The real estate financing market has the following three basic components:
Government influences, primarily the Federal Reserve System
The primary mortgage market: Loans are originated
The secondary mortgage market: Loans are sold
Upon purchasing a property if in need of financing a borrower will work with a mortgage broker who will bring the borrower and lender together for the real estate transaction.
A lender then evaluates certain factors to decide whether to grant a borrower a mortgage loan. A lender can evaluate for credit worthiness, income, but not for things like martial status. In fact, the Equal Credit Opportunity Act, states that lenders cannot discriminate any of the seven protected classes (race, color, religion, national origin, sex, familial status, and disability), including age (no discrimination against the elderly) and cannot discriminate based on source of income)
The borrower then pays the lender a charge for the use of the money, known as simple interest.
A state law that regulates the maximum interest rates that lender can charge is know as usury law.
Primary Mortgage Market
The lenders that originate mortgage loans
Savings associations and fiduciary lenders
Insurance Companies: accumulate large sums of money from the premiums paid by their policyholders
Credit Unions: cooperative organizations whose members place money in savings accounts
Pension Funds: have large amounts of money available for investment with real estate activity being handled through mortgage bankers and mortgage brokers
Endowment Fund: provide a good source of financing for low-risk commercial and industrial properties
Investment group financing: financed as joint ventures through group financing arrangements like syndicates, limited partnerships, and real estate investment trust for large real estate projects like highrise apartment buildings or shopping centers
Mortgage Banking Companies: originate mortgage loans with money belonging to insurance companies, pension funds, and individuals, as well as funds of their own
Second Mortgage Market
Institutional investors who buy and sell loans after they have been funded.
Fannie Mae: buys from a lender a block or pool of mortgages that may then be used as collateral for mortgage-backed securities that are sold on the global market. Fannie Mae deals in conventional as well as FHA-insured and VA-guaranteed loans.
Freddie Mac: provides a secondary market for mortgage loans, primarily conventional loans
Ginne Mae: administers special-assistance programs and guarantees investment securities issued by private offerors (such as banks, mortgage companies, and savings and loan associations) and backed by pools of FHA-insured and VA-guaranteed mortgage loans.
Farmer Mac: creates a secondary market for agricultural mortgage and rural utilities loans and the portions of agricultural and rural development loans guaranteed by the U.S. Department of Agriculture (USDA).
The biggest distinction between primary mortgage market and the secondary is in the origination of the mortgage loan vs the purchase of the mortgage loan.
Mortgage loans can be classifies by their loan-to-value ratio which is the ratio of debt to the value of the property, where the value is the sales price or appraised value, whichever is less.
Conventional Loans
Any loan not government insured or guaranteed, unlike FHA-insured and VA-guaranteed loans
LTV of a Conventional Loan is either the sales price or appraised value (which ever is lower)
Considered to be the most secure because their loan-to-value ratios are often lowest
The borrower must make a down payment of at least 20% (OR 80% LTV)
There are LTV 90 to 95% loan but this is a high risk loan and it needed to be insured by private mortgage insurance
Could have a prepayment penalty
To qualify for a conventional loan under Fannie Mae guidelines: the borrower’s monthly housing expenses, including PITI (principal, interest, taxes, and insurance), must not exceed 28% of total monthly gross income
PRIVATE MORTGAGE INSURANCE (PMI)
PMI is an insurance policy that provides the lender with funds in the event of borrower default on the loan
FHA (Federal Housing Administration)
Functions to insures loans on real property made by approved lending institutions
These loans are insured by HUD (Department of Housing and Urban Development)
Funds for FHA loans are usually provided by qualified lenders.
The most popular FHA program covers fixed-rate loans for 10 to 30 years on one- to four-family residences
Not a participant in the second market
The property must be approved by a government approved appraiser if seeking to obtain this loan.
Loan amount can be determined by geographical location
FHA loans do require mortgage insurance
VA
Does not require a down payment - meaning 100% LTV is possible
Available to veterans and their spouses including unremarried spouses of veterans whose deaths were service-related
The borrower must apply for a certificate of eligibility
Likely to have the HIGHEST loan-to-value ratio
Maximum repay period is 30 years
On a VA loan, the guaranty / entitlement is the amount of money that protects a lender if an eligible veteran defaults on their loan.
There is usually a 2% funding fee
Guaranteed by the Veteran's Affairs Administration (VA)
A final concept we should also pay attention to when discussing loans is loan assumption.
Loan assumption does not require a loan origination fee unlike the other three loan types. A person who assumes an existing mortgage loan is personally responsible for paying the principle back.
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