Real Estate Financing

As of the fall of 2003, there was a total of $9¼ trillion of mortgage debt outstanding, $6.82 trillion of which was residential mortgages (1-4 family structures). A mortgage is a secured loan in which the property is pledged as collateral for the loan, thereby creating a lien, or encumbrance, against the property. In the event that payments on the loan are not made in a timely manner, the mortgagee can seize the property through foreclosure. The property is then sold in order to generate the funds to satisfy the debtholder's claim. Funds realized in excess of the claim go to the owner of the property (mortgagor).

Promissory Note

The loan for property is a promissory note, a written promise to repay a debt. The promissory note contains

 names of the borrower and lender  amount of the loan  promise to pay  manner and amount of payment, and  right to prepay

Mortgage, Deed of Trust (Security Instruments)

A mortgage, deed of trust, or other security instrument is an accompanying document signed and dated along with the promissory note. The mortgage document includes

 names of the borrower and lender  amount of the loan  legal description of the property pledged  details regarding payments of taxes, insurance and other charges (but not the note)  the order in which payments will be applied to obligations  insurance requirements  acceleration of debt and due-on-sale clauses  reinstatement (curing default)  foreclosure procedure  other covenants

Truth-in-Lending Disclosure Statement

A Truth-in-Lending disclosure statement is also required. This statement reveals

 amount of the loan  stated rate of interest  exact payments to be made  sum of the total payments  additional fees paid (origination, discount, processing)  effective rate of interest on the loan

Foreclosure Process

In the event of default, the mortgagee can institute procedures for seizing control of the pledged property for purposes of selling it to satisfy the debt obligation

 Judicial foreclosure (Texas) - court action is initiated  Nonjudicial foreclosure - lender can sell the property directly  Strict foreclosure - title to the property is transferred to the lender

Housing Finance System

Stucture  Primary market - creation of a new loan agreement between a borrower and a lender (loan origination)  Secondary market - selling of existing loan obligations from one lender to another

Federal Housing Administration (FHA)  Created in 1934 as a result of the collapse of the economy during the Depression and the numerous defaults on existing short-term, interest-only mortgages  Established rigorous borrowing and lending standards to reduce risk to lenders  Promoted long-term, fully amortizing loans consistent with borrowers' budgets  Established a mortgage insurance program to cover losses to lenders who followed the strict guidelines  203(b) Program - borrower pays 2¼% of loan at the time of origination (added to loan amount) plus ½% annually (of the original loan amount) for the remainder of the loan (up to 30 years)  Loan can be up to 97% of the purchase price  Available for loans up to $160,176 in Bexar county (varies by county -- for a county/state look-up, go to http://www.fhatoday.com/mtg_limits.htm)  Need not be a first-time buyer

Private Mortgage Insurance  Not restricted to limits of FHA loans  Generally, cheaper than FHA at loan origination and annually  Can finance as much as 100% of property purchase price

Federal National Mortgage Association (Fannie Mae)  Created in 1938 to buy FHA-insured mortgages, thereby creating a secondary market  Sells securities backed by the mortgages  Became a private corporation in 1968 traded on NYSE  Can receive loans from the U.S. Treasury if needed

VA Loans  Established as a part of the GI Bill of Rights following World War II  Available to those who served at least 2 years in the armed services or 6 years in the reserves or National Guard  Loans up to $240,000  Loans up to 100% of property purchase price  No mortgage insurance requirements - Department of Veteran Affairs guarantees the loans  Assumable subject to VA approval of assumer's credit

Government National Mortgage Association (Ginnie Mae)  Created in 1968 after Fannie Mae went private in order to provide subsidized loans to qualified borrowers  Guarantees payments of interest and principal on FHA and VA loans, thereby making the Mortgage-Backed Securities (MBS) more desirable to investors and creating more loanable funds

Federal Home Loan Mortgage Corporation (Freddie Mac)  Created in 1970 to facilitate the secondary markets for conventional loans (i.e., non- FHA, non-VA loans)  Competes with Fannie Mae in the secondary markets

Mortgage Market Participants

The providers of funds for mortgages include:

 Commercial banks  Savings associations  Credit unions  Insurance companies  Federal agencies  Mortgage pools and trusts  Individuals

Independent mortgage brokers originate approximately one-half of all mortgages and then sell them in the secondary markets. Similarly, commercial banks, savings associations and credit unions generally sell the mortgages that they originate, although they do continue to hold some of them as investments.

Uniform Residential Loan Application  Standardized loan application used by most lenders complying with the requirements necessary for resale in the secondary markets dominated by Fannie Mae and Freddie Mac  Collects information on the borrower including  Employment  Income and mandatory expenses  Assets and liabilities  Residence history Federal Legislation  Equal Credit Opportunity Act - Requires notification of approval or denial within 30 days of application. Prohibits discrimination based on race, color, religion, national origin, sex, marital status, age, sources of income from public assistance programs and applicant's actions under the Consumer Credit Protection Act  Consumer Credit Protection Act (Truth-in-Lending Law) - required to disclose the full details of the loan to the applicant within three business days of application. Allows consumers to shop for best loan by disclosing the effective interest rate, or Annual Percentage Rate (APR), of the loan. (residential loans only)  Real Estate Settlement Procedures Act (RESPA) - establishes duties of mortgage lenders of residential loans  Requires lenders to provide a copy of the Department of Housing and Urban Development's information booklet "Settlement Costs and You: A HUD Guide for Home Buyers"  Requires lenders to provide borrowers with a good faith estimate of the settlement costs associated with the loan  Prohibits kickbacks or referral fees to parties who refer a borrower to a lender  Gives the loan applicant the right to request a copy of any appraisal report used to evaluate the property being pledged as collateral  Requires the use of the HUD-1 Uniform Settlement Statement at the loan closing  Requires the lender to disclose if the loan is expected to be sold in the secondary market  Limits the amount of money the lender can require the borrower to deposit to cover property taxes, hazard insurance or other periodic assessments  Flood Disaster Protection Act - requires lenders to disclose if the property they are purchasing lies in a flood zone. If so, the lender must require that the borrower purchase flood insurance  Fair Credit Report Act - requires lenders to obtain permission from the borrower before investigating the applicant's credit history. If a loan request is denied based on information contained in a credit report, the lender must notify the applicant of this fact and provide contact information for the credit agency issuing the report

Mortgage Underwriting  Qualifying an applicant – evaluating the applicant’s creditworthiness  Qualifying the property – obtaining an independent appraisal  Risk assessment  Loan-to-Value ratio  Downpayment sources (gift is common)  Income to debt ratios – fixed monthly payments including PITI and installment debt should be in the range of 28%-32% of gross monthly income

Sources of Commercial Property Capital

 Individual Investors – direct ownership and owner-carry  Life insurance companies – long-term investments  Pension funds – Texas TRS, CALPERS, TIAA-CREF  Real estate investment trusts (REITs)  Commercial banks – tend to be shorter term  Commercial mortgage-backed securities (CMBS) – collateralized securities Commercial Underwriting Criteria – primary criterion is the ability of the property’s net operating income to service the debt. Loan-to-value ratios are generally no higher than 80% and debt coverage ratios (NOI/(principal + interest) are 1.2 or better.