Mortgages and Real Estate : Priority Senior Instruments (First Mortgages)

To hold the first mortgage on real estate means that the lender`s rights are superior to the rights of subsequent lenders. This means less risk to the lender, which normally results in a lower interest rate charged to the borrower than charged on second or junior mortgages. Certain lenders only make first mortgages due to regulatory requirements; others limit mortgages to these senior instruments due to company policy.

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Conventional Mortgages

The majority of permanent residential financing provided in this country is through the fully amortized conventional mortgage. The term “conventional” refers to a mortgage that is not FHA insured or VA guaranteed. Since there is not third party to insure or guarantee the mortgage, the lender assumes full risk of default by the borrower. A lender`s decision to make a conventional loan is usually dependent upon: (1) the value of the property being used to secure the debt and (2) the credit and income position of the borrower. As more and more conventional loans have been made, the loan to value ratio (relationship between amount borrowed and the appraised value of the property) has continued to increase, even though most lenders still limit the amount they will lend to no more than 80% of value unless private mortgage insurance is carried.

This down payment requirement is higher than with either FHA or VA loans. As the market price of residential real estate has continued to increase, more cash down payment has been required of the borrower, and thus many people have been eliminated from financing with a conventional mortgage. With both insured and guaranteed mortgages, people have been able to purchase real estate with a smaller cash down payment.
Federal Housing Administration Insured Mortgages (FHA)

In 1934, Congress passed the National Housing Act, thus establishing the Federal Housing Administration (FHA) which immediately resulted in more construction jobs for the unemployed. This in turn helped to stimulate the depressed economy. In order to provide the means by which these new homes could be purchased, FHA (www.fha-home-loans.com/) established an insurance program to safeguard the lender against the risk of nonpayment by people purchasing these homes. The result was that the majority of homes financed were FHA insured. Even though the percentage of homes insured under FHA coverage has continued to decrease, the standards and requirements under FHA programs have been credited with influencing lending policies and techniques in financing residential real estate.

Under an FHA insured mortgage, both the property and the borrower must meet certain minimum standards. The borrower is charged an insurance fee of one half percent on the unpaid balance and can, under certain conditions, receive up to 97% financing on the appraised value of the property.

If a purchaser using FHA financing is paying more than the appraised value, the difference between the appraised value and the sales price must come from the purchaser`s assets. Borrowers are not permitted to obtain second mortgages to use as down payments. Also, FHA sets limits as to the maximum loan origination fee charged by the lender. The subject property must be appraised prior to the loan being made; this fee is normally absorbed by the mortgagor. FHA insures these loans for up to 30 years. Thus, the low closing costs, the relatively low down payment and the long amortization period permitted under FHA have all aided in providing residential financing for millions of people who otherwise would not have been able to purchase a home. On a conventional mortgage, the interest rate is determined by the lender rather than by the Secretary of Housing and Urban Development.

This rate is periodically raised or lowered to reflect changes in the cost of money, although historically, interest rates on FHA mortgages have been slightly below conventional mortgage interest rates. In addition, borrowers financing with FHA coverage may be charged discount points since points can be paid by either the buyer or the seller. In recent years, FHA has expanded its operation; currently, the agency administers a number of programs dealing with housing. The basic home mortgage program is normally referred to as 203(b), and the program which provides insured mortgages for low or moderate income families is referred to as 221 (d)(2).

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Veterans Administration Loan Guaranty Program (VA)

Included in the Servicemen`s Readjustment Act of 1944 were provisions covering the compensation to lenders for losses they might sustain in providing financing to approved veterans. The maximum guaranteed amount, which has periodically been increased, is set by the VA (www.va.gov/ and www.homeloans.va.gov/faqelig.htm) as is the maximum interest rate charged by lenders. There are no provisions on the upper limits of the loan to value ratio, which means that it is quite common for an approved veteran to receive 100% VA financing. It should be noted that some lenders set limits on how much they will finance using VA financing. VA guarantees loans up to 30 years.

To qualify for VA financing the veteran applies for a certificate of eligibility. The property as well as the borrower must qualify. If the property is approved a certificate of reasonable value is issued. As is true with FHA, junior financing is essentially prohibited under VA. (Junior financing is rare and its terms keep it rare.) Coverage also extends to the financing of mobile homes, condominiums and nonreal estate purchases such as farm equipment and business loans. A VA loan is assumable; however, unless released by the lender, the veteran who borrowed the funds initially remains liable to the lender. Lenders cannot insert prepayment penalties under either VA or FHA loans. A mortgage without a prepayment penalty is commonly referred to as an open mortgage while one that cannot be prepaid is a closed mortgage. VA limits the points charged to the buyer to one point. Any other points must be paid by the seller.
California Farm and Home Purchase Program (CAL VET)

The Cal Vet (www.cdva.ca.gov/calvet/) began in 1921 as a program to assist California veterans in acquiring suitable farm or home property at low financing cost. It is a complete financing program within the Cal Vet office. The funds for financing come from the authorized sale of state general obligation bonds approved by the voters, and most recently from the sale of revenue bonds authorized by the legislature. The department purchases the property from the seller, and then sells to the qualified veteran on a land contract. The veteran holds equitable title, while the department holds legal title.

To be eligible, veterans must use their benefits within 30 years of their date of release from active military duty. No time limit is placed on those who were wounded, disabled, or prisoners of war. Nearly any veteran wanting to buy a home in California is eligible. They currently have funds for all qualified wartime era veterans, regardless of when they served in the military. They also have funds available for peacetime veterans who meet the criteria for Revenue Bond funds (first-time homebuyers or purchasers in targeted areas who meet income and purchase price limitations). There are no residency restrictions. Veterans are eligible regardless of where they entered service. Only one loan may be active at any time; however, a second loan is possible if the veteran served during multiple war periods.

The loan includes single family homes, condominiums, town houses, and mobile home on land owned by the borrower.

Insured Conventional Loan

An insured conventional loan is one which is insured by a private (nongovernmental) insurance company. The establishment of FHA insured loans and VA guaranteed loans resulted in higher loan to value ratios and longer amortization periods than lenders were willing to offer under conventional financing. As the costs of housing continued to increase year after year, some means of providing protection against loss of high loan to value conventional mortgages was needed. Thus, in 1957, the Mortgage Guaranty Insurance Corporation (MGIC) or “Magic” as it is normally referred to, established a private mortgage insurance program (PMI) for approved lenders.

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MGIC offered the lender quicker service and less red tape than FHA. Today private mortgage insurance companies insure more loans than both FHA and VA. Unlike FHA, which insures the whole loan, PMI insures only the top 20 or 25% of the loan, and the insurer normally relies on the lender to appraise the property. While the majority of PMI loans are for 90% loan to value, coverage does extend to a maximum of 95%. On a 90% loan, the borrower is normally charged one half of 1% at closing and one fourth of 1% of the outstanding balance each year thereafter. With a 95% loan, the rate is normally 1% of the loan at closing plus 1/4% of the outstanding balance each year the insurance is carried. Since only the top portion of the loan is covered, once the loan to value drops below a certain percentage, the lender may terminate the coverage, and thus, the insurance premium is no longer charged to the customer. In case of default, the insurance company can either pay off the loan or let the lender foreclose and pay the loss up to the amount of the insurance coverage.

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