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HMLO Hard Money Loan Online
A hard money loan is a specific type of asset-based loan financing in which a
borrower receives funds based on the value of a parcel of real estate. Hard
money loans are typically issued at much higher interest rates than conventional
commercial or residential property loans and are almost never issued by a
commercial bank or other deposit institution. Hard money is similar to a bridge
loan which usually has similar criteria for lending as well as cost to the
borrowers. The primary difference is that a bridge loan often refers to a
commercial property or investment property that may be in transition and not yet
qualifying for traditional financing. Whereas hard money often refers to not
only an asset-based loan with a high interest rate, but can signify a distressed
financial situation such as arrears on the existing mortgage or bankruptcy and
foreclosure proceedings are occurring.
Many hard money mortgages are made by private investors. often in their local
area. Usually the credit score of the borrower is not important. The loan is
purely against the collateral of the property. Typically the maximum loan to
value is 65-70%. That is, if the property is worth $100,000 you can borrow
$65,000-70,000 against it. This low LTV is to cover the lender if the borrower
does not pay and they have to foreclose on the property. Evaluate the mortgage
collateral
Loan structure
A hard money loan is a species of real estate loan collateralized against the
quick-sale value of the property for which the loan is made. Most lenders fund
in the first lien position, meaning that in the event of a default, they are the
first creditor to receive remuneration. Occasionally, a lender will subordinate
to another first lien position loan; this loan is known as a mezzanine loan or
second lien.
Hard money lenders structure loans based on a percentage of the quick-sale value
of the subject property. This is called the loan-to-value or LTV ratio and
typically hovers between 60-70% of the market value of the property. For the
purpose of determining an LTV, the word "value" is defined as "today's purchase
price." This is the amount a lender could reasonably expect to realize from the
sale of the property in the event that the loan defaults and the property must
be sold in a one- to four-month timeframe. This value differs from a market
value appraisal, which assumes an arms-length transaction in which neither buyer
nor seller is acting under duress.
Below is an example of how a commercial real estate purchase might be structured
by a hard money lender:
65% Hard money (Conforming loan)
20% Borrower equity (cash or additional collateralized real estate)
15% Seller carryback loan or other subordinated (mezzanine) loan
History
Hard Money is a term that is used almost exclusively in the United States and
Canada where these types of loans are most common. In commercial real estate,
hard money developed as an alternative "last resort" for property owners seeking
capital against the value of their holdings. The industry began in the late
1950s when the credit industry in the US underwent drastic changes (see FDIC:
Evaluating the Consumer Revolution).
The hard money industry suffered severe setbacks during the real estate crashes
of the early 1980s and early 1990s due to lenders overestimating and funding
properties at well over market value. Since that time, lower LTV rates have been
the norm for hard money lenders seeking to protect themselves against the
market's volatility. Today, high interest rates are the mark of hard money loans
as a way to protect the loans and lenders from the considerable risk that they
undertake.
Cross collateralizing a hard money loan
In some cases the low loan to values do not facilitate a loan sufficient to pay
the existing mortgage lender off in order for the hard money lender to be in
first lien position. Because securing the property is the basis of making a hard
money loan, the first lien position of the lender is usually always required. As
an alternative to a potential shortage of equity beneath the minimum lender Loan
To Value guidelines, many hard money lender programs will allow a "Cross Lien"
on another of the borrowers properties. The cross collateralization of more than
one property on a hard money loan transaction, is also referred to as a "blanket
mortgage". Not all homeowners have additional property to cross collateralize.
Cross collateralizing or blanket loans are more frequently used with investors
on Commercial Hard Money Loan programs.
Commercial hard money
Commercial hard money is similar to traditional hard money, but may sometimes be
more expensive as the risk is higher on investment property or non-owner
occupied properties. Commercial Hard Money Loans may not be subject to the same
consumer loan safeguards as a residential mortgage may be in the state the
mortgage is issued. Commercial hard money loans are often short term and
therefore interchangeably referred to as bridge loans or bridge financing.
Commercial hard money lender or bridge lender programs
Commercial hard money lender and bridge lender programs are similar to
traditional hard money in terms of loan to value requirements and interest
rates. A commercial hard money or bridge lender will usually be a strong
financial institution that has large deposit reserves and the ability to make a
discretionary decision on a non-conforming loan. These borrowers are usually not
conforming to the standard Fannie Mae, Freddie Mac or other residential
conforming credit guidelines. Since it is a commercial property, they usually do
not conform to a standard commercial loan guideline either. The property and or
borrowers may be in financial distress, or a commercial property may simply not
be complete during construction, have its building permits in place, or simply
be in good or marketable conditions for any number of reasons.
Some private investment groups or bridge capital groups will require joint
venture or sale-lease back requirements to the riskiest transactions that have a
high likelihood of default. Private Investment groups may temporarily offer
bridge or hard money, allowing the property owner to buy back the property
within only a certain time period. If the property is not bought back by
purchase or sold within the time period the commercial hard money lender may
keep the property at the agreed to price.
Traditional commercial hard money loan programs are very high risk and have a
higher than average default rate. If the property owner defaults on the
commercial hard money loan, they may lose the property to foreclosure. If they
have exhausted bankruptcy previously, they may not be able to gain assistance
through bankruptcy protection. The property owner may have to sell the property
in order to satisfy the lien from the commercial hard money lender, and to
protect the remaining equity on the property.
Legal and regulatory issues
From inception, the hard money field has always been formally unregulated by
state or federal laws, although some restrictions on interest rates (usury laws)
by state governments restrict the rates of hard money such that operations in
several states, including Tennessee and Arkansas are virtually untenable for
lending firms.
Commercial lending industry
Thanks to freedom from regulation, the commercial lending industry operates with
particular speed and responsiveness, making it an attractive option for those
seeking quick funding. However, this has also created a highly predatory lending
environment where many companies refer loans to one another (brokering),
increasing the price and loan points with each referral.
There is also great concern about the practices of some lending companies in the
industry who require upfront payments to investigate loans and refuse to lend on
virtually all properties while keeping this fee. Borrowers are advised not to
work with hard money lenders who require exorbitant upfront fees prior to
funding in order to reduce this risk. If you feel you have been the victim of
unfair practices, contact your state's attorney general office or the office of
the state in which the lender operates.
Hard money rate
Hard Money Mortgage loans are generally more expensive than traditional
sub-prime mortgages. However all mortgage loans are not necessarily considered
to be a high cost mortgage. Generally a hard money loan carries additional risk
that a borrower is aware of. Rather than selling the property a borrower will
opt to keep the loan and if a lender is willing to assume some of the risk by
offering a hard money loan.
Interest rate on hard money
The rate is not dependent on the Bank Rate. It is instead more dependent on the
real estate market and availability of hard money credit. As of 2007 and for the
past decade hard money has ranged from the mid 15%-25% range[citation needed].
When a borrower defaults they may be charged a higher "Default Rate". That rate
can be as high as allowed by law which may go up to or around 25%-29%.
Hard money points
Points on a hard money loan are traditionally 1-3 more than a traditional loan,
which would amount to 3-6 points on the average hard money loan. It is very
common for a commercial hard money loan to be upwards of four points and as high
as 10 points. The reason a borrower would pay that rate is to avoid imminent
foreclosure or a "quick sale" of the property. That could amount to as much as a
30% or more discount as is common on short sales. By taking a short term bridge
or hard money loan, the borrower often saves equity and extends his time to get
his affairs in order to better manage the property.
All hard money borrowers are advised to use a professional real estate attorney
to assure the property is not given away by way of a late payment or other
default without benefit of traditional procedures which would require a court
judgement.
Home Mortgage Loan Online
A mortgage loan is a loan secured by real property through the use of a mortgage
(a legal instrument). However, the word mortgage alone, in everyday usage, is
most often used to mean mortgage loan.
According to Anglo-American property law, a mortgage occurs when an owner
(usually of a fee simple interest in realty) pledges his interest as security or
collateral for a loan. Therefore, a mortgage is an encumbrance on property just
as an easement would be, but because most mortgages occur as a condition for new
loan money, the word mortgage has become the generic term for a loan secured by
such real property.
As with other types of loans, mortgages have an interest rate and are scheduled
to amortize over a set period of time; typically 30 years. All types of real
property can, and usually are, secured with a mortgage and bear an interest rate
that is supposed to reflect the lender's risk.
Mortgage lending is the primary mechanism used in many countries to finance
private ownership of residential property. For commercial mortgages see the
separate article. Although the terminology and precise forms will differ from
country to country, the basic components tend to be similar:
Property: the physical residence being financed. The exact form of ownership
will vary from country to country, and may restrict the types of lending that
are possible.
Mortgage: the security created on the property by the lender, which will usually
include certain restrictions on the use or disposal of the property (such as
paying any outstanding debt before selling the property).
Borrower: the person borrowing who either has or is creating an ownership
interest in the property.
Lender: any lender, but usually a bank or other financial institution.
Principal: the original size of the loan, which may or may not include certain
other costs; as any principal is repaid, the principal will go down in size.
Interest: a financial charge for use of the lender's money.
Foreclosure or repossession: the possibility that the lender has to foreclose,
repossess or seize the property under certain circumstances is essential to a
mortgage loan; without this aspect, the loan is arguably no different from any
other type of loan.
Many other specific characteristics are common to many markets, but the above
are the essential features. Governments usually regulate many aspects of
mortgage lending, either directly (through legal requirements, for example) or
indirectly (through regulation of the participants or the financial markets,
such as the banking industry), and often through state intervention (direct
lending by the government, by state-owned banks, or sponsorship of various
entities). Other aspects that define a specific mortgage market may be regional,
historical, or driven by specific characteristics of the legal or financial
system.
Mortgage loan basics
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Mortgage loans are generally structured as long-term loans, the periodic
payments for which are similar to an annuity and calculated according to the
time value of money formulae. The most basic arrangement would require a fixed
monthly payment over a period of ten to thirty years, depending on local
conditions. Over this period the principal component of the loan (the original
loan) would be slowly paid down through amortization. In practice, many variants
are possible and common worldwide and within each country.
Lenders provide funds against property to earn interest income, and generally
borrow these funds themselves (for example, by taking deposits or issuing
bonds). The price at which the lenders borrow money therefore affects the cost
of borrowing. Lenders may also, in many countries, sell the mortgage loan to
other parties who are interested in receiving the stream of cash payments from
the borrower, often in the form of a security (by means of a securitization). In
the United States, the largest firms securitizing loans are Fannie Mae and
Freddie Mac, which are government sponsored enterprises.
Mortgage lending will also take into account the (perceived) riskiness of the
mortgage loan, that is, the likelihood that the funds will be repaid (usually
considered a function of the creditworthiness of the borrower); that if they are
not repaid, the lender will be able to foreclose and recoup some or all of its
original capital; and the financial, interest rate risk and time delays that may
be involved in certain circumstances.
More recently, mortgage loan brokers have expanded their businesses to include a
web presence. There is now even a market for standard web templates which are
used by brokers who want to quickly develop an online component to their
business.
Mortgage loan types
There are many types of mortgages used worldwide, but several factors broadly
define the characteristics of the mortgage. All of these may be subject to local
regulation and legal requirements.
Interest: interest may be fixed for the life of the loan or variable, and change
at certain pre-defined periods; the interest rate can also, of course, be higher
or lower.
Term: mortgage loans generally have a maximum term, that is, the number of years
after which an amortizing loan will be repaid. Some mortgage loans may have no
amortization, or require full repayment of any remaining balance at a certain
date, or even negative amortization.
Payment amount and frequency: the amount paid per period and the frequency of
payments; in some cases, the amount paid per period may change or the borrower
may have the option to increase or decrease the amount paid.
Prepayment: some types of mortgages may limit or restrict prepayment of all or a
portion of the loan, or require payment of a penalty to the lender for
prepayment.
The two basic types of amortized loans are the fixed rate mortgage (FRM) and
adjustable rate mortgage (ARM) (also known as a floating rate or variable rate
mortgage). In many countries, floating rate mortgages are the norm and will
simply be referred to as mortgages; in the United States, fixed rate mortgages
are typically considered "standard." Combinations of fixed and floating rate are
also common, whereby a mortgage loan will have a fixed rate for some period, and
vary after the end of that period.
Historical U.S. Prime RatesIn a fixed rate mortgage, the interest rate, and
hence periodic payment, remains fixed for the life (or term) of the loan. In the
U.S., the term is usually up to 30 years (15 and 30 being the most common),
although longer terms may be offered in certain circumstances. For a fixed rate
mortgage, payments for principal and interest should not change over the life of
the loan, although ancillary costs (such as property taxes and insurance) can
and do change.
In an adjustable rate mortgage, the interest rate is generally fixed for a
period of time, after which it will periodically (for example, annually or
monthly) adjust up or down to some market index. Common indices in the U.S.
include the Prime Rate, the London Interbank Offered Rate (LIBOR), and the
Treasury Index ("T-Bill"); other indices are in use but are less popular.
Adjustable rates transfer part of the interest rate risk from the lender to the
borrower, and thus are widely used where fixed rate funding is difficult to
obtain or prohibitively expensive. Since the risk is transferred to the
borrower, the initial interest rate may be from 0.5% to 2% lower than the
average 30-year fixed rate; the size of the price differential will be related
to debt market conditions, including the yield curve.
Additionally, lenders in many markets rely on credit reports and credit scores
derived from them. The higher the score, the more creditworthy the borrower is
assumed to be. Favorable interest rates are offered to buyers with high scores.
Lower scores indicate higher risk for the lender, and higher rates will
generally be charged to reflect the (expected) higher default rates.
A partial amortization or balloon loan is one where the amount of monthly
payments due are calculated (amortized) over a certain term, but the outstanding
principal balance is due at some point short of that term. This payment is
sometimes referred to as a "balloon payment" or bullet payment. The interest
rate for a balloon loan can be either fixed or floating. The most common way of
describing a balloon loan uses the terminology X due in Y, where X is the number
of years over which the loan is amortized, and Y is the year in which the
principal balance is due.
Other loan types:
Assumed mortgage
Balloon mortgage
Blanket loan
Bridge loan
Budget loan
Buydown mortgage
Commercial loan
Equity loan
Foreign National mortgage
Graduated payment mortgage loan
Hard money loan
Jumbo mortgages
Package loan
Participation mortgage
Reverse mortgage
Repayment mortgage
Seasoned mortgage
Term loan or Interest-only loan
Wraparound mortgage
Negative amortization loan
Non-conforming mortgage
Loan to value and downpayments
Upon making a mortgage loan for purchase of a property, lenders usually require
that the borrower make a downpayment, that is, contribute a portion of the cost
of the property. This downpayment may be expressed as a portion of the value of
the property (see below for a definition of this term). The loan to value ratio
(or LTV) is the size of the loan against the value of the property. Therefore, a
mortgage loan where the purchaser has made a downpayment of 20% has a loan to
value ratio of 80%. For loans made against properties that the borrower already
owns, the loan to value ratio will be imputed against the estimated value of the
property.
The loan to value ratio is considered an important indicator of the riskiness of
a mortgage loan: the higher the LTV, the higher the risk that the value of the
property (in case of foreclosure) will be insufficient to cover the remaining
principal of the loan.
Value: appraised, estimated, and actual
Since the value of the property is an important factor in understanding the risk
of the loan, determining the value is a key factor in mortgage lending. The
value may be determined in various ways, but the most common are:
Actual or transaction value: this is usually taken to be the purchase price of
the property. If the property is not being purchased at the time of borrowing,
this information may not be available.
Appraised or surveyed value: in most jurisdictions, some form of appraisal of
the value by a licensed professional is common. There is often a requirement for
the lender to obtain an official appraisal.
Estimated value: lenders or other parties may use their own internal estimates,
particularly in jurisdictions where no official appraisal procedure exists, but
also in some other circumstances.
Equity or homeowner's equity
The concept of equity in a property refers to the value of the property minus
the outstanding debt, subject to the definition of the value of the property.
Therefore, a borrower who owns a property whose estimated value is $400,000 but
with outstanding mortgage loans of $300,000 is said to have homeowner's equity
of $100,000.
Payment and debt ratios
In most countries, a number of more or less standard measures of
creditworthiness may be used. Common measures include payment to income
(mortgage payments as a percentage of gross or net income); debt to income (all
debt payments, including mortgage payments, as a percentage of income); and
various net worth measures. In many countries, credit scores are used in lieu of
or to supplement these measures. There will also be requirements for
documentation of the creditworthiness, such as income tax returns, pay stubs,
etc; the specifics will vary from location to location. Many countries have
lower requirements for certain borrowers, or "no-doc" / "low-doc" lending
standards that may be acceptable in certain circumstances.
Standard or conforming mortgages
Many countries have a notion of standard or conforming mortgages that define a
perceived acceptable level of risk, which may be formal or informal, and may be
reinforced by laws, government intervention, or market practice. For example, a
standard mortgage may be considered to be one with no more than 70-80% LTV and
no more than one-third of gross income going to mortgage debt.
A standard or conforming mortgage is a key concept as it often defines whether
or not the mortgage can be easily sold or securitized, or, if non-standard, may
affect the price at which it may be sold. In the United States, a conforming
mortgage is one which meets the established rules and procedures of the two
major government-sponsored entities in the housing finance market (including
some legal requirements). In contrast, lenders who decide to make nonconforming
loans are exercising a higher risk tolerance and do so knowing that they face
more challenge in reselling the loan. Many countries have similar concepts or
agencies that define what are "standard" mortgages. Regulated lenders (such as
banks) may be subject to limits or higher risk weightings for non-standard
mortgages. For example, banks in Canada face restrictions on lending more than
75% of the property value; beyond this level, mortgage insurance is generally
required (as of April 2007, there is a proposal to raise this limit to 80%).
Repaying the capital
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There are various ways to repay a mortgage loan; repayment depends on locality,
tax laws and prevailing culture.
Capital and interest
The most common way to repay a loan is to make regular payments of the capital
(also called principal) and interest over a set term. This is commonly referred
to as (self) amortization in the U.S. and as a repayment mortgage in the UK. A
mortgage is a form of annuity (from the perspective of the lender), and the
calculation of the periodic payments is based on the time value of money
formulas. Certain details may be specific to different locations: interest may
be calculated on the basis of a 360-day year, for example; interest may be
compounded daily, yearly, or semi-annually; prepayment penalties may apply; and
other factors. There may be legal restrictions on certain matters, and consumer
protection laws may specify or prohibit certain practices.
Depending on the size of the loan and the prevailing practice in the country the
term may be short (10 years) or long (50 years plus). In the UK and U.S., 25 to
30 years is the usual maximum term (although shorter periods, such as 15-year
mortgage loans, are common). Mortgage payments, which are typically made
monthly, contain a capital (repayment of the principal) and an interest element.
The amount of capital included in each payment varies throughout the term of the
mortgage. In the early years the repayments are largely interest and a small
part capital. Towards the end of the mortgage the payments are mostly capital
and a smaller portion interest. In this way the payment amount determined at
outset is calculated to ensure the loan is repaid at a specified date in the
future. This gives borrowers assurance that by maintaining repayment the loan
will be cleared at a specified date, if the interest rate does not change.
Interest only
The main alternative to capital and interest mortgage is an interest only
mortgage, where the capital is not repaid throughout the term. This type of
mortgage is common in the UK, especially when associated with a regular
investment plan. With this arrangement regular contributions are made to a
separate investment plan designed to build up a lump sum to repay the mortgage
at maturity. This type of arrangement is called an investment-backed mortgage or
is often related to the type of plan used: endowment mortgage if an endowment
policy is used, similarly a Personal Equity Plan (PEP) mortgage, Individual
Savings Account (ISA) mortgage or pension mortgage. Historically,
investment-backed mortgages offered various tax advantages over repayment
mortgages, although this is no longer the case in the UK. Investment-backed
mortgages are seen as higher risk as they are dependent on the investment making
sufficient return to clear the debt.
It is not uncommon for interest only mortgages to be arranged without a
repayment vehicle, with the borrower gambling that the property market will rise
sufficiently for the loan to be repaid by trading down at retirement (or when
rent on the property and inflation combine to surpass the interest rate).
No capital or interest
For older borrowers (typically in retirement), it may be possible to arrange a
mortgage where neither the capital nor interest is repaid. The interest is
rolled up with the capital, increasing the debt each year.
These arrangements are variously called reverse mortgages, lifetime mortgages or
equity release mortgages, depending on the country. The loans are typically not
repaid until the borrowers die, hence the age restriction. For further details,
see equity release.
Interest and partial capital
In the U.S. a partial amortization or balloon loan is one where the amount of
monthly payments due are calculated (amortized) over a certain term, but the
outstanding capital balance is due at some point short of that term. In the UK,
a part repayment mortgage is quite common, especially where the original
mortgage was investment-backed and on moving house further borrowing is arranged
on a capital and interest (repayment) basis.
Foreclosure and non-recourse lending
In most jurisdictions, a lender may foreclose the mortgaged property if certain
conditions - principally, non-payment of the mortgage loan - obtain. Subject to
local legal requirements, the property may then be sold. Any amounts received
from the sale (net of costs) are applied to the original debt. In some
jurisdictions, mortgage loans are non-recourse loans: if the funds recouped from
sale of the mortgaged property are insufficient to cover the outstanding debt,
the lender may not have recourse to the borrower after foreclosure. In other
jurisdictions, the borrower remains responsible for any remaining debt. In
virtually all jurisdictions, specific procedures for foreclosure and sale of the
mortgaged property apply, and may be tightly regulated by the relevant
government; in some jurisdictions, foreclosure and sale can occur quite rapidly,
while in others, foreclosure may take many months or even years. In many
countries, the ability of lenders to foreclose is extremely limited, and
mortgage market development has been notably slower.
Mortgage lending: United States
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United States mortgage process
In the U.S., the process by which a mortgage is secured by a borrower is called
origination. This involves the borrower submitting an application and
documentation related to his/her financial history and/or credit history to the
underwriter. Many banks now offer "no-doc" or "low-doc" loans in which the
borrower is required to submit only minimal financial information. These loans
carry a slightly higher interest rate (perhaps 0.25% to 0.50% higher) and are
available only to borrowers with excellent credit.Sometimes, a third party is
involved, such as a mortgage broker. This entity takes the borrower's
information and reviews a number of lenders, selecting the ones that will best
meet the needs of the consumer.
Loans are often sold on the open market to larger investors by the originating
mortgage company. Many of the guidelines that they follow are suited to satisfy
investors. Some companies, called correspondent lenders, sell all or most of
their closed loans to these investors, accepting some risks for issuing them.
They often offer niche loans at higher prices that the investor does not wish to
originate.
If the underwriter is not satisfied with the documentation provided by the
borrower, additional documentation and conditions may be imposed, called
stipulations. The meeting of such conditions can be a daunting experience for
the consumer, but it is crucial for the lending institution to ensure the
information being submitted is accurate and meets specific guidelines. This is
done to give the lender a reasonable guarantee that the borrower can and will
repay the loan. If a third party is involved in the loan, it will help the
borrower to clear such conditions.
The following documents are typically required for traditional underwriter
review. Over the past several years, use of "automated underwriting" statistical
models has reduced the amount of documentation required from many borrowers.
Such automated underwriting engines include Freddie Mac's "Loan Prospector" and
Fannie Mae's "Desktop Underwriter". For borrowers who have excellent credit and
very acceptable debt positions, there may be virtually no documentation of
income or assets required at all. Many of these documents are also not required
for no-doc and low-doc loans.
Credit Report
1003 — Uniform Residential Loan Application
1004 — Uniform Residential Appraisal Report
1005 — Verification Of Employment (VOE)
1006 — Verification Of Deposit (VOD)
1007 — Single Family Comparable Rent Schedule
1008 — Transmittal Summary
Copy of deed of current home
Federal income tax records for last two years
Verification of Mortgage (VOM) or Verification of Payment (VOP)
Borrower's Authorization
Purchase Sales Agreement
1084A and 1084B (Self-Employed Income Analysis) and 1088 (Comparative Income
Analysis) - used if borrower is self-employed
Predatory mortgage lending
There is concern in the U.S. that consumers are often victims of predatory
mortgage lending [1]. The main concern is that mortgage brokers and lenders,
operating legally, are finding loopholes in the law to obtain additional profit.
The typical scenario is that terms of the loan are beyond the means of the
borrower. The borrower makes a number of interest and principal payments, and
then defaults. The lender then takes the property and recovers the amount of the
loan, and also keeps the interest and principal payments, as well as loan
origination fees.
Option ARM
An option ARM provides the option to pay as little as the equivalent of an
amortized payment based on a 1% interest rate,(please note this is not the
actual interest rate). As a result, the difference between the monthly payment
and the interest on the loan is added to the loan principal; the loan at this
point has negative amortization. In this respect, an option ARM provides a form
of equity withdrawal (as in a cash-out refinancing) but over a period of time.
The option ARM gives a number of payment choices each month (for example, the
equivalent of an amortized payment were the interest rate 1%, interest only
based on actual interest rate, actual 30 year amortized payment, actual 15 year
amortized payment). The interest rate may adjust every month in accordance with
the index to which the loan is tied and the terms of the specific loan. These
loans may be useful for people who have a lot of equity in their home and want
to lower monthly costs; for investors, allowing them the flexibility to choose
which payment to make every month; or for those with irregular incomes (such as
those working on commission or for whom bonuses comprise a large portion of
income).
One of the important features of this type of loan is that the minimum payments
are often fixed for each year for an initial term of up to 5 years. The minimum
payment may rise each year a little (payment size increases of 7.5% are common)
but remain the same for another year. For example, a minimum payment for year 1
may be $1,000 per month each month all year long. In year 2 the minimum payment
for each month is $1,075 each month. This is a gradual increase in the minimum
payment. The interest rate may fluctuate each month, which means that the extent
of any negative amortization cannot be predicted beyond worst-case scenario as
dictated by the terms of the loan.
Option ARM mortgages have been criticized on the basis that some borrowers are
not aware of the implications of negative amortization; that eventually option
ARMs reset to higher payment levels (an event called "recast" to amortize the
loan), and borrowers may not be capable of making the higher monthly payments;
and that option ARMs have been used to qualify mortgages for individuals whose
incomes cannot support payments higher than the minimum level.
Costs
Lenders may charge various fees when giving a mortgage to a mortgagor. These
include entry fees, exit fees, administration fees and lenders mortgage
insurance. There are also settlement fees (closing costs) the settlement company
will charge. In addition, if a third party handles the loan, it may charge other
fees as well.
The United States mortgage finance industry
Mortgage lending is a major category of the business of finance in the United
States. Mortgages are commercial paper and can be conveyed and assigned freely
to other holders. In the U.S., the Federal government created several programs,
or government sponsored entities, to foster mortgage lending, construction and
encourage home ownership. These programs include the Government National
Mortgage Association (known as Ginnie Mae), the Federal National Mortgage
Association (known as Fannie Mae) and the Federal Home Loan Mortgage Corporation
(known as Freddie Mac). These programs work by buying a large number of
mortgages from banks and issuing (at a slightly lower interest rate)
"mortgage-backed bonds" to investors, which are known as Mortgage Backed
Securities (MBS).
This allows the banks to quickly relend the money to other borrowers (including
in the form of mortgages) and thereby to create more mortgages than the banks
could with the amount they have on deposit. This in turn allows the public to
use these mortgages to purchase homes, something the government wishes to
encourage. The investors, meanwhile, gain low-risk income at a higher interest
rate (essentially the mortgage rate, minus the cuts of the bank and GSE) than
they could gain from most other bonds.
Securitization is a momentous change in the way that mortgage bond markets
function, and has grown rapidly in the last 10 years as a result of the wider
dissemination of technology in the mortgage lending world. For borrowers with
superior credit, government loans and ideal profiles, this securitization keeps
rates almost artificially low, since the pools of funds used to create new loans
can be refreshed more quickly than in years past, allowing for more rapid
outflow of capital from investors to borrowers without as many personal business
ties as the past.
Mortgage in the UK
Main article: UK mortgage terminology
Mortgage types
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The UK mortgage market is one of the most innovative and competitive in the
world. Unlike other countries there is no intervention in the market by the
state or state funded entities and virtually all borrowing is funded by either
mutual organisations (building societies and credit unions) or proprietary
lenders (typically banks). Since 1982, when the market was substantially
deregulated, there has been substantial innovation and diversification of
strategies employed by lenders to attract borrowers. This has led to a wide
range of mortgage types.
As lenders derive their funds either from the money markets or from deposits,
most mortgages revert to a variable rate, either the lender's standard variable
rate or a tracker rate, which will tend to be linked to the underlying Bank of
England (BoE) repo rate (or sometimes LIBOR). Initially they will tend to offer
an incentive deal to attract new borrowers. This may be:
A fixed rate; where the interest rate remains constant for a set period;
typically for 2, 3, 4, 5 or 10 years. Longer term fixed rates (over 5 years)
whilst available, tend to be more expensive and/or have more onerous early
repayment charges and are therefore less popular than shorter term fixed rates.
A capped rate; where similar to a fixed rate, the interest rate cannot rise
above the cap but can vary beneath the cap. Sometimes there is a collar
associated with this type of rate which imposes a minimum rate. Capped rate are
often offered over periods similar to fixed rates, e.g. 2, 3, 4 or 5 years.
A discount rate; where there is set margin reduction in the standard variable
rate (e.g. a 2% discount) for a set period; typically 1 to 5 years. Sometimes
the discount is expressed as a margin over the base rate (e.g. BoE base rate
plus 0.5% for 2 years) and sometimes the rate is stepped (e.g. 3% in year 1, 2%
in year 2, 1% in year three).
A cashback mortgage; where a lump sum is provided (typically) as a percentage of
the advance e.g. 5% of the loan.
To make matters more confusing these rates are often combined: For example, 4.5%
2 year fixed then a 3 year tracker at BoE rate plus 0.89%.
With each incentive the lender may be offering a rate at less than the market
cost of the borrowing. Therefore, they typically impose a penalty if the
borrower repays the loan within the incentive period or a longer period
(referred to as an extended tie-in). These penalties used to be called a
redemption penalty or tie-in, however since the onset of Financial Services
Authority regulation they are referred to as an early repayment charge.
Self Cert Mortgage
Mortgage lenders usually use salaries declared on wage slips to work out a
borrower's annual income and will usually lend up to a fixed multiple of the
borrower's annual income. Self Certification Mortgages, informally known as
"self cert" mortgages, are available to employed and self employed people who
have a deposit to buy a house but lack the sufficient documentation to prove
their income.
This type of mortgage can be beneficial to people whose income comes from
multiple sources, whose salary consists largely or exclusively of commissions or
bonuses, or whose accounts may not show a true reflection of their earnings.
Self cert mortgages have two disadvantages: the interest rates charged are
usually higher than for normal mortgages and the loan to value ratio is usually
lower.
100% Mortgages
Normally when a bank lends a customer money they want to protect their money as
much as possible; they do this by asking the borrower to fund a certain
percentage of the property purchase in the form of a deposit.
100% mortgages are mortgages that require no deposit (100% loan to value). These
are sometimes offered to first time buyers, but almost always carry a higher
interest rate on the loan.
Together/Plus Mortgages
A development of the theme of 100% mortgages is represented by Together/Plus
type mortgages, which have been launched by a number of lenders in recent years.
Together/Plus Mortgages represent loans of 100% or more of the property value -
typically up to a maximum of 125%. Such loans are normally (but not universally)
structured as a package of a 95% mortgage and an unsecured loan of up to 30% of
the property value. This structure is mandated by lenders' capital requirements
which require additional capital for loans of 100% or more of the property
value.
UK mortgage process
UK lenders usually charge a valuation fee, which pays for a chartered surveyor
to visit the property and ensure it is worth enough to cover the mortgage
amount. This is not a full survey so it may not identify all the defects that a
house buyer needs to know about. Also, it does not usually form a contract
between the surveyor and the buyer, so the buyer has no right to sue if the
survey fails to detect a major problem. For an extra fee, the surveyor can
usually carry out a building survey or a (cheaper) "homebuyers survey" at the
same time. [1]
Mortgage insurance
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Mortgage insurance is an insurance policy designed to protect the mortgagee
(lender) from any default by the mortgagor (borrower). It is used commonly in
loans with a loan-to-value ratio over 80%, and employed in the event of
foreclosure and repossession.
This policy is typically paid for by the borrower as a component to final
nominal (note) rate, or in one lump sum up front, or as a separate and itemized
component of monthly mortgage payment. In the last case, mortgage insurance can
be dropped when the lender informs the borrower, or its subsequent assigns, that
the property has appreciated, the loan has been paid down, or any combination of
both to relegate the loan-to-value under 80%.
In the event of repossession, banks, investors, etc. must resort to selling the
property to recoup their original investment (the money lent), and are able to
dispose of hard assets (such as real estate) more quickly by reductions in
price. Therefore, the mortgage insurance acts as a hedge should the repossessing
authority recover less than full and fair market value for any hard asset.
Islamic mortgages
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The Sharia law of Islam prohibits the payment or receipt of interest, which
means that practising Muslims cannot use conventional mortgages. However, real
estate is far too expensive for most people to buy outright using cash: Islamic
mortgages solve this problem by having the property change hands twice. In one
variation, the bank will buy the house outright and then act as a landlord. The
homebuyer, in addition to paying rent, will pay a contribution towards the
purchase of the property. When the last payment is made, the property changes
hands.
Typically, this may lead to a higher final price for the buyers. This is because
in some countries (such as the United Kingdom and India) there is a Stamp Duty
which is a tax charged by the government on a change of ownership. Because
ownership changes twice in an Islamic mortgage, a stamp tax may be charged
twice. Many other jurisdictions have similar transaction taxes on change of
ownership which may be levied.
An alternative scheme involves the bank reselling the property according to an
installment plan, at a price higher than the original price.
All of these methods are still compensating the lender as if they were charging
interest, but the loans are structured in a way that in name they are not, but
they share the financial risks involved in the transaction with the homebuyer.
See Islamic finance.
Other Terminologies
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Like any other legal system, the mortgage business sometimes uses confusing
jargon. Below are some terms explained in brief. If a term is not explained here
it may be related to the legal mortgage rather than to the loan.
Advance This is the money you have borrowed plus all the additional fees.
Base Rate In UK, this is the base interest rate set by the Bank of England. In
the United States, this value is set by the Federal Reserve and is known as the
Discount Rate.
Bridging Loan This is a temporary loan that enables the borrower to purchase a
new property before the borrower is able to sell another current property.
Disbursements These are all the fees of the solicitors and governments, such as
stamp duty, land registry, search fees, etc.
Early Redemption Charge / Pre-Payment Penalty / Redemption Penalty This is the
amount of money due if the mortgage is paid in full before the time finished.
Equity This is the market value of the property minus all loans outstanding on
it.
First time buyer This is the term given to a person buying property for the
first time.
Loan Origination Fee A charge levied by a creditor for underwriting a loan. The
fee often is expressed in points. A point is 1 percent of the loan amount.
Sealing Fee This is a fee made when the lender releases the legal charge over
the property.
Subject To Contract This is an agreement between seller and buyer before the
actual contract is made.
Disclosure
The United States Home Mortgage Disclosure Act (or HMDA, pronounced HUM-duh) was
passed in 1975. It requires financial institutions to maintain and annually
disclose data about home purchases, home purchase pre-approvals, home
improvement, and refinance applications involving 1 to 4 unit and multifamily
dwellings. It also requires branches and loan centers to display a HMDA poster.
HMDA was designed by the Federal Reserve Board in order to:
Details of the Law
A US company is covered by HMDA if
It has at least $36 million in assets (as of December 31, 2007; the limit varies
each year)
It has made at least one home mortgage loan in the preceding year
The company itself is Federally insured or regulated or at least one of the
loans it made were intended to be sold to Fannie Mae or Freddie Mac
Approximately 8,400 companies are covered by HMDA.
Companies covered under HMDA are required to keep a Loan Application Register (LAR).
Each time someone applies for a home mortgage at an institution covered by HMDA,
the company is required to make a corresponding entry into the LAR, noting the
following information.
The loan amount
The purpose of the loan (home purchase, home improvement, refinancing)
The type of property involved (single-family, multifamily)
The loan type (conventional loan, FHA loan, VA loan or a loan guaranteed by the
Farmers Home Administration)
The location (state, county, MSA and census tract) of the property
The race of the borrower(s)
The ethnicity (Hispanic or non-Hispanic) of the borrower(s)
The gender of the borrower(s)
Whether or not the loan was granted
If the loan was denied, the reason why it was denied
If the loan was denied, whether the interest rate charged was over a certain
threshold
If the loan was subsequently sold in the secondary market, the type of entity
that purchased it
Every March reporting institutions are required to submit their LARs to the
Federal Financial Institutions Examination Council (FFIEC), an interagency body
empowered to administer HMDA. Nowadays reporting takes place electronically.
FFIEC screens the data for errors and the releases it to the public
electronically (on CD-ROM and over the internet). Reporting institutions are
also required to disclose their individual LARs to members of the public upon
request.
Ways to Use HMDA to Pinpoint Discrimination
HMDA data can be used to identify probable housing discrimination in various
ways:
If an institution turns down a disproportionate percentage of applications by
certain races (e.g. African Americans), ethnicities (e.g. Hispanics) or genders
(typically women) then there is reason to suspect that the institution may be
discriminating against these classes of borrowers by unfairly denying them
credit. Such discrimination is illegal in the United States.
If an institution has a disproportionately low percentage of applications by
certain races (e.g. African Americans), ethnicities (e.g. Hispanics) or genders
(typically women) then there is reason to suspect that the institution may be
discriminating against these classes of borrowers by unfairly discouraging them
from applying for mortgage loans. Such discrimination is illegal in the United
States.
If an institution has a disproportionately low percentage of applications from
certain areas, compared to areas immediately surrounding the area in question,
then there is reason to suspect that the institution is engaging in redlining.
If there is a disproportionate prevalence of high-interest loans to certain
classes of borrowers (e.g., Hispanics or women) then there is a reason to
suspect that the institution is engaging in price discrimination.
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