Chapter 14 - Mortgage Basics and Real Estate Finance

I. The Mortgage Instrument

A mortgage is a legal document that creates a lien on real property as security for a debt.

• Note (Bond): The personal promise to repay the money. The mortgage is the security; the note is the evidence of the debt.

• Parties: * Mortgagor: The borrower (who gives the mortgage to the lender).

• Mortgagee: The lender (who receives the mortgage).

• PITI: The four components of a monthly mortgage payment: Principal, Interest, Taxes, and Insurance.

II. Types of Mortgages and Loans

Lenders offer various structures to suit different borrower needs.

Common Loan Structures:

• Fixed-Rate: Interest rate remains the same for the entire life of the loan.

• Adjustable-Rate (ARM): The interest rate fluctuates based on an economic index.

• Balloon Mortgage: Features lower monthly payments but requires a large final "balloon" payment at the end of the term.

• Blanket Mortgage: Covers more than one parcel of land; commonly used by developers.

• Purchase Money Mortgage (PMM): Seller financing where the seller "takes back" a note for part of the purchase price.

• Reverse Mortgage: Allows seniors (62+) to convert home equity into cash; the loan is repaid when the owner dies or sells.

Government-Backed Loans:

• FHA (Federal Housing Administration): Insures loans made by private lenders. Known for low down payments (3.5%) and more lenient credit requirements.

• VA (Department of Veterans Affairs): Guarantees loans for eligible veterans. Typically requires $0 down payment.

• SONYMA (State of New York Mortgage Agency): Offers below-market interest rates and low down payment programs specifically for first-time homebuyers in NY.

III. The Secondary Mortgage Market

Lenders often sell their loans to the secondary market to gain "liquidity" so they can lend to more people.

• Fannie Mae (FNMA): Federal National Mortgage Association.

• Freddie Mac (FHLMC): Federal Home Loan Mortgage Corporation.

• Ginnie Mae (GNMA): Government National Mortgage Association (specifically for FHA/VA loans).

IV. Underwriting and Qualifying

Lenders use the Loan-to-Value (LTV) ratio to determine risk.

• LTV Formula: $\frac{\text{Loan Amount}}{\text{Appraised Value or Sales Price (whichever is LOWER)}} = \text{LTV}$

• PMI (Private Mortgage Insurance): Usually required on conventional loans if the LTV is higher than 80% (less than 20% down).

V. Predatory Lending and Consumer Protection

Predatory Lending refers to unfair or abusive loan terms imposed on a borrower.

• Subprime Loans: Loans with higher interest rates for "high-risk" borrowers.

• Common Abuses: * Equity Stripping: Making a loan based on equity rather than the ability to repay.

• Loan Flipping: Frequent refinancing that serves only to generate fees for the lender.

• Regulation Z (Truth in Lending Act): Requires lenders to disclose the Annual Percentage Rate (APR), which reflects the true cost of borrowing (interest + fees).

• Right of Rescission: For certain refinances or home equity loans (not original purchases), borrowers have 3 business days to cancel the deal.

⚠️ EXAM ALERT: QUICK FACTS

• Judicial Foreclosure: New York is a Judicial Foreclosure state, meaning the lender must go through the court system to foreclose.

• Deficiency Judgment: If a foreclosure sale doesn't cover the full debt, the lender can seek a Deficiency Judgment against the borrower for the remaining balance. In NY, the motion for this must be made within 90 days of the deed delivery.

• Acceleration Clause: The provision in a mortgage that allows the lender to demand the entire balance due immediately if the borrower defaults.

• Trigger Terms: Under Regulation Z, if an ad mentions a specific number (like "3% down" or "$500 a month"), it must also disclose the APR and all other loan terms. General phrases like "low down payment" are okay.

KEY TERMS

Acceleration Clause: A provision in a mortgage or promissory note that allows the lender to demand immediate payment of the entire remaining loan balance if the borrower defaults on any part of the agreement.
Adjustable-Rate Mortgage (ARM): A loan characterized by an interest rate that adjusts periodically based on a specific economic index.
Alienation Clause: Also known as a "Due on Sale" Clause, it allows the lender to demand full payment of the loan if the property is sold or transferred, preventing the buyer from assuming the mortgage.
Amortization: The systematic repayment of a loan through regular periodic installments of principal and interest until the debt is paid in full.
Assignment: The transfer of a mortgage or other legal interest from the original lender (assignor) to a third party (assignee).
Balloon Mortgage: A loan that features lower periodic payments for a set time but requires a final payment that is significantly larger than the previous ones to pay off the remaining principal.
Blanket Mortgage: A single mortgage that covers more than one parcel of real estate, commonly used by developers.
Bridge Loan: A short-term loan used to provide immediate funds until permanent financing can be secured, often used by buyers who need to close on a new home before selling their current one.
Buydown: A financing technique in which the borrower or a third party (like a builder) pays points or a lump sum to the lender to lower the interest rate for the first few years of the loan.
Construction Mortgage: A short-term loan used to finance the building of an improvement on real estate; funds are typically disbursed in stages as work is completed.
Conventional Mortgage: A loan that is not insured or guaranteed by a government agency, such as the FHA or VA.
Default: The failure of a borrower to meet the legal obligations of a loan, such as failing to make timely payments.
Discount Points: Fees paid directly to the lender at closing in exchange for a reduced interest rate; one point equals 1% of the loan amount.
FHA Mortgage: A loan insured by the Federal Housing Administration, which protects the lender against loss if the borrower defaults.
Grace Period: A set length of time after the due date during which a payment can be made without incurring a late penalty.
Graduated Mortgage: A loan where payments start lower and increase gradually over a set period before leveling off.
Home Equity Loan: A loan where the borrower uses the equity of their home as collateral; it is often a second mortgage.
Inflation: An economic condition where there is a general increase in prices and a corresponding fall in the purchasing value of money.
Interest and Tax Deductibility: The ability for homeowners to subtract mortgage interest and property taxes from their adjusted gross income on federal and state tax returns.
Lifetime Cap/Ceiling: The maximum interest rate that can be charged on an adjustable-rate mortgage over the entire life of the loan.
Loan Flipping: A predatory lending practice where a lender encourages a borrower to refinance a loan repeatedly to charge high points and fees each time.
Loan-to-Value Ratio (LTV): The relationship between the amount of the mortgage loan and the value of the real estate (either the sales price or appraised value, whichever is lower).
Margin: The fixed percentage added to the index rate to determine the final interest rate on an adjustable-rate mortgage.
MIP (Mortgage Insurance Premium): The insurance fee paid by a borrower for FHA-insured loans.
Mortgage, Mortgagor, Mortgagee: A Mortgage is a legal document that pledges property as security for a debt. The Mortgagor is the borrower (who gives the mortgage); the Mortgagee is the lender (who receives the mortgage).
Negative Amortization: A situation where the monthly mortgage payments are not enough to cover the interest due, causing the unpaid interest to be added to the principal balance, increasing the total debt.
Package Mortgage: A mortgage that covers both real property and personal property (such as appliances or furniture).
Pledged Account Mortgage: A financing technique where the borrower deposits money into a savings account held by the lender; this account is then used to subsidize the mortgage payments during the early years of the loan.
PMI (Private Mortgage Insurance): Insurance provided by a private company to protect lenders against loss on high-LTV conventional loans (usually those with less than a 20% down payment).
Point: A unit of measurement used for various loan charges; one point equals 1% of the loan amount.
Predatory Lending: Unscrupulous actions carried out by a lender to entice, induce, and assist a borrower into taking a mortgage that carries high fees or a high interest rate, often stripping the borrower of equity.
Prepayment Penalty Clause: A charge imposed by a lender on a borrower who pays off the loan principal early.
Primary Market / Secondary Market: The Primary Market is where loans are originated (lender to borrower). The Secondary Market is where existing loans are bought and sold among lenders and investors.
Promissory Note: A written promise to pay a specified sum of money to a designated person or entity at a fixed time.
Rate Cap / Payment Cap: A Rate Cap limits how much the interest rate on an ARM can change. A Payment Cap limits how much the actual monthly dollar payment can increase.
Redlining: The illegal practice of a lender refusing to make loans in certain geographic areas based on the racial or ethnic composition of the neighborhood.
Regulation Z: The federal regulation that implements the Truth-in-Lending Act, requiring lenders to inform borrowers of the true cost of obtaining credit.
Release Clause: A provision in a blanket mortgage that allows for the release of a specific parcel from the lien once a certain portion of the loan is repaid.
RESPA (Real Estate Settlement Procedures Act): A federal law requiring lenders to provide borrowers with disclosures regarding settlement costs and prohibiting kickbacks.
Reverse Annuity Mortgage: A loan designed for seniors (62+) that allows them to convert home equity into cash; the lender makes payments to the homeowner, and the loan is repaid when the home is sold or the owner dies.
Sale-and-Leaseback: A transaction where an owner sells their property to an investor and then immediately leases it back to continue using the premises.
Satisfaction of Mortgage: A legal document issued by a lender acknowledging that a mortgage debt has been paid in full.
Shared Equity Mortgage: A mortgage where the lender or an investor agrees to provide a portion of the down payment or subsidized interest in exchange for a share of the property's future appreciation.
SONYMA (State of New York Mortgage Agency): A state agency that provides low-interest-rate mortgages and closing cost assistance to eligible first-time homebuyers in New York.
Straight Mortgage / Term Mortgage: A non-amortizing loan where the borrower pays only interest during the term, with the entire principal balance due in a lump sum at the end.
Sub-prime Loan: A loan made to a borrower with a poor credit history or high debt-to-income ratio, usually carrying a higher interest rate to compensate for the increased risk.
Usury: The illegal act of charging an interest rate that is higher than the maximum limit established by state law.
VA Mortgage: A loan guaranteed by the Department of Veterans Affairs, available to eligible veterans and their spouses, often requiring little to no down payment.
Wrap-around Mortgage: A form of secondary financing where a new mortgage "wraps" around an existing first mortgage; the borrower makes one payment to the new lender, who then pays the original lender.