tie up banks’ money

● Credit unions

■ Lenders typically want to get their money back as soon as they created a loan ○ Nondepository lenders-​ replaced depository lenders

■ Mortgage banks/ mortgage companies-​ originate and own loans long enough to sell ● Known as conduit lenders-​ ​ act as the source of the loan

○ Sell loans “whole,” meaning sell the loan before mortgage banker

collects a payment

○ Acts as servicer, collects monthly payment, remits to payments to

investors, for property taxes, etc.

○ Earn money from service fees

■ Mortgage broker​- info provider, match borrower and lender together for a fee ● Different from mortgage companies

● Never owns the loan

● Concern: “front-loaded” compensation-​ brokers are out of the market once they found a lender; therefore, some of them do not have the incentive to find a good borrower

● Risk of mortgage banking

○ Pipeline risk-​ risk between loan commitment and loan sale (in #3 and #4)

■ Stages of loan origination:

● 1. Borrower applies for a loan

● 2. Lender issues a loan commitment

● 3. Borrower and lender close on the loan

● 4. Exists the pipeline when the mortgage banker sells the loan to an investor ■ Fallout risk-​ risk that borrower backs out due a decrease in the interest rate ● Ex. committed a 7% interest rate loan, now interest rate falls to 5%, borrower backs out

■ Price risk-​ closed the loan but did not sell it due to the increase of interest rate ● Ex. Mortgage banker has a 6% 30 years loan, but due to the increase of

interest rate, lender can get a 7% 30 years loan

■ Very sensitive to disruptions

○ Early defaults: agreement with investors that the mortgage banker needs to buy back a mortgage when there is an early default

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