Mortgage Lending Basics

Welcome to PMI s On Demand Training Bootcamp Mortgage Lending Basics PRESENTED BY PMI MORTGAGE INSURANCE CO.

Introduction to Mortgage Lending Course Overview Mortgage Lending Basics Origination Process Overview of the Secondary Market 1

Obtain Your Certificate of Completion Fill in the date Enter Your Name Here Webinar Course Name Populates Here Fill in the date 2

Mortgage Lending - Agenda Overview Types of Lenders Types of Borrowers Types of Mortgages 3

Mortgage Lending - Overview Mortgage lending is more than dollars and interest rates. It s about making people s dreams of homeownership come true. For most people, buying a home is the biggest purchase they ll ever make and their largest investment. The federal government has made homeownership a priority, and since the 1930s has passed many laws encouraging it. Let s take a quick look at the evolution of the mortgagelending industry and the role the government plays. In the 1920s, America was primarily a nation of renters. Lending was localized, unregulated, and restrictive. And the Great Depression of 1929 made finding and paying back a mortgage even more difficult. 4

Mortgage Lending - Overview To address the twin problems of too little money being lent and too little money being repaid, the Hoover administration created the Federal Home Loan Bank Board (FHLBB) in 1932. The FHLBB became a stable source of low-cost funds to mortgage finance companies, which pledged their existing housing portfolios as collateral. Another government agency created around this time was the Home Owner s Loan Corporation (HOLC), which operated from 1933 to 1936. The HOLC refinanced homes to prevent foreclosure and bailed out troubled mortgage-holding banks. In 1934, the Federal Housing Administration (FHA) was created as part of Roosevelt s New Deal. The FHA provided 30-year loans with loan-to-value (LTV) ratios of up to 90%. Today the FHA is the largest insurer of mortgages in the world, having insured over 34 million properties since its inception. 5

Mortgage Lending - Overview In 1938, the government created the Federal National Mortgage Association, a government-sponsored enterprise (GSE) commonly known as Fannie Mae because of its initials. Fannie Mae was formed to purchase FHA loans, pool them, and sell them to investors. This replenishes the supply of money the FHA has to lend to new borrowers. The government s involvement in mortgage lending continued. In 1944, the G.I. Bill authorized the Veteran s Administration to provide veterans with no-down-payment mortgage financing (100% LTV ratio). In 1968, the Government National Mortgage Association, nicknamed Ginnie Mae, was spun off from Fannie Mae. Ginnie Mae, another GSE, guarantees loans made to low- and middleincome homebuyers. Ginnie Mae is owned by the government while Fannie Mae became a publicly-traded company. Did You Know? Fannie Mae creates a secondary market for the FHA. The secondary mortgage market refers to the buying and selling of loans or groups of loans by investors. We talk more about secondary markets in the Overview of the Secondary Markets module but for now, if you think of mortgage lenders as retail stores where borrowers go to get mortgages, the secondary mortgage market is the supplier to those stores. SOURCE: http://www.hud.gov/offices/hsg/fhahistory.cfm, 4/13/09 6

Mortgage Lending - Overview In 1957, Max Karl founded the first modern private mortgage insurance ( MI ) company. Mortgage lenders and homebuilders were looking for alternatives to FHA-insured loans, given the agency red tape and imposed ceilings on mortgage interest rates that made those mortgages less attractive than conventional mortgages. Conventional mortgages, however, required large down payments, making it difficult for people of moderate income to buy homes. Mr. Karl saw the opportunity to form a company that would insure low down payment mortgages against foreclosure at half the cost of FHA insurance. He could also approve the insurance within a day or two, compared to the 4 to 8 weeks FHA approvals required. Today, MI insurers work with both the GSEs and private lenders. MI is usually required on conventional loans with down payments of less than 20%, and occasionally on loans that do not meet standard loan underwriting criteria. The cost of this coverage is generally paid by the borrower along with the monthly mortgage payment. Did You Know? In 2008, PMI helped approximately 18,000 borrowers retain their homes in lieu of foreclosure. 7

Mortgage Lending - Overview In 1970, the government created another GSE called the Federal Home Mortgage Corporation, nicknamed Freddie Mac. Initially Freddie Mac bought mortgage loans from savings and loans. Today it competes with Fannie Mae in the secondary market. These federal programs made home loans more accessible, but not for everyone. Discrimination against women and minorities among lenders was still common in the early 1960s. To fight this, Congress passed the Civil Rights Act (1964), the Fair Housing Act (1968), and the Equal Credit Opportunity Act (1974), among other laws. Together these laws prohibit discrimination in access to housing and credit. 8

Mortgage Lending Overview Self Check Which statement is NOT true about the mortgage lending industry: Provides funding for homeownership Works with GSEs to provide funds for home loan mortgages Mortgage lending is not a priority to the federal government Required to adhere to laws meant to prevent discrimination in residential lending 9

Mortgage Lending Overview Self Check Which entity is NOT considered a government sponsored entity (GSE): Ginnie Mae FHA Fannie Mae Freddie Mac 10

Mortgage Lending Types of Lenders Where does mortgage money come from? Who makes home loans? There are two types of mortgage lenders: Portfolio lenders Mortgage Bankers Portfolio lenders are generally banks and savings and loan institutions (also known as S&Ls or thrifts). They re called portfolio lenders because they take in deposits and use them to make mortgage loans for their portfolio. They usually hold the loan until it is paid off. While portfolio lenders typically charge a fee for each mortgage, they make their main profit from the interest differential between what they charge borrowers and what they pay depositors. 11

Mortgage Lending Types of Lenders Mortgage bankers, the second kind of lender, serve as financial intermediaries. They make loans, sell those loans to someone else in the secondary market, get their money back, and then make more loans, repeating the process. They make their profit by charging a fee for each loan they issue and by servicing the loans even after they are sold. Servicing a mortgage means collecting monthly payments from the borrower, making sure taxes and insurance get paid, and handling foreclosure on the house if that becomes necessary. Did You Know? Many types of organizations can be mortgage bankers: banks, thrifts, credit unions, insurance companies, brokerage firms, and so on. Even General Motors (through its GMAC arm) has been a major player in the mortgage business. 12

Mortgage Lending Types of Lenders Self Check Portfolio lenders make most of their profit from loan origination and servicing fees. True False 13

Mortgage Lending Types of Lenders Self Check Where do mortgage bankers sell their loans to get their money back and make more loans? Secondary Market Portfolio Lenders Banks Savings and loans 14

Mortgage Lending Types of Borrowers We ve examined lenders. Now let s focus on borrowers. Borrowers fall into three categories: An owner-occupant is someone who plans to live in a property. A non-occupying owner is an investor who will rent the property to others as a way of generating income. A non-occupying co-borrower is a person whose name will be on the title but who doesn t plan to live in the property. This is often a family member or friend of the occupying borrower. Their income and liabilities are combined with the occupant s to help the occupant qualify for the loan. 15

Mortgage Lending Types of Borrowers While many borrowers use mortgage loans to purchase a home, there are other forms of mortgages. When interest rates fall, a borrower may take out a new loan to pay off an existing one, a process called refinancing. Someone who wants to build a new home might take out a construction loan, a short-term loan to finance the cost of construction. Finally, there are home equity loans, which enable homeowners to borrow money against the equity that has accrued in their homes. Home equity loans come in two types: Single advance (or second mortgage) Revolving line of credit (also called a home equity line of credit or HELOC) 16

Mortgage Lending Types of Borrowers With a single-advance home equity loan, the borrower gets the entire loan amount upfront and makes monthly payments until the loan is repaid. With a home equity line of credit, a person can borrow what they need up to a certain maximum draw, pay it back, and reborrow if they wish. These loans offer flexibility, but can be risky for consumers because HELOCs use adjustable interest rates. 17

Mortgage Lending Types of Borrowers Self Check John plans on purchasing a home and occupying it as his primary residence. He is unable to qualify on his own and has asked his brother Bill to help him qualify. Bill will not be occupying the property. Bill is considered a(n) Owner-occupant borrower Non-occupying owner Non-occupying co-borrower 18

Mortgage Lending Types of Borrowers Self Check Tony currently owns his home. He wants to pay off his existing mortgage and replace it with a lower-interest loan. What form of mortgage loan will Tony obtain? Refinance Construction loan Purchase loan Home equity loan 19

Mortgage Lending Types of Mortgages Home mortgages come in two broad categories: government and conventional. A government mortgage is one that is insured by the FHA or guaranteed by the Veterans Administration (VA). A conventional mortgage is any non-government loan. Let s examine four basic types of mortgages: Fixed rate Adjustable rate FHA insured VA guaranteed Are only veterans eligible for a VA loan? In general, VA loans are available to veterans, active service members, reservists, and members of the Public Health Service. More than 29 million veterans and active duty service personnel are eligible to receive VA loans. A widow or widower may also apply for a loan, provided the spouse s death was service-related. SOURCE: http://www.valoans.com/geninfo-01c.cfm, 4/18/09 20

Mortgage Lending Types of Mortgages Fixed-rate mortgages (FRMs) are popular with borrowers because they have the least risk; meaning the interest rate remains the same over the life of the loan. Therefore, payments remain fixed over the life of the loan, generally 15 to 30 years. No matter whether interest rates go up or down, the borrower s mortgage payments stay the same. Adjustable-rate mortgages (ARMs) are loans with interest rates that move up or down according to an index and margin. The index is a base interest rate, such as the one-year U.S. Treasury Bill rate. The margin (often 2% to 3%) is added to the index to determine the interest rate on the loan. The most popular ARM adjusts every year, but ARMs with shorter and longer adjustment periods are available. The interest rate for an ARM is typically lower than for a comparable FRM. 21

Mortgage Lending Types of Mortgages Most ARMs have a cap on how much the interest rate can increase. A typical cap is 2% a year and 6% over the life of the loan. Other ARMs limit the dollar amount the payment can rise when an adjustment is made. So which is better: FRM or ARM? It all depends on whether interest rates rise or fall. Consumers prefer fixed-rate loans when interest rates are low. When rates are high, consumers like ARMs because they don t want to lock in a high rate. 22

Mortgage Lending Types of Mortgages Adjustable Rate Mortgages are considered riskier because, if interest rates rise and ARMs adjust upwards, borrowers may find it difficult to make payments. For example, if a homeowner borrowed $400,000 three years ago at an adjustable rate of 4% that resets to 7%, the monthly payment would jump from $1,910 to $2,661. This payment shock leads to a delinquency rate on ARMs that s almost twice as high as for fixed-rate mortgages. Extra caution must be taken when offering an ARM to make sure the borrower can afford higher payments if interest rates rise. 23

Mortgage Lending Types of Mortgages The FHA doesn t make loans. It insures loans made by private lenders. That means the FHA pays the lender if the borrower defaults. An FHA loan has different qualifying guidelines than a conventional loan. Some of the differences include the amount of down payment, qualifying ratios and credit history. What are some drawbacks of FHA loans? Because FHA loans are aimed at low- and middle-income homebuyers, they can t exceed a certain ceiling. Also, FHA loans have had a reputation for cumbersome paperwork, although this burden has eased recently and processing an FHA loan is now easier than before. 24

Mortgage Lending Types of Mortgages A VA loan works the same way as an FHA loan: if the borrower defaults, the lender is protected against loss. The VA guarantees the loan. Actually, the VA doesn t guarantee the entire loan, just 25% of it. But that s enough to protect the lender. A big advantage of VA loans is that they require no down payment and are available from most lenders. The current maximum VA loan amount is $417,000 (higher in Alaska and Hawaii). Due to the Housing and Economic Recovery Act of 2008, the loan amount may be increased in certain high-cost areas. FHA and VA loans can be either fixed-rate loans or ARMs. 25

Mortgage Lending Types of Mortgages Self Check Which type of loan is considered the riskier of the two financing options: Fixed-rate mortgage (FRM) Adjustable-rate mortgage (ARM) 26

Mortgage Lending Types of Mortgages Self Check Denise, an Army veteran, wants to buy a home but has no money for a down payment. She wants her monthly payments to stay the same over time. Which loan would be the most suitable for her? An FHA fixed-rate loan A VA fixed-rate loan A VA ARM with a low margin A VA ARM with a high margin 27

Mortgage Lending Basics Review Bottom Line Portfolio lenders fund mortgages with deposits and hold on to them (or put them on the shelf ), while mortgage bankers fund new mortgages by selling existing loans to the secondary market. Consumers seek mortgages for many reasons: to purchase an existing home, build a new home, refinance their current home, or tap into home equity. In broad terms, mortgages are either government or conventional, with either a fixed- or adjustable-interest rate. 28