“Mortgage Financing and Life Insurance Protection” DOHRN INSURANCE TRAINING, INC. 8517 WEST GRAND AVENUE RIVER GROVE, IL 60171 (O) 800-876-3313 (F) 847-455-1153 © 2009 Entire Contents by Dohrn Insurance Training, Inc. No portion of this document may be reproduced, in any format or for any purpose of any kind without the express permission of the owner. Persons accessing it from www.dohrnit.com may print a copy solely for their personal use in the course of study. 2 TABLE OF CONTENTS Chapter 1: Mortgages and Real Estate Financing Concepts The Mortgage - Introduction 7 The Reality of Home Buying 7 Loan Amortization 8 Types of Mortgage Lenders – Primary Market 10 Mortgage Bankers 10 Mortgage Brokers 10 Wholesale Lenders 10 Portfolio Lenders 11 Direct Lenders 11 Correspondents 12 Banks, Savings and Loans (S&L) 12 Credit Unions 12 Choosing a Mortgage Lender 12 Secondary Mortgage Markets 15 Fannie May 15 Ginnie Mae 16 Freddie Mac 17 Private Mortgage Insurance Market (PMI) 17 Types of Mortgages 20 Conventional Mortgage 20 Adjustable Rate Mortgage 22 Minimum Payment (ARM Option 1) 25 Interest Only Payment (ARM Option 2) 25 Fully Amortized 30 year Payment 25 (ARM Option 3) Fully Amortized 15 year Payment 25 (ARM Option 4) Federal Housing Administration (FHA) 27 Veterans Administration (VA) 29 Growing Equity Mortgage (GEM) 30 Graduated Payment Mortgage (GPM) 31 Reverse Annuity Mortgage (RAM) 32 Home Equity Line of Credit 33 First and Junior Mortgage 33 Flexible Payment Mortgage 33 Balloon Mortgage 34 Fixed Rate Mortgage (FRM) 34 Biweekly Mortgage 34 3 Buy to Let Mortgage 35 Construction Loan-to-Permanent Mortgage 36 Bridge Loans (Swing Loans) 36 Budget Mortgage 37 Wraparound Loan 37 Chattel Mortgage 37 Package Mortgage 38 BAD Credit Mortgage 38 Blanket Mortgage 38 Open-End Mortgage 39 Refinancing Mortgage 39 Property Appraisal 40 Chapter 2: Real Estate Ownership 44 The Land Estate 44 Fee Simple Absolute 44 Leasehold Interests 45 Other Real Property Concepts 45 Legal and Equitable Title 45 Situs and Domicile 46 Concurrent Ownership Forms 47 Tenancy In Common 47 Joint Tenancy with Right of Survivorship 47 Tenancy by the Entirety 47 Chapter 3: Term Life Insurance 48 Definition 48 Rising Popularity 48 Types of Term Policies 49 Level Term 49 Which Level Term Product is the Cheapest? 50 What is the Role of the Insurance Professional? 50 Decreasing Term 50 Uniformly 51 Mortgage 53 Which is better coverage: Level or Decreasing Term? 53 Disadvantages of Relying on Group Term Life 54 Term Life Uses and Typical Riders 55 Traditional Riders Used With Term Life 55 Protecting Insurability with Term Life 57 Group Life Concepts 57 4 Historical Significance 57 Role of the NAIC 58 Standard Group Policy Provisions 58 Group Master Policy 60 Chapter 4: Whole Life Insurance 60 Traditional Whole Life Products 62 Other types of Whole Life 63 Uses of Whole Life 65 Advantages 65 Disadvantages 66 Using Term as a Rider 66 Family Policy 67 Family Plans 67 Other Whole Life Riders 68 Waiver of Premium 68 Accidental Death 69 Guaranteed Insurability Option 70 Payor Benefit 71 Joint and Survivorship Life 71 Chapter 5: Interest Sensitive Insurance Products 73 Introduction 73 An Historical Review 73 Guaranteed Products 78 Products Without Guarantees 79 Variable versus Fixed Return Rates 80 Universal Life 84 Policy Costs and Charges 85 IRS Guideline 87 Death Benefit Options A and B 88 Special Features 88 Variable Life 90 Loading actors 90 Interest Factors 90 Comparison: Universal and Variable Life 91 Interest Sensitive Whole Life 92 Guaranteed Product 92 5 Cash Value Accumulation 93 Comparison with Universal Life 93 Equity Index life Insurance 94 The Time Value of Money 95 Consumer Price Index 96 Chapter 6: The Life Insurance Contract 99 Introduction to Contract and Formation 99 Offer and Acceptance 99 Initial Consideration and Receipts 100 Risk Classification 102 Role of the Underwriter 103 Key Underwriting Factors 104 The Standard of Insurable Interest 106 Required Policy Provisions 107 Optional Policy Provisions 110 Other Contract Provision Concepts 112 Beneficiary Considerations 114 Types of Beneficiaries 114 Common Disaster 115 Ineligible and Incompetent Beneficiaries 115 Chapter 7: Trust Basics 117 Creation of a Trust 117 Elements of a Trust 118 Rule Against Perpetuities 119 The Living Trust 120 The Life Insurance Trust 121 Fiduciary Relationships 122 Fiduciary Duty 122 Fiduciary Power 124 Fiduciary Selections 125 The Trustee 125 Guardians 126 Executors 126 Trustee Substitution 127 6 Chapter 8: Disability Income Insurance 129 Need for Income Replacement 129 Individual and Group Disability Coverage 130 Disability Product Taxation Concepts 131 Total, Partial and Residual Disability Definitions 132 Uniform Provisions Policy Law 133 Rights of Renewability 135 Common Policy Provisions 137 Elimination (Waiting) Period 137 Cost of Living Adjustment 137 Waiver of Premium 137 Social Security Offset Benefit 138 Disability Buyout Contracts 138 Elements of the Buy-Sell Agreement 138 General Nature of Buy-Sell Agreements 138 Cross Purchase 140 Entity Purchase 140 Use of Insurance: Premium Selection and Payment 141 Disability Underwriting Considerations 141 Business Overhead Expense (BOE) 142 Social Insurance 144 Disability Rider Use in Mortgage Coverage 144 Chapter 9: Ethical Considerations 145 Disclosure 145 Compliance and State Advertising Laws 145 Direct Response Advertising 147 Agent and Group Insurance Advertising 147 Replacements 148 Illustrations 149 Professional Liability Insurance 149 Malpractice 149 Errors and Omissions 150 7 Chapter 1: Mortgages and Real Estate Financing Concepts (14 Exam Questions) The Mortgage Introduction The term mortgage is a generic term used to describe several different combinations of legal documents that allow a home buyer to get financing. The documents (note, bond, mortgage, deed of trust, open-end-mortgage, security deed, and riders) that are used depend on the state in which the property is located and the type of loan being applied for. A mortgage is a financial claim against real estate. A mortgage is given to a lending institution, along with a bond or a note, which is a personal promise to repay. In return, the lender provides the money or cash needed to complete the transaction. The person who takes on the mortgage debt is called the “mortgagor” because he is technically the party who is accepting the mortgaging. The lender takes and holds the mortgage until repayment has been made and is called the “mortgagee.” Loans secured by properties located in deed of trust states are secured by a document called a deed of trust. When deed of trust is signed, ownership of the property is actually transferred to a trustee. The trustee holds the deed to the property in trust until the loan is paid off. If a dispute arises between lender and borrower, the trustee must to follow state law in resolving the dispute. When a borrower stops making loan payments then it becomes necessary for the trustee to conduct a foreclosure sale for the purpose of paying off the lender. The procedure for a foreclosure is detailed in the deed of trust and controlled by state law. In most states, a court hearing is not required to accomplish foreclosure. In most states allowing mortgages, however, the lender must go to court, argue the case before a judge and obtain the judge’s approval before a foreclosure sale can be held. Lenders prefer to have loans secured by deed of trust because foreclosing on a deed of trust is cheaper and quicker than on a mortgage. As a borrower, you can consider mortgages and deeds of trust as generally interchangeable terms. Reality of Home Buying Affordable housing programs were greatly expanded since the late1990’s. People have become more knowledgeable about real estate buying while lenders have come to realize that it is not a perfect world when it comes to credit history. However, some of the loose availability of mortgages to people who could not repay them has lead to the recent banking crisis which nearly brought down the American and world economies. Since rules have become tighter to qualify for a mortgage since the near financial meltdown of 2008-2009, it will likely be harder for Americans to achieve the dream of home ownership than it was just a few years earlier. 8 Tax Advantages ● Mortgage interest is deductible. ● Property taxes are deductible This means that taxing authorities help you buy your home with years of indirect tax subsidization. Although you may be paying one thousand dollars a month in total interest and real estate tax charges, you do not have to pay income taxes on some the money that is used for this payment. The higher your tax bracket, the more of the payment that is not taxable. Pre-payment Advantages ● Saves thousands of dollars in interest payments by paying off mortgage early. ● No additional mortgage payments. ● Safety and security in case of income reduction. ● Home equity provides a source of cash for retirement, investments, emergencies or education funding. When a mortgagor pays a little extra principal with every payment it can have a powerful effect on the amortization of a mortgage and reduce the repayment period by many years. By paying off a mortgage term early, the mortgagor enjoys all of the advantages listed above. The basic idea is to achieve greater financial stability and flexibility in the future by creating a plan today to reduce the term of a mortgage period. Owning a home free and clear helps provide more economic freedom and security, frees up cash for other investments, provides a greater credit line for the owner and most importantly offers the peace of mind that only freedom from debt allows. Loan Amortization Amortization is an impressive sounding word that lenders use to describe the tedious process of liquidating a debt by making periodic installment payments throughout the loan’s term.