Nontraditional Mortgage Products

Chapter 8 Nontraditional Mortgage 1 Nontraditional Mortgage SAFE Act Anything other than a 30-year fixed rate mortgage Interagency Guidance on Nontraditional Mortgage Product Risks Mortgage products that allow borrowers to defer principal and, sometimes, interest 2 Chapter Objectives Describe the advantages and disadvantages of buydown plans. Identify the elements that make up an adjustable rate mortgage. Identify characteristics of a reverse mortgage. Identify factors that define a subprime loan. Discuss agency guidelines on lending and subprime loans. Contrast various types of alternative financing. 3 1

Deferring Higher Interest Rate/Payment Growth Equity Mortgage (GEM) Fixed rate mortgage set up like a 30-year conventional loan Payments increase over time with predictable and scheduled escalation Good for borrower with expected increases in income 100% of scheduled payment increases reduce principal balance Reduction Option Mortgage Fixed rate loan with limited opportunity to reduce interest rate Avoids certain refinancing costs, such as for an appraisal Shared Appreciation Mortgage (SAM) Lender charges below-market interest in exchange for a share of the gains the borrower realizes when the property is eventually sold Shared risks/rewards, especially on commercial projects 4 Buydown Plans Point = 1% loan amount Discount points: Paid upfront to lower interest rate Buydownmay be paid by: Borrower Seller Interested third party If borrower, appears on GFE as borrower charge Advantages: Lower monthly payment May allow qualification on reduced payment 5 Case in Point Borrower financing $180,000 Quoted 6.5% interest rate for 30-year conventional loan Payments would be $1,137.72 per month At 6.25% for the same $180,000 30-year loan, payments would be only $1,108.29 Paying discount points up front to buy down the interest rate 1/4%, buyer saves $29.43 / month May help borrower qualify for the home loan Makes mortgage payments more attractive 2 points cost approximately $3,600 123 months to recapture upfront discount points 6 2

Buydown Plans: Paid by Seller Less money to seller May help close the deal Buydown amount subtracted from loan proceeds Reflected on HUD-1 as charge to seller Buyer signs note for full amount 7 Permanent Buydown Points paid to lender to reduce the interest rate and loan payments for the entire life of the loan Interest rate written into promissory note Nominal rate (or coupon rate) stated in the note will be the actual reduced interest rate 8 Temporary Buydown Funds deposited at closing to supplement monthly payment Short-term discount Lender receives full payment Borrower s discounted payment Supplemented by deposited funds When deposited funds run out, borrower makes full payment Underwriters generally consider payments using fully indexed rate, not starting rate 9 3

Temporary Buydown: Level Level payment reduction plan: Constant throughout buydown period 10 Temporary Buydown: Graduated Payments increase every year, as per note, until sufficient to amortize loan 2-1 buydown: Subsidized for 2 years 3-2-1 buydown: Subsidized for 3 years 11 Buydowns: Fannie / Freddie Limits Limits interested party contributions (IPCs) to % of sale price or appraised value, whichever is less Excessive contributions deducted from maximum loan amount Contributions from employers or immediate family members usually not subject to limits Property Type LTV/CLTV Max. IPC Investment All CLTV ratios 2% Principal residence or second home Greater than 90% 75.01% to 90% Less than 75% 3% 6% 9% 12 4

Buydowns: FHA / VA Limits FHA: Will not underwrite at temporary buydown rate Unless permanent, borrower must qualify at note rate Reduction limited to 2% below note rate Allows maximum interest party contribution of 6% Excess contribution deducted from maximum loan amount Excludes family and employer contributions VA has no set limits 13 Mortgage Exercise 8-1 A borrower wants to buy a $150,000 home, and is going to make a $15,000 down payment. The borrower is seeking a conventional loan, but doesn t want to pay more than 6 1/2% interest. The lender agrees to 6 1/2% interest if the loan has three discount points and the loan origination fee is 2%. 14 Mortgage Exercise 8-1 1. What s the total amount of points (in dollars and percentage) that the lender will receive for making this loan? Points are based on the loan amount, in this case, $135,000 ($150,000 -$15,000 down). The lender is charging a total of 5 points, or 5% of the loan. Discount points total $4,050 ($135,000 x.03) and the loan origination fee is $2,700 ($135,000 x.02). The total the lender will receive in points is $6,750 ($4,050 + $2,700). 15 5

Mortgage Exercise 8-1 2. If the seller agrees to pay the discount points, how much will the seller net from the transaction? (Assume the seller pays no other costs.) The seller net is the sale price minus any sellerpaid points, so the seller will net $145,950 ($150,000 - $4,050). 16 Mortgage Exercise 8-1 3. What will the borrower s note state as the interest rate on the loan? What dollar amount will the note say was borrowed? The loan note rate will be 6.500% since this is not a temporary buydown. The amount on the note equals the loan amount, not the sale price, so it s $135,000 ($150,000 -$15,000). The note amount does not reflect the sellerpaid points. 17 Mortgage Exercise 8-1 4. Can the lender sell this loan to Fannie Mae or Freddie Mac on the secondary market? Why or why not? Yes, the lender should be able to sell this loan to Fannie Mae/Freddie Mac on the secondary market because it has less than the 6% seller assistance limit that the programs allow with a 90% LTV. 18 6

Adjustable Rate Mortgages (ARMs) Frees lender from being locked into fixed rate Interest rates may adjust to reflect fluctuations in cost of money May allow borrower to qualify more easily Allows lenders to pass risk on to borrowers Lenders may charge lower starting interest rate than for fixed Must adhere to guidelines of appropriate regulatory agency, Fannie Mae/Freddie Mac, FHA, and private mortgage insurers 19 ARM Elements Index Margin Rate adjustment period Mortgage payment adjustment period Interest rate cap/floor (if any) Mortgage payment cap (if any) Negative amortization cap (if any) Conversion option (if any) 20 ARM Elements: Index Statistic consumer can examine Generally reliable indicator of cost of money, e.g.: Average One-Year Treasury Constant Maturity Index (TCM) Cost of Funds Index (COFI) (used by Fannie Mae) London Interbank Offered Rate (LIBOR) Interest rate adjustments based on up / down movement of index Index must be: Independent of lender Affected by market conditions Regularly listed in major publication 21 7

ARM Elements: Margin Difference between index value and interest rate charged (margin + index = interest rate) Generally remains fixed; negotiated with lender 22 ARM Elements: Adjustment Periods Rate adjustment period: Length of time between at which interest rate changes Often every six months or 1 year Payment adjustment period: Length of time between payment adjustments Can range from months to several years May be adjusted parallel to rate adjustment May be adjusted less frequently than rate adjustment Negative amortization: Interest paid insufficient to pay interest accrued from previous month Excess interest paid may be applied to principal 23 ARM Elements: Interest Rate Cap Discounted indexed rate or teaser rate Start rate lower than fully indexed rate Makes ARMs more attractive to borrowers Could result in significant payment shock Interest rate caps limit % points rate can increase May be shown as 2 numbers, such as 2/6: 1st number: Max. increase at adjustment 2nd number: Max. lifetime increase May be shown as 3 numbers, such as 5/2/6: 1st number: Max. increase at 1st adjustment 2nd number: Max. increase at subsequent adjustments 3rd number: Max. lifetime increase May also limit how much interest rate can decrease 24 8

ARM Interest Rates 1-year ARM loan for $100,000 for 30 years 5/2/6 interest rate cap Current index rate is 4.5%; margin is 3%; discounted start rate is 4%. 9% 7% 9% 10% 25 ARM Elements: Interest Rate Caps Fannie Mae: 2%per year / 6%lifetime Freddie Mac: 2%per year / 5%lifetime FHA: 1% per year / 5% lifetime VA: 1%per year / 5% lifetime on traditional ARMs (adjusts annually) 2%per year / 6%lifetime on hybrid ARM (fixed for at least five years) 26 ARM Elements: Payment Cap Protects a borrower from large payment increases Limits magnitude of payment changes with interest rate adjustments Some lenders only use interest rate caps; others use both rate and payment caps Could allow for negative amortization if current interest rate exceeds payment cap 27 9

ARM Elements: Negative Amortization Cap Negative amortization: Loan balance grows because payments don t cover the accrued interest due on the loan Most likely to occur with frequent rate changes and less frequent payment adjustments Cap limits growth of loan balance beyond a certain point Maintains manageable LTV May require readjustment (recast) of monthly payments 28 ARM Elements: Conversion Option Gives the borrower the right to convert from an adjustable rate loan to a fixed rate loan Conversion option note normally includes: Higher interest rate Limited time to convert Conversion fee If sold to the secondary market, terms would have to be honored by purchaser 29 ARM Standardization Most lenders follow secondary market guidelines Loan-to-value a consideration May not make higher LTV if chance of negative amortization Higher LTV generally requires occupancy Fannie Mae / Freddie Mac require occupancy for all ARM loans Credit scores may be considered Appraisal must not be influenced by financing concessions May use smaller housing expense and debt-toincome ratios for qualifying 30 10

Index / where to find it How interest rate and payment are determined Suggestion to ask about current margin / interest rate Initial discount rate and suggestion to ask about amount of discount Rate / payment adjustment periods Rate and payment caps ARM Disclosures Disclose APR to comply with TILA (Reg Z) CHARM Handbook discloses (as appropriate): Statement payment caps may result in negative amortization Statement if loan has demand provision Description / time of adjustment notice Availability of other ARM loan disclosures Maximum interest rate / payment Initial interest rate / payment Conversion option details Example based on $10,000 loan Advance notice of change in payment / interest rate 31 ARM: Annual Percentage Rate Annual percentage rate(apr): Relationship between the cost of borrowing money and the total amount financed, represented as a percentage Disclosure cannot be made based solely on ARM s initial rate Must reflect the finance charges and fees as well as the composite annual percentage rate Based on initial payment rate and fully indexed rate that could exist for the remaining loan term Lets consumers comparison shop for rates among lenders 32 ARM: Payment Option Allows borrowers to pick a payment option each month Traditional payment of principal and interest Reduces the amount owed Interest only payment Pays interest due but does not reduce principal Minimum (or limited) payment May be less than the amount of interest due Balloon payment may be required Built-in recalculation period, e.g., every 5 years New minimum payment amortizes loan Uncommon today; could result in negative amortization 33 11

ARM: Hybrid ARM Loan has a fixed rate for a specified number of years, then interest rate adjusts regularly for remainder of loan term according to note May be designated by: Number years fixed and adjustable: 2/28 or 3/27 ARM fixed for first 2 or 3 years; interest rate adjusts at predetermined point Number of years fixed and adjustment period: 3/1, 5/1, 7/1, or 10/1 ARM --fixed for first 3, 5, 7, or 10 years with annual adjustment after CAUTION: Be careful when using the term fixed 34 Mortgage Exercise 8-2 A borrower received a 30-year ARM mortgage loan for $120,000. The start rate was 3.50% and the loan adjusts every 12 months for the life of the mortgage. Rate caps are 3/2/6. The index used for this mortgage is the LIBOR. For this exercise, let s say it was: 3.00% at the start of the loan 5.00% at the end of the first year 4.50% at the end of the second year The margin on the loan is 3.00%. 35 Mortgage Exercise 8-2 1. What s the initial rate (start rate) and what is the interest rate after the first year? The start rate is 3.50%. The fully indexed rate after the first year is 8.00% (5.00% index + margin of 3.00% = 8.00%). BUT, the periodic maximum rates caps (in this example, annual) have to be taken in consideration also. In this mortgage, the maximum rate increase the first year is 3.00% (2.00% in all other years). So 3.50% + 3.00% = 6.50%, which will be the interest rate after the first adjustment. 36 12

Mortgage Exercise 8-2 2. What is the fully indexed rate after the second year? The fully indexed rate is 7.50% (LIBOR rate of 4.50% + 3.00% margin). 37 Mortgage Exercise 8-2 3. What is the borrower s interest rate after the second adjustment? The borrower s interest rate after the first adjustment period was 6.50%. Adding the periodic maximum adjustment cap of 2.00% = 8.50%. However, the borrower s interest rate would be the LOWER of the two interest rates, which is 7.50%. 38 Mortgage Exercise 8-2 4. What is the maximum interest rate this loan could have? The maximum interest rate equals the start rate of 3.50% + the life of the loan cap of 6.00%, so the maximum interest rate this loan could have is 9.50%. 39 13

Mortgage Exercise 8-2 5. What would the LIBOR have to be to obtain that interest rate? In order for this loan to get to that rate, the LIBOR would have to increase 2.00% from its current rate of 4.50% to 6.50%: 9.50% (maximum lifetime rate) 3.00% (margin) = 6.50% (LIBOR) 40 ARM: Be Prepared to Answer 1. What will my interest rate be? 2. How often will my interest rate change? 3. How often will my payment change? 4. Is there any limit to how much my interest rate can be increased? 5. Is there any limit to how much payments can be increased at any one time? 6. What is the probability of runaway negative amortization? 7. Can my ARM be converted to a fixed rate loan? 41 Advantages & Disadvantages Advantages Disadvantages 42 14

Advantages & Disadvantages Advantages Lower initial interest rate and payments May be easier to qualify for loan Leverage buyer into a higherpriced home Payments may decrease over time May be converted to a fixedrate loan Good in times of low inflation or for short-term ownership Disadvantages 43 Advantages & Disadvantages Advantages Lower initial interest rate and payments May be easier to qualify for loan Leverage buyer into a higherpriced home Payments may decrease over time May be converted to a fixedrate loan Good in times of low inflation or for short-term ownership Disadvantages No interest rate guarantees No payment guarantees Buyer s financial situation may change Buyer may over-leverage Possibility of negative amortization May have to pay a fee to convert even if you choose not to convert 44 Subprime Loans Riskier than conforming loans Less creditworthy borrowers (also called B-C loans) Less documentation provided Rely on equity in property to offset credit risk, so may require larger down payment Requires experienced / specialized underwriter Allows lenders to charge higher interest / fees Borrowers showing good credit/payment history may be able to refinance at more favorable terms Rare in today s market 45 15

Interagency: Nontraditional Interagency Guidance on Nontraditional Mortgage Product Risks Mortgage products that allow borrowers to defer principal and, sometimes, interest, for example: Interest only (IO) feature Potential for negative amortization Qualifying standards/guiding principles: Recognize potential impact of payment shock Nontraditional loans may not be appropriate for high LTV, high DTI, and low credit scores Analysis should consider fully indexed rate Avoid over-reliance on credit scores 46 Interagency: Nontraditional Avoid collateral-dependent loans Compensate risk layering with risk mitigating features Reduced documentation acceptable only if other risk mitigating features available Simultaneous seconds minimal equity loans should not allow delayed / negative amortization Teaser rates minimize early or disruptive recastingsor extraordinary payment shock I/O feature should evaluate ability to repay by final maturity at fully indexed rate Negative amortization analysis should consider initial loan amount + balance increases 47 Interagency: Statement on Subprime Promote consumer protection standards, particularly on ARMs offered to subprime borrowers that have: Very high / no limits on payment amount / interest rate increases Limited / no income documentation Features leading to frequent refinancing Prepayment penalties: Substantial Extend beyond initial fixed rate period 48 16

Interagency: Statement on Subprime Provides consumer protection through disclosure: Payment shock potential Prepayment penalties and how calculated, imposed Balloon payments Cost of reduced documentation loans Responsibility for taxes and insurance 49 Interagency: Statement on Subprime Defines predatory lending as: Making loans based on foreclosure / liquidation value of collateral rather than on borrower s ability to repay Inducing borrower to repeatedly refinance in order to charge high points and fees ( loan flipping or equity skimming ) Engaging in fraud or deception to conceal the true nature of the obligations from unsuspecting or unsophisticated borrower 50 Reverse Mortgages Allows borrower to convert equity in home without selling or making payments Funds may be used for virtually anything Also called reverse equity mortgage or reverse annuity mortgage (RAM) FHA s Home Equity Conversion Mortgage (HECM) most popular Balance of loan rises as equity shrinks (rising debt, falling equity) At end of loan, all equity could be gone 51 17

Reverse Mortgages: Eligibility No income requirements (must be able to pay continuing obligations related to property) All individuals with ownership interest must be at least 62 years old Generally, single-family homes, including condos and PUDs Mobile homes / co-ops not generally eligible Homeowner s insurance at replacement value Principal residence with little or no mortgage balance Required pre-loan counseling 52 Reverse Mortgages: Amount Many factors: Appraisal of home value Amount of equity Payment options Interest rate Fees Age of borrower Older can borrow more Age of youngest borrower determines 53 Reverse Mortgages: Payment Payment options: Fixed monthly payments Lump sum Line of credit as needed Combination Spending options: Virtually anything Tax implications: Generally not considered income Interest deducted only at loan conclusion Could affect eligibility for other programs 54 18

Reverse Mortgages: Repayment If not in breach, due when last surviving borrower: Dies Sells the home Ceases to live in home for 12 consecutive months Total amount due (interest, insurance, fees, etc.) Any remaining equity belongs to estate Lender generally may not sell home during loan term Non-recourse Cannot claim other assets Borrower cannot owe more than fair market value Repayment could be accelerated under some circumstances 55 Seller Financing / Purchase Money Seller extends some or all credit to purchase property Buyer may not be able to get traditional financing Allows seller to enhance marketability Alienation (due on sale) clause gives lender certain rights upon transfer of some interest in property Purchase money mortgage -given to seller by buyer Sellers not bound by institutional policies Can take any form, e.g., fixed, adjustable, etc. Cannot violate laws, e.g., usury laws 56 Seller Financing Assumption: One party agrees to take over payments of another party s debt, with terms of the note staying unchanged FHA / VA loans require approval of lender Buyer becomes primarily liable but lender may have recourse against seller upon default without release Wraparound financing: Seller retains existing loan on the property while giving the buyer a second loan Buyer pays seller full amount; seller pays original lender, keeps excess Original mortgage must: Be assumable with lender approval or Not have an alienation clause 57 19

Land Contracts Installment agreement where buyer pays seller for right to occupy and use property Also called land installment contracts, installment sales contracts, land sales contracts, real estate contracts No deed or title is transferred until all, or a specified portion, of the payments have been made Seller (vendor) holds legal title to property as security Buyer/debtor (vendee) may possess and enjoy land, but is not legal owner (equitable title) No institutional loan qualifying standards Cannot be sold to Fannie Mae / Freddie Mac Generally require vendor to provide annual statement 58 Lease / Option Property lease for specific term with option to buy at a predetermined price during lease term Lease: Rent in exchange for possession of real estate Option: Contract giving right to do something within a designated time period, without obligation Optionee: Prospective purchaser Optionor: Property owner May credit any portion of rent that is above established market for comparable property toward: Down payment Loan amount Sales price 59 Lease / Purchase Seller leases property for specific term; tenant agrees to buy property at set price during or following the lease term Equivalent of a sale where purchase agreement: Locks in a predetermined price Sets date for sale transaction Reasons for lease / purchase include buyer: Needs time to acquire cash Will qualify once circumstances change Will take advantage of rent credit 60 20

Equity Exchanges Value in one property traded for another Also called tax-deferred or tax-free exchange, like-kind exchange, Section 1031 Properties must be: Exchanged, or qualify as delayed exchange Like-kind property (real estate for real estate) Held for use in a trade, business, or investment Seller defers paying tax until profit is realized from transaction Legal and tax advice should always be consulted 61 Participation Plans Partnership between buyer and another investor (or seller, lender, etc.) Investor provides cash; receives percentage of equity in lieu of or in addition to interest Buyer pays principal (or it is deferred) Things to negotiate: Loan application Equity calculation Investor s equity percentage Investor repayment Handling improvements Responsibility for taxes and insurance 62 Homebuyer Assistance Programs May provide: Down payment assistance Subsidized mortgage interest rates Help with closing costs Offered by government, non-profits, lenders Program funding usually limited Lender programs developed to provide financing flexibility First time homebuyer Community homebuyer Positive: Help get people into homes Negative: Potential for default 63 21

Key Term Review Adjustable Rate Mortgage (ARM) Buydown Caps Equity Exchange Estoppel Index Land Contract Lease/Option Lease/Purchase Margin Option Participation Plan Points Rate Adjustment Period Reverse Mortgage Subprime Loan Teaser Rate 64 Summary 1. Nontraditional mortgage products Defined by the SAFE Act as anything other than 30-year fixed rate loans. Defined by Interagency Guidance on Nontraditional Mortgage as mortgage products that allow borrowers to defer principal and, sometimes, interest. Such products can help buyers qualify for larger loans or help them reach other financial goals. 65 Summary 2. Buydowns are additional money (discount points) paid to the lender at the start of a loan to lower interest rate and payments. Make up the difference between the market interest rate and the rate a borrower gets in the note. A permanent buydown (for life of loan) has a reduced rate stated in the note. A temporary buydown (early in loan) can be level payment or graduated payment. Buyer can qualify 2% below market rate. FHA requires buyers to qualify at note rate, not buydown rate. Fannie Mae, Freddie Mac, and FHA limit points and other interested party contributions (IPCs) that can be paid. 66 22

Summary 3. Adjustable rate mortgages(arms) Borrowers select index(statistical report reflecting cost of money), lenders add a margin(spread) = fully indexed ratepaid on the loan. Loan documents must state: Rate, index, margin, and payment adjustment period; caps (if any) on rate, payments or negative amortization; conversion option (if any). Rates that change more frequently than payments may create negative amortization(payments insufficient to cover interest due). Capskeep loans from growing out of control. Lenders periodically readjustor recast the loan by recalculating payments based on the loan balance at specific interval. Conversion optionsallow buyers to convert to fixed rate. Lenders/MLOs must provide CHARM booklet to borrower in addition to other mandated disclosures, including the annual percentage rate(apr). For ARMs, it is a composite rate that reflects the lower rate for certain number of years and the higher rate for later years. Lenders cannot disclose only initial low rates. 67 Summary 4. Reverse mortgages provide monthly income, a lump sum of cash, or a line of credit to borrowers aged 62 or older, based on the equity in their homes Loan generally repaid when the borrower dies, moves out of the house for 12 months, or sells the house (assuming no breach). 5. Structured mortgageshelp borrowers reach other financial goals. Growth equity: Fixed rate, but payments increase to pay off faster. Reduction option: Buyer can reduce rate one time, with fewer refinancing costs. Shared appreciation: Lender shares equity in commercial project. 6. Subprimeloans (B-C loans, low-doc, stated income) have more risk than what is allowed by the conventional market. Borrower risk factors determine interest rate and terms. A-minus loans are riskier than prime loans, less risky than subprime loans. 68 Summary 7. Seller financing is when seller extends credit to buyer to finance the purchase of property. Seller can extend all or partial credit. Can help buyer who doesn t have enough cash to buy a property, can t qualify for a conventional loan, or wants or needs a lower-than-market interest rate. Seller gets the benefit of a home that s easier to sell, and often a better price by offering terms. A purchase money mortgageor seller-held mortgage is given by buyer to the seller to secure part or all of the money borrowed to purchase property. Unencumbered property with no liens is best for this transaction; encumbered property with liens needs assumption or wraparound. Assumptionhas the buyer take responsibility for the mortgage, but the seller must get a release from the lender. A seller-wraparound mortgagehas the seller retain existing mortgage (the buyer makes one larger payment; the seller pays the lender and keeps difference). 69 23

Summary 8. A land contract is a real estate installment agreement. Buyer (vendee) makes payments to seller (vendor) for right to occupy land, but no title is transferred until all, orpartof, paymentsaremade. Buyer has equitable title under a land contract. States differ in how they treat land contracts. Problems for the buyer include difficulty in borrowing against equity with a land contract and protecting equity if land contract is not recorded. Lender may consent to deal using an estoppelletter. 70 Summary 9. Other alternative financing: A lease/optionhas the seller (optionee) lease to a tenant (optionor) who has the right (but not the obligation) to buy the property at a set price within a certain time. An option can be used for profit, speculation, investment, comparison, or to give the optionor time to acquire cash, to qualify, or credit rent toward purchase price. A lease/purchasecombinesa lease with a purchasecontract. An equity exchange(tax-deferred exchange, Section 1031) is property traded for value in other property. Properties must be exchanged (or delayed exchange), like kind, and held for trade, business, or investment. Capital gains tax is deferred, but boot (unlike property added to balance value) is taxed. Tax-free exchanges are not available for residential property. Participation planshave investors share equity of the property instead of or in addition to receiving interest. 71 Summary 10. Homebuyer assistance programs: Down payment assistance programs (DAP) Subsidized mortgage interest rates Help with closing costs (or combination) Programs can be offered by government or nonprofit groups, or by lenders 72 24

1. A borrower is purchasing a home for $100,000. The LTV on the loan is 80%. If the borrower pays a total of 6 points on the loan, how much will the points cost him? A. $2,400 B. $3,400 C. $4,800 D. $6,000 73 2. A buydownplan can reduce the borrower s payments A. early in the loan only, but requires a large balloon payment. B. early in the loan or for the entire life of the loan. C. for the entire life of a loan, but with an automatic prepayment penalty. D. with gradual payment decreases throughout the life of the loan. 74 3. Which statement is true about interest rate buydownson FHA loans? A. Borrowers may qualify at the buydown rate. B. Borrowers must qualify at the note rate. C. FHA does not allow builder-paid buydowns. D. FHA does not allow seller-paid buydowns. 75 25

4. Which of the following is NOT an element of an ARM? A. index B.margin C. positive amortization cap D. rate 76 5. What is the adjustable number used to compute the interest rate on an ARM called? A.cap B. index C. margin D. prepayment 77 6. With an ARM, the index is added to the to determine the. A. APR / cost of funds B. home value / amount borrowed C. margin / interest rate charged D.qualifying ratio / maximum monthly mortgage payment 78 26

7. Negative amortization occurs when A. a borrower suffers payment shock. B. each mortgage payment is adjusted more frequently than is the interest rate. C. the payment made does not cover the interest due for that period. D. all of the above 79 8. How are subprime loans different from conforming loans? A. They allow for lower interest rates. B. They allow for more risk. C. They are only offered by banks. D. They are sold in the secondary market. 80 9. Which scenario best describes a land contract? A. A buyer makes payments to the seller in exchange for the right to occupy, use, and enjoy the property, but no deed or title transfers until a specified portion of payments have been made. B. A buyer takes over primary liability for the loan of a seller, usually implying no change in loan terms. C. A seller keeps the existing loan and continues to pay on it while giving the buyer another loan. D. A seller leases the property with the provision that part of the rent payments be applied to the sale price if the tenant decides to purchase before the lease expires. 81 27

10.An equity exchange may be treated as a taxfree exchange when property is A. for profit and of like kind. B. held for sale by a dealer only. C. owner-occupied. D. rental only. 82 11.In which federal law would you find the definition of a nontraditional loan? A. Homeowners Equity Protection Act B. Real Estate Settlement Procedures Act C. Secure and Fair Enforcement for Mortgage Licensing Act D. Truth in Lending Act 83 12.During the life of a typical reverse mortgage, which of the following factors is decreased? A. debt B. equity C. interest D. monthly payments 84 28

13.According to the Interagency Guidance on Nontraditional Mortgage, nontraditional mortgage loans may be LEAST risky for borrowers with A. high debt-to-income ratios. B. high loan-to-value. C. low credit scores. D. low debt-to-income ratios. 85 14.Each of these are characteristics that could make a loan nontraditional EXCEPT A. 15-year term. B. adjustable rate. C. fixed rate. D. temporary buydown. 86 15.A borrower has a ARM with a 5/2/6 interest rate cap. The start rate is 4%, the current index is 3%, and the margin is 3%. What is the borrower s interest rate if the index rises to 5% at the time of the first adjustment? A. 5% B. 6% C. 8% D. 9% 87 29