SHORT INTRODUCTION TO CALIFORNIA REAL ESTATE PRINCIPLES,
© 1994 by Home Study, Inc. dba American Schools
Educational Objectives: Learn about Private Mortgage Insurance, Government Mortgage Insurance, FHA, FHA Insurance, Section 203(b), Graduated Payment Mortgage, VA, CAL-VET, R. E. TERMS GLOSSARY, INDEX.
Private mortgage insurance is insurance on conventional loans indemnifying the lending institution against default on the mortgage by the borrower (mortgagor). It serves to reduce the risk taken by the investor. Insured conventional loans are more salable in the secondary mortgage market than are uninsured ones.
The mortgage industry has traditionally considered 80% loans (those requiring 20% down payment) to be "safe." This view has been held on the assumption that a borrower with at least 20% of the value of the property coming out of his/her own pocket would be less likely to allow the "investment" to be wiped out by foreclosure.
In addition, private mortgage guaranty companies have believed that, in the case of 80% loans, even if there is a foreclosure, the sale of the property will probably generate enough funds to cover 80% of the appraised price.
Loans that have less than 20% down payments are generally considered more "risky." in these cases, lenders will normally require the borrower to purchase private mortgage insurance. Both "Fannie Mae" and "Freddie Mac" require mortgage insurance on any loan they purchase in the secondary market that has a less than 20% down payment.
Private mortgage guaranty companies have made a significant contribution to the achievement of the so-called "American Dream" of home ownership by insuring mortgages of less than 20% down payment. Home buyers may now be able to qualify for 90% or even 95% loans with the purchase of mortgage insurance.
Development of Mortgage Insurance
Private mortgage insurance seems to have originated during the middle 1880's in New York. It was an outgrowth of a broad interpretation of New York state statutes dealing with title insurance. By the early 1900's New York became the first state allowing the insuring of mortgage debt and allowing insurance companies to trade in mortgages.
In the beginning this was an unregulated activity which was characterized by several unsound business practices such as poor credit practices and failures to maintain adequate reserves. This apparent house of cards fell with the bank holiday of 1933 and the subsequent liquidation of virtually all mortgage guaranty companies.
In 1934 the National Housing Act was passed. This act established the Federal Housing Administration and established the Mutual Mortgage Insurance Fund. This was the beginning of the federal government's involvement in mortgage guaranty insurance.
The Mutual Mortgage Insurance Fund was designed to be a self supporting insurance system that avoided many of the poor business practices of its predecessors. The Fund collects premiums which are held in reserve and claims by lenders are paid from that reserve.
While the Veterans Administration does not provide mortgage insurance, the VA guarantee on the loan protects the lender against loss of the payments that are not made, and is intended to encourage lenders to offer veterans loans with favorable terms.
The amount of guaranty on the loan depends on the loan amount and whether the veteran used some entitlement previously. The amount a veteran may borrow depends on maximum loan amounts, the borrower's income level and the appraised value of the property.
Non-Government Mortgage Insurance
The private mortgage insurance industry was revived in the middle 1950's with the establishment of the Mortgage Guaranty Insurance Corporation (MGIC). MGIC insures only the top 20% of the loan. This represents the major risk portion of the investment.
MGIC helped encourage the passage of legislation that helps prevent the mistakes experienced by the first mortgage guaranty insurance companies. It operates on sound business practices and insurance principles.
Since the early 1960's several additional mortgage guaranty insurance companies began operations. These companies also operate under sound insurance principles and business practices.
The regulation of mortgage guaranty insurance covers three major areas of importance:
1. Sometimes called the "Monoline Rule," mortgage guaranty insurance companies are restricted to writing only mortgage guaranty insurance. This "rule" does not prevent "monoline" companies from either owning other insurance companies or being owned by one.
2. Mortgage guaranty insurance has a mandated limit on the amount of business the company can write. This is usually called "exposure ratio." Exposure ratio, in this case, means the insurance company's liability may not exceed 25 times the total of its surplus and contingency reserve.
3. The "contingency reserve" is designed to protect the insurance company from loss during the contraction phase of the business cycle. It is mandated that mortgage insurance companies set aside one half of each premium dollar earned.
The mortgage insurance companies must also meet requirements placed upon them by the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae). Obviously, the secondary mortgage market is interested in underwriting policies, claims procedures, and other financial requirements. These requirements have served to help standardize the mortgage insurance business.
Another stabilizing influence On the mortgage insurance industry is provided by the bond rating agencies. They do not "regulate" the mortgage insurance companies, but their criteria for rating mortgage-backed securities include operating and financial standards for the mortgage insurers.
Underwriting is the process of selecting and classifying risk. Underwriting mortgage insurance means selecting those mortgages with the lower apparent risk and spreading acquired risk among risk classifications.
Mortgage insurance underwriting involves qualifying the various lenders, verifying information and checking the conditions in areas where the mortgages are insured.
The first step in mortgage insurance underwriting is the issuance of a master policy to accepted lenders. These lenders will usually be state or federally regulated, have demonstrated good management ability, use approved appraisers and may be required to have a specific company size.
The mortgage insurance companies will monitor the master policy holders for:
1. loss experience
2. rejections of applications submitted
3. spot checks of credit reports and appraisals
Master policy holders receive applications for mortgage insurance coverage on individual mortgages normally from lenders. The mortgage insurance company will require the following documents to be submitted with the application:
1. mortgage insurance application
2. credit report
3. employment verification
4. any deposit requirement verifications
5. loan application
6. appraisal report and property photograph
Each application for mortgage insurance is evaluated on an individual basis. Specifically, the underwriter is looking for evidence that either the borrower or the property has characteristics that may cause the loan to go into default.
The mortgage insurance companies' master policies generally require lenders to report delinquencies. It also requires the lenders to begin foreclosure proceedings if there are continued delinquencies.
When a mortgage insurance company receives a claim, it will either pay 20% to 25% of the total claim or pay the entire claim and take title to the property.
In recent years and in selected cases, mortgage insurance companies will meet with the borrower who has financial difficulties to discuss his/her personal finances. The counselor will help the borrower examine his/her total obligations and, if possible, make some recommendations in spending patterns that may help the borrower avoid default on the loan. In these cases, the counselor may bring in the lender and together with the borrower begin a repayment plan. Obviously, in these cases, the mortgage insurance company and the lender will monitor the case closely.
Mortgage insurance companies retain a specific portion of each premium dollar in the reserve fund. In addition, any investment earnings of the reserve fund become a part of the reserve fund.
There are two reasons the mortgage insurance company reserve funds have been effective. First, the company does not "earn" the premium funds during the first year of the policy. Rather, the company "earns" the premium over the life of the mortgage insurance policy. Second, the investment income of the company tends to increase and helps support the fund during adverse phases of the business cycle.
Mortgage insurance companies are required to keep three general types of reserves.
1. The contingency reserve is discussed earlier.
2. The "loss reserve" is for delinquent loans and claims.
3. The "unearned premium reserve" is that amount of premium that has been collected but has not yet been "earned".
Virtually all mortgage guaranty companies will issue policies of qualified properties and borrowers on one to four family principal resident units where the loan to value ratio is not more than 95% of the appraised value.
Some mortgage guaranty companies will issue policies on a second or leisure home. In these cases, the company will generally require the loan to value ratio not exceed 80%.
Mortgage insurance does not assume the entire risk for the lender. Rather, the insurance company assumes only the primary risk.
While the amount of the mortgage insurance may vary, it is typically 20% of the loan amount. For example, if the sales price of the house is $100,000 and the borrower applies for a 90% conventional loan, private mortgage insurance will be 20% of the loan amount or PMI coverage will be for $18,000.
$100,000 X .90 =$90,000 (9O% loan)
$90,000 X .20 (PMI coverage) = $18,000 (amount of PMI coverage)
In the event of foreclosure, the lender may have the expenses of unpaid property taxes, hazard insurance, interest, attorney fees and the costs of selling the foreclosed property.
To illustrate the use of PMI consider the following. A buyer makes a down payment of 5% on a home priced at $100,000 and subsequently defaults. The outstanding loan balance at the time of the foreclosure sale is $89,000. The property sells for only $85,000. PMI-would compensate the lender the $4,000 difference between the loan balance and the foreclosure sale price. The maximum that the PMI issuer would compensate the lender in this case would be $22,250, or 25% of the outstanding loan balance. If the property sold for less than 25% of the loan balance the lender would have to bear the loss. Another variety of PMI covers the entire declining value of the mortgage and pays upon the death or total disability of the borrower. Such insurance is a type of term insurance that protects both the lender and the family of the borrower. The lender gets paid off at a time when the borrowers may not be able to meet the monthly payments, and the family gets a mortgage-free home. After the mortgage financing is arranged the buyer takes a major step toward closing the real estate transaction.
PRIVATE MORTGAGE INSURANCE PREMIUM
Most mortgage guaranty companies charge a "one-time" fee when the loan is made and a recurring fee which is called a "renewal premium." These are frequently added to the borrower's monthly payment.
The "one-time" mortgage insurance premium fee is normally charged to the borrower at the closing. This fee may be one-half of one percent of the loan amount. However, mortgage guaranty insurance companies do have rate charts available and these should be referred to for accurate, current premium rates.
To figure one-time PMI premium on a $100,000 sales price with a 90% loan:
$100,000 sales price X .90 = $90,000 loan amount
$90,000 loan amount X .005 (one time fee) = $450 PMI due at closing
To figure the renewal premium on the same example:
$90,000 (loan amount) X .33% (.0033) (an average rate) = $297 annual premium
$297 annual premium divided by 12 months = $24.75 monthly premium
NOTE: The above are for educational example purposes only. To find actual rates, please obtain a mortgage guaranty insurance company's rate chart. The above are for a 30 year, fixed interest rate loan. Other rates exist for ARM's and other kinds of loans.
Benefits of PMI Coverage
For the lender:
1. The PMI insurance allows the lender to make 90 to 95 per cent loans and to sell these loans in the secondary market.
2. With the ability to make higher loan-to-value ratio loans, the amount of possible loans is expanded.
3. The lender can secure an additional amount of security for the loan at no extra cost.
4. The processing time and the issuance of the insurance commitment is usually faster from a PMI company than the FHA.
For the borrower:
1. The borrower has the ability to purchase a home with a conventional loan with as little as 5 percent down payment.
2. With the need for less money down, the borrower can buy a home sooner and sometimes larger than expected.
3. The processing time for the insurance commitment is usually faster than with the FHA.
4. The payment of the insurance premiums is for a shorter period than FHA.
GOVERNMENT MORTGAGE INSURANCE
The Federal Housing Administration (FHA) does not make mortgage loans but insures mortgage loans to protect lenders. The insurance protection enables lenders to provide financing when there is a very high loan-to-value ratio. This means that the loan amount is very high in comparison to the property value, thereby requiring only a small down payment to be made by the borrower. The amount of insurance protection to the lender is always sufficient to protect the lender from financial loss in the event of a foreclosure sale.
The Federal Housing Administration (FHA) insures loans made by lenders in an effort to make available housing to low- middle income homebuyers. There are a number of different programs available that have downpayment requirements. The 1990 National Affordable Housing Act limited the amount of buyer's closing costs that could be financed to 57% . This limitation is effecting on these FHA programs; 223e ("regular program"), 223e (inner city properties), 234c (Condominiums), 245 (GPM/GEM) and 251 (Adjustable Rate) mortgages. Loan programs that are not covered by the 57% rule are 203K, 221d1 and 203V. The following are brief summaries of selected programs.
FHA 203b Program
This is the original and still the basic FHA program. This program provides for insuring loans for the purchase or construction of one-to-four-family dwellings. The loan amounts are based on the FHA appraised value of the property plus the FHA estimate of the borrower's closing costs, if the borrower is paying these costs. If the seller is to pay all or part of the closing costs for the buyer, the amount paid by the seller will not be included in the total.
This program requires 3% down on the first $25,000 and 5% down on the amount in excess of $25,000). The FHA has implemented two formulas that must be calculated to determine the actual FHA loan amount. It is possible that the 57% rule will be eliminated soon allowing the buyer to include 100% of the buyer's closing costs in the calculation of the maximum mortgage amount. This change would make this program more attractive to first time homebuyers or borrowers with limited resources This program requires the payment of a one-time mortgage insurance premium (LA x .5 /12). The monthly mortgage insurance premium became effective on July 1, 1991, on purchase transactions. This requirement is currently under review by HUD/FHA and may be eliminated in the future.
FHA 203b Modestly Priced Dwellings
This program reduces the downpayment for homebuyers on those properties where the loan-to-value is the lesser of
(1) appraised value plus the allowable percentage of closing costs or
(2) the sales price of the property plus closing costs and/or rehabilitation of the property to 3% of whose value is less than $50,000.
The loan is included in the 57% rule and does have both onetime and monthly MIP required.
FHA 203b Co-mortgagor Program
When there are two or more borrowers, but one will not occupy the property as a principal residence, the maximum mortgage is limited to 75% LTV. However, maximum financing is available for borrowers related by blood (parent-child, siblings, etc ) or for unrelated individuals that can document evidence of a family type, longstanding and substantial relationship not arising out of the loan transaction. HUD will not object to legitimate transactions where the non-borrower assists in the financing of the property, such as a parent assisting children with the purchase of their first home or a college student to purchase a house near campus. This arrangement may not be used by non-occupant borrowers to develop a portfolio of rental properties.
FHA 203K Program
The FHA 203K loan program is a program that enables a borrower to purchase (or refinance) a property and include in the permanent loan the purchase price (or existing balance) plus any rehabilitation work required to bring the property up to the minimum property standards There is a minimum amount of acceptable rehabilitation of $5,000 required. The repair/rehabilitation work is escrowed for at the time of closing with the completion of the work required within 180 days after closing. This program is not covered by the 57% rule and requires only monthly mortgage insurance. The FHA allows the mortgage lender to collect a supplemental origination fee on this program and there are some additional loan processing costs.
FHA Secondary Residence Loans
The FHA will allow a purchaser to obtain a loan on a secondary residence. The maximum mortgage available under this program is 85%.To be eligible for a secondary residence. a borrower must document that there is not affordable rental housing that meets the needs of the family within a reasonable commuting distance to work. The secondary residence must not be a vacation home or otherwise be used for recreational purposes The borrower must obtain a secondary residence because of season employment, employment relocation or other circumstances not related to recreational use. The determination about the acceptability of a secondary residence will be made by the local HUD office.
FHA 203V Program
For veterans with a Certificate of Veteran Status., the veteran is not required to put the 3% down on the first $25,000 providing the prepaids total $200.00 or more. The veteran is required to put the 5% down on the balance of the sales price which again must be the lesser of the acquisition cost or appraised value plus allowable percentage of closing costs. This program is not covered by the 57% rule. This loan program does include both the one-time MIP and the monthly mortgage insurance program
FHA Identity of Interest Transactions
Properties that are sold with an Identity of Interest have a maximum mortgage amount of 85% . Identity of Interest is defined as a transaction between family members, business partners or other business affiliation. However, maximum financing is available under the following circumstances:
- A family member purchasing another family member's principal residence.
- An employee of a builder purchasing one of the builder's new homes or models as a principal residence.
- Current tenants purchasing the property that they have rented for at least six months preceding the sales contract.
- Sales by corporations that transfer employees out of an area, purchase the transferred employee's home and then resell to another employee.
FHA 221d2 Program
This loan is targeted toward low-moderate income homebuyers who have limited resources to purchase a home. The program allows the borrowers to finance 97% of the sales price (lesser of sales price or appraised value) plus buyer's closing costs (not covered by 57% rule) plus prepaids. This allows the borrower a high loan amount thereby reducing the cash assets required for closing The borrower(s) must still pay the prepaids and closing costs, but has an increased loan amount, thereby reducing the downpayment. To be eligible for this program the borrowers must be a ''family unit" which is defined as "Not less than two persons related by blood, marriage or operation of law, who occupy the same unit. " However, any persons who are 6'' years of age or over, or who are handicapped persons who have physical impairments which are expected to be of continued duration which impedes their ability to live independently shall be eligible for this program.
Note: There is a requirement on this program that a letter or certificate from the city/county health department be provided showing that the property being purchased meets the minimum health standards.
Income Qualifying Guidelines
For FNMA conventional loans, ratios using income and housing expense/obligations are used to determine whether the borrower will be able to meet the expenses involved in home ownership. Ratio guidelines may be exceeded as long as there are documented factors to justify their use. The ratio used on fixed rate mortgage for the housing ratio (principal, interest, taxes, hazard insurance, mortgage insurance and subordinate financing) is 28% for all loans. This ratio is calculated using the gross monthly income (3 years or longer) for all borrowers divided into the monthly housing expense. The second ratio includes the projected house payment plus any obligations extending 10 months or longer divided by the gross monthly effective income and is 36%.
FHA uses the gross effect income method in qualifying homebuyers. This method is like the process described in the FNMA Conventional qualifying above except that the ratios used on FHA loans are:
- Mortgage Payment Expenses to effective income should not exceed 29% without sufficient compensating factors.
- Total Fixed Payment (obligations with a remaining payment period of more than six months) to be effective income should not exceed 41% without significant compensating factors.
One other consideration that should be considered is that FHA allows properties that qualify as Energy Efficient (EEH) to have ratios that are 2.0% higher on both the Monthly Payment Expense and Total Fixed Payment ratios.
For many years, a mutual mortgage insurance of 1/2% was added to the contract rate. If the contract rate was 9 1/2%, the MMI would add another 1/2%, bringing the actual payment rate to 10%. Currently, a single Mortgage Insurance Premium (MIP) is assessed at closing. This may be 3.8% of the loan. The MIP may be paid in cash at closing, in which case the MIP will be exempt from the loan to value ratios and maximum loan value, and the loan must be rounded down to $50 multiples Alternately, the MIP may be totally financed with the loan and the loan is simply rounded down to $1 multiples. The lender, however, must send the entire MIP payment to the regional HUD office within 15 days of closing.
MORTGAGE CREDIT ANALYSIS
The purpose of mortgage credit analysis is to determine the borrower's ability and willingness to repay the mortgage debt, and thus, limit the probability of default or collection difficulties.
The borrower's ability to repay the debt is measured by:
1. History of stability of employment and income.
2. The projected increase in the borrower's housing expense from the present housing expense
ash reserves following loan closing.
4. Other non-mortgage obligations.
The borrower's willingness to repay the debt is measured by his/her history of paying habits, including any payments 30 or more days late, judgments, collections, bankruptcies, foreclosures? or other derogatory information.
The acceptability of credit risk is determined by analyzing each borrower's credit history, stability and adequacy of income to support the mortgage and other obligations, and assets to close the transaction. n
Borrower's Basic Eligibility
HUD will insure mortgages made to qualifying individuals, state and local government agencies, and qualifying non-profit organizations. Eligible investor loans may not be insured solely in the name of a business entity, except on streamline refinances.
Co-borrowers take title to the property and obligate themselves on the mortgage note. Similarly, HUD will also permit a cosigner with no ownership interest in the property (does not take title) to execute the loan application and mortgage note and, thus, become liable for repayment of the obligation. The cosigner's income, assets, liabilities, and credit history are included in the determination of creditworthiness
Neither a co-borrower nor a cosigner may be a party that has an interest in the transaction, such as the seller, builder, real estate agent, etc. Exceptions may be granted if the seller and co-borrower/cosigner is a family member of the occupant owner.
An individual signing the loan application must not be otherwise ineligible for participation. The occupying borrower must sign the security instrument and mortgage note.
Unless otherwise exempted, any non-occupying co-borrowers or cosigners must have a principal residence in the United States.
Citizenship of the United States is not required for eligibility. However, the subject property must either occupying borrower's principal residence or, if an eligible secondary residence or investment property, the 's principal residence must be located in the United States. The borrower must also have a social security
Non-purchasing spouses: If required by state law in order to perfect a valid and enforceable first lien, the non-purchasing spouse may be required to either sign the security instrument or documentation evidencing that he or she is relinquishing all rights to the property. If the non-purchasing spouse executes the security instrument for such reasons, he or she is not considered a borrower for HUD purposes and need not sign the loan application.
Military personnel are considered occupant owners and eligible for maximum financing if a member of the immediate family will occupy the property as a principal residence even if the service person is stationed elsewhere.
Living trusts are eligible for HUD mortgage insurance as long as the individual borrower remains beneficiary and occupies the property as a principal residence. One or more individuals and the trust must appear on all security instruments and mortgage notes, and the lender must be satisfied that the trust provides the lender with a reasonable means to assure that it is notified of any subsequent change of occupancy or transfer of beneficial interest.
Past credit performance serves as the most useful guide in determining the attitude toward credit obligations that will govern the borrower's future actions. A borrower who has made payments on previous or current obligations in a timely manner represents reduced risk. Conversely, if the credit history, despite adequate income to support obligations, reflects continuous slow payments, judgments, and delinquent accounts, strong offsetting factors will be necessary to approve the loan.
Late or slow payments: When analyzing the borrower's credit record, it is the general pattern of credit behavior that must be examined rather than isolated occurrences of unsatisfactory or slow payments. A period of financial difficulty in the past does not necessarily make the risk unacceptable if a good payment record has been maintained since. When delinquent accounts are revealed, the lender must determine whether the late payments were due to a disregard for, or an inability to manage, financial obligations, or to factors beyond the control of the borrower.
Derogatory credit information must be explained by the borrower in writing. While minor derogatory information occurring two or more years in the past does not require explanation, significant indications of derogatory credit, including judgments and collections, and any other recent credit problems, require sufficient explanation from the borrower. The borrower's explanation must make sense and be consistent with other credit information in the file.
While collection accounts indicate the borrower's regard for credit obligations and must be considered in the analysis of creditworthiness, HUD does not arbitrarily demand these be paid off as a condition for loan approval. Conversely, court-ordered judgments must be paid-off before the mortgage loan is eligible for insurance endorsement.
Credit history not established. For those borrowers who choose not to use credit or have not yet established credit, the lender must develop a credit history from rent verifications, utility payment records, or other means. However, neither the lack of credit history nor the lifestyle of the borrower may be used as a basis for rejection
Recent debts: The lender must ascertain the purpose of any recent debts as the indebtedness may have been incurred to obtain part of the required cash investment on the property being purchased.
Projected increase in obligations: The projected increase in the borrower's housing expense from the present housing expense must be carefully analyzed. When the new housing expense will significantly exceed the previous housing expense, and the borrower has not exhibited an ability to accumulate savings or otherwise manage financial affairs, strong compensating factors must be present to allow for borrower approval. The projected mortgage interest deduction on the borrower's federal income tax return, while beneficial to the borrower, is neither a compensating factor nor may it be included in the analysis.
Previous marriage foreclosure: A borrower whose previous residence or other real property was foreclosed on or has given a deed-in-lieu of foreclosure within the previous three years is generally not eligible for an insured mortgage. However, if the foreclosure was the result of extenuating circumstances beyond the borrower's control (such as the death of the principal wage earner, loss of employment due to factory closing, reductions-in-force, etc., or serious long-term illness) and the borrower has since established good credit, an exception may be granted. Extenuating circumstances do not include the inability to sell a house when transferring from one area to another.
Bankruptcy: A Chapter 7 liquidation bankruptcy will not disqualify the borrower if at least two years have passed since the bankruptcy was discharged he borrower has re-established good credit or has chosen not to incur new credit obligations, and has demonstrated an ability to manage financial affairs. An elapsed period of less than two years may be acceptable if the borrower can show that the bankruptcy was caused by extenuating circumstances beyond his or her control (such as the death of the principal wage earner, loss of employment due to factory closing, reductions-in-force, etc., or to serious long-term illness, and has since exhibited an ability to manage financial affairs and the borrower's current situation is such that the events leading to the bankruptcy are not likely to recur.
A borrower paying off debts under Chapter 13 of the Bankruptcy Act may also qualify if
1. One year of the pay-out period has elapsed and performance has been satisfactory; and
2. The borrower receives court approval to enter into the mortgage transaction.
Credit Eligibility Requirements
In addition to the credit analysis described above, a borrower must be rejected for any of the following reasons:
1. Suspensions and debarment: A borrower suspended, debarred, or otherwise excluded from participation in the Department's programs is not eligible for a HUD-insured mortgage. The lender must examine HUD's "Limited Denial of Participation List" and the government-wide General Services Administration's "List of Parties Excluded from Federal Procurement or Nonprocurement Programs." If the name of any party to the transaction appears on either list, the application is not eligible for mortgage insurance. An exception is made when a seller appears on the LDP list and the property being sold is the seller's principal residence.
2. Delinquent Federal debts: If the borrower is presently delinquent on any Federal debt (e.g. VA-guaranteed mortgage, HUD Section 312 Rehabilitation loan or Title I loan, Federal student loan, Small Business Administration loan, delinquent Federal Taxes, etc.) or has a lien, including taxes, placed against his or her property for a debt owed to the United States, the borrower is not eligible until the delinquent account is brought current, paid or otherwise satisfied, or a satisfactory repayment plan is made between the borrower and the Federal agency owed and is verified in writing. Tax liens may be eligible for inclusion in a refinance in some cases.
3. HUD's Credit Alert Interactive Voice Response System (CAIVRS): Lenders must screen all borrowers using CAIVRS. If CAIVRS indicates the borrower is presently delinquent or has had a claim paid within the previous three years on a loan made or insured by HUD on his or her behalf, the borrower is not eligible.
Exceptions to this may be granted under the following situations:
1. Assumptions: If the borrower sold the property, with or without "release of liability" to a mortgagor who subsequently defaulted and it can be established that the loan was not in default at the time of assumption, the borrower is eligible.
2. Divorce: A borrower may be eligible if the divorce decree or legal separation agreement awarded the property and responsibility for payment is to the former spouse. However, if a claim was paid on a mortgage in default at the time of the divorce, the borrower is not eligible.
3. Bankruptcy: When the property was included in a bankruptcy that was caused by circumstances beyond the borrower's control (such as the death of the principal wage earner, loss of employment due to factory closing, reductions-in-force, etc. or serious long-term illness), the borrower may be eligible.
If the lender has reason to believe the CAIVRS message is erroneous or must establish the date of claim payment, it must contact the local HUD Field Office for instructions on documentation to support the borrower's eligibility. The local HUD offices can provide information regarding when the three-year writing d has passed or that the social security number in CAIVRS is an error. Additionally, HUD Field Offices can de instructions to lenders regarding processing requirements for non-Title Il defaults and claims.
The anticipated income and the likelihood of its continuance must be established. Income from any source that cannot be verified, is not stable, or will not continue may not be used in calculating the borrower's income ratios.
1. Stability of income: While HUD does not impose an arbitrary minimum length of time borrower must have held a position to be eligible, the lender must verify the most recent two full years' worth of employment. If a borrower's employment history indicates he or she was in school or in the military during any of this time, the borrower must provide evidence supporting this. The borrower must also explain any gaps in employment of a month or more. Allowances for seasonal employment, such as is typical in the building trades may be made.
To analyze the probability of continued employment, lenders must examine the borrower's past employment record, qualifications for the position, previous training and education, and the employers confirmation of continued employment.
A borrower who changes jobs frequently within the same line of work, but continues to advance in income, may be considered favorably.
2. Salaries, wages, and other forms Or effective income: The income of each borrower to be obligated for the mortgage debt must be analyzed to determine whether it can be expected to continue through the first five years of the mortgage loan. If the borrower intends to retire during this period the effective income will be the amount of retirement benefits, social security payments, etc. No inquiry may be made regarding possible future maternity leave.
In most cases, borrower income will be limited to salaries or wages. Income from most other sources, provided it is properly verified by the lender, can be included as effective income.
A. Overtime and bonus income: Both may be used to qualify if the borrower has received such income for the past two years and will in all likelihood continue to do so. The lender must develop an average of bonus or overtime income for the past two years and the employment verification must state that overtime or bonus income will continue.
Additionally, an earnings trend must also be established for either source of income. If either type of income shows a continual decline, the lender must provide a sound rationalization for including the income for borrower qualifying. If bonus income varies significantly from year-to-year, a period of more than two years must be used in calculating the average income.
B. Part-time income: Part-time income, including employment in seasonal work, may be used in qualifying if the borrower has worked the part-time job uninterrupted for the past two years and will continue to do so. Seasonal employment (e.g. umpiring baseball games in summer, working at a department store during the Christmas shopping season) is considered uninterrupted and may be used in qualifying if the borrower has worked the same job for the past two years and expects to be rehired during the next season. Income from part-time positions that do not meet these requirements should be considered as a compensating factor only.
C. Military income: In addition to base pay, military personnel may be entitled to additional for ns of pay. Income from variable housing allowances, clothing allowances, flight or hard pay, rations, and proficiency pay is acceptable provided its continuance is verified. An additional consideration may be the tax-exempt nature of some of these items.
D. Commission income: commission income must be averaged over the previous two years. The borrower must provide his or her last two years tax returns along with a recent pay stub. Individuals whose commission income shows a decrease from one year to the next require significant compensating factors to allow for loan approval.
E. Retirement and Social Security Income: Such income requires verification from the source such as the former employer or the Social Security Administration or through Federal tax returns. If any benefits expire within approximately five years, it must be considered a compensating factor.
F. Alimony, Child Support or Maintenance Payments: Income in this category may be considered as effective if such payments are likely to be consistently received for approximately the first five years of the mortgage. The borrower must provide a copy of the divorce decree or legal separation agreement and evidence that payments have been made during the last twelve months. Acceptable evidence of regularity of payments includes cancelled checks, deposit slips, tax returns, court records, etc. Periods less than twelve months may be acceptable provided payor's ability and willingness to make timely payments can be documented by the lender.
G. Notes Receivable; A copy of the note must be presented to establish the amount and length of payment. The borrower must also provide evidence these payments have been received consistently for the last twelve months which may include deposit slips, cancelled checks, or tax returns.
H. Interest and dividends: Interest and dividend income may be used provided documentation such as tax returns or account statements support a two-year history of receipt. This income must be averaged over the two years. Any funds derived from these sources and required for the cash investment must be subtracted before the projected interest or dividend income is calculated.
I. Mortgage Credit Certificates and Differential Payments: If the employer or government entity subsidies the mortgage payments, either through direct payments or through tax rebates, these payments can be considered as acceptable income if verified in writing. Either type of subsidy may be added to gross income before calculating gross ratios. They may not be used to directly offset the mortgage payment.
J. VA Benefits: Direct compensation, such as for a service-related disability, is acceptable subject to documentation from the Department of Veterans Affairs. Education benefits, used to offset education expenses, are not acceptable
K. Government Assistance Programs: Income received under a welfare program, unemployment income, workman's compensation, payments for foster children, etc., is acceptable subject to documentation from the paying agency provided the income is expected to continue approximately five years. If not expected to last approximately five years, the income is considered a compensating factor.
Unemployment income requires a two-year documentation of its receipt and reasonable assurance of its continuance. This may be appropriate for individuals employed on a seasonal basis, such as farm workers, resort area employees, etc.
L. Rental Income: Rent received from properties owned by the borrower may he acceptable, subject to proper documentation. Income from roommates, etc., in a single-family property to be occupied as the borrower's primary residence, is not acceptable. Rent received from the additional units in a multiple-unit property are acceptable. Rental income from "boarders" is acceptable only as a compensating factor and only when provided by a relative and adequately documented by the lender.
M. Automobile Allowances and Expense Account Payments: Only the amount by which the borrower's automobile allowance or expense account payments exceed actual expenditures may be considered as income. The borrower must provide IRS Form 2106, Employee Business Expenses, for the previous two years to establish the amount of income that may be added to gross income, along with verification from the employer these payments will continue. If these calculations show a loss that amount must be treated as a recurring debt. Additionally, the borrower's monthly car payment must be treated as a recurring debt. It may not be offset by the car allowance.
N. Trust Income: Income from trusts may be used if guaranteed, constant payment will continue for approximately five years and adequately documented. Documentation requirements include a copy of the Trust Agreement or other trustee's statement confirming amount, frequency of distribution, and duration of payments. Funds from the trust account may also be used for the required cash investment with adequate documentation.
O. Non-taxable Income: If a particular source of income is not subject to Federal taxes (e.g. certain types of disability payments, military allowances, etc.), the amount of continuing tax savings attributable to the non-taxable income source may be added to the borrower's gross income. The percentage of income that may be added may not exceed the appropriate tax rate for that income amount and no additional allowances for dependents is acceptable. The lender must document and support the adjustments made (i.e. the amount the income is "grossed-up") for any non-taxable income source.
P. Projected Income: Projected or hypothetical income is not acceptable for qualifying purposes. Exceptions are permitted for income from cost-of-living adjustments, performance raises, bonuses, etc., verified by the employer and scheduled to begin within 60 days of loan closing.
A borrower with a 5% or greater ownership interest in a business is considered self-employed for mortgage loan underwriting purposes.
Income from self-employment is considered stable and effective if the borrower has been self-employed for two or more years. The high incidence of failure during the first few years of a new business require the following for individuals employed less than two years:
1. Between one and two years: An individual self-employed between one and two years must have at least two years previous successful employment, or a combination of one year of employment and formal education or training, in that or a related occupation to be eligible.
2. Less than one year: The income from borrowers self-employed less than one year may not be considered as effective income.
1. Signed and dated individual tax returns, plus all applicable schedules, for the most recent two years.
2. Signed copies of federal business income tax returns for the last two years, with all applicable schedules, if the business is a corporation, an "S" corporation, or a partnership.
3. A year-to-date profit-and-loss statement and balance sheet, along with evidence of quarterly tax payments.
4. A business credit report on corporations and "S" corporations.
Types of Liabilities
A. Recurring liability The borrower's liabilities include all installment loans, revolving charge accounts, real estate loans, alimony, child support, and all other continuing obligations. In computing the debt-to-income ratio, the lender must include the monthly housing expense, and all other additional recurring charges, including payments on installment and revolving accounts extending six months or more, alimony, child support or separate maintenance payments, etc. If there are any young children in the family, the borrower must provide information regarding child care expenses or satisfactory evidence no expenses are incurred; any monthly expenses must be included as "recurring charge in the ratio computations. Debts lasting less than six months need not be counted unless the amount of the debt seriously affects the borrower's ability to make the mortgage payment during the month immediately after loan closing.
B. Contingent liabilities: A contingent liability exists when an individual would be held responsible for payment of a debt should another party jointly or severally obligated default on that payment. Unless the borrower can provide conclusive evidence that there is no possibility the debt holder will pursue debt collection against him or her should the other party default, the following rules regarding contingent liability apply:
1. Co-signed obligations: If the borrower is a co-signer on a car loan, student loan, or any other obligation, contingent liability applies unless (a) statements from both parties show the co-signer has not made payments on the loan over the past twelve months are provided and the borrower furnishes evidence attesting to this fact; or (b) there was a divorce and the borrower's ex-spouse was given the responsibility for payment of the obligation as part of a legal separation or divorce settlement.
2. Borrower/Co-borrower on a Mortgage: When a borrower is obligated on an outstanding HUD-insured, VA-guaranteed, or conventional mortgage secured by a property which has been sold or traded within the last five years without a release of liability, or is to be sold on assumption without a release of liability being obtained, contingent liability must be considered unless:
a. There was a divorce and the borrower's ex-spouse was awarded both the property and responsibility for payment of the mortgage as part of a legal separation or divorce settlement; or
b. The borrower was transferred by his or her employer and is covered by a home sale guarantee plan; or
c. An appraisal or closing statement from the sale of the property supports a value that results in a 75 percent loan-to-value ratio, i.e., the outstanding balance on the mortgage loan (minus any upfront MIP, if applicable) cannot exceed 75% of the appraised price; or
d. The property sold had a HUD-insured mortgage and was sold to an owner-occupant. Proof that the property was sold to an owner-occupant must be obtained.
C. Projected Obligations: If a debt payment, such as a student loan, is scheduled to begin within twelve months of the mortgage loan closing, the lender must include the anticipated monthly obligation in the underwriting analysis. Similarly, balloon notes that come due within one year of loan closing must be considered.
D. Obligations Not To Be Considered: Obligations not to be considered as a debt, nor subtracted from gross income, include federal, state and local taxes, FICA or other retirement contributions such as 401(k)s, commuting costs, union dues, open accounts with zero balances, automatic deductions to savings accounts, and other voluntary deductions.
Debt-to-Income Ratios: Ratios are used to determine whether the borrower can reasonably be expected to meet the expenses involved in home ownership, and otherwise provide for the family.
The lender must compute two ratios:
A. Mortgage Payment Expense to Effective Income: If the total mortgage payment (principal, interest, taxes, insurance, payments for any acceptable secondary financing, and any additional required escrows or payments such a homeowners association dues, does not exceed 29% of gross effective income, the relationship of the mortgage payment to income is considered acceptable. A ratio exceeding 29% may be acceptable if significant compensating factors are presented. Typically, for borrowers with limited recurring expense, greater latitude is permissible on this ratio than the total fixed payment ratio.
B. Total Fixed Payment To Effective Income: If the total mortgage payment and all recurring charges does not exceed 41% of gross effective income, the relationship of total obligations to income is considered acceptable. A ratio exceeding 41% may be acceptable if significant compensating factors are presented.
Compensating factors that may be used in justifying approval of mortgage loans with ratios exceeding the guidelines above include those listed below. These must be described in the "remarks" section of the HUD-92900WS.
A. The borrower makes a large downpayment toward the purchase of the property of at least 10%.
B. The borrower has demonstrated a conservative attitude toward the use of credit and ability to accumulate savings.
C. Previous credit history shows that the borrower has the ability to devote a greater portion of income to housing expenses.
D. The borrower receives compensation or income not reflected in effective income, but directly affecting the ability to pay the mortgage.
E. There is only a small increase of 10% or less in the borrower's housing expense.
F. The borrower has substantial cash reserves after closing of at least three months PITI.
G. The borrower has substantial non-taxable income (if no adjustment is made previously in the ratio computations).
H. The borrower has potential for increased earnings, as indicated by job training or education in the borrower's profession.
The Servicemen's Readjustment Act of 1944 (the GI Bill) was passed to provide benefits of World War II veterans. It has since been amended to include veterans of Korea, Vietnam and Desert storm.
More than 28.8 million veterans and service personnel are eligible for VA financing. Many of these people have used their veterans' loan benefit before, but may now be able to buy homes with VA financing again using remaining or restored loan entitlement.
Before arranging for a new mortgage to finance a home purchase, veterans should consider some of the advantages of VA home loans:
- No downpayment is required in most cases.
- No maximum loan amount, except the loan may not exceed the VA-established reasonable value of the property.
- Lower interest rates (which are fixed for the life of the loan).
- No monthly mortgage insurance premium to pay.
- Limitation on buyer's closing costs.
- An appraisal which informs the buyer of property value
- Thirty year loans with a choice of repayment plans:
Traditional fixed payment (monthly payments stay the same for the life of the loan);
In some areas, Growing Equity Mortgages (gradually increasing payments with all of the increase applied to principal, resulting in an early payoff of the loan.)
- For most loans for new houses, construction is inspected at appropriate stages to ensure compliance with the approved plans, and a 1-year warranty is required from the builder that the house is built in conformity with the approved plans and specifications. In those cases where the builder provides an acceptable 10-year warranty plan, only the final inspection may be required.
- An assumable mortgage, subject to VA approval of the assumer's credit.
- Right to repay loan without penalty.
- VA performs personal loan servicing and offers financial counseling to help veterans avoid losing their homes during temporary financial difficulties.
What Is a VA-Guaranteed Loan
These loans are made by a lender, such as a mortgage company, savings and loan or bank. VA's guaranty on the loan protects the lender against loss if the payments are not made, and is intended to encourage lenders to offer veterans loans with more favorable terms. The amount of the guaranty on the loan depends on the loan amount and whether the veteran used some entitlement previously. With the current maximum guarantee, a veteran who has not previously used the benefit may be able to obtain a VA loan up to $184,000 depending on the borrower's income level and the appraised value of the property. The local VA office can provide more details on guaranty and entitlement amounts.
Uses for a VA Loan
- To buy a home, including townhouse or condominium unit in a VA-approved project.
- To build a home.
- To simultaneously purchase and improve a home.
- To improve a home, including installation of solar heating and/or cooling system or other weatherization improvements.
- To refinance an existing home loan.
- To buy a manufactured home and/or lot.
Veterans with active duty service, that was not dishonorable, during World War Il and later periods are eligible for VA loan benefits. World War II (September 16, 1940 to July 25, 1947), Korean conflict (June 27, 1950 to January 31, 1955), and Vietnam era (August 5, 1964 to May 7, 1975) veterans must have at least 90 days of service. Veterans with service only during peacetime periods and active duty military personnel must have had more than 180 days of active service. Veterans of enlisted service which began after September 7, 1980 or officers with service beginning after October 16, 1981, must in most cases have served at least two years.
For the Persian Gulf Conflict, reservists and National Guard members who were activated on or after August 2, 1990, served at least 90 days and were discharged honorably are eligible. VA regional office personnel may assist with eligibility questions.
Veterans who had a VA loan before may still have "remaining entitlement" to use for another VA loan. The current amount of entitlement available to each eligible veteran is $36,000. This was much lower in years past and has been increased over time by changes in the law. For example, a veteran who obtained a $'5,000 loan in 1974 would have used $12,500 guaranty entitlement, the maximum then available. Even if that loan is not paid off, the veteran could use the $23,500 difference between the $12,500 entitlement originally used and the current maximum of $36,000 to
buy another home with VA financing. An additional $10,000, up to a maximum entitlement of $46,000 is available for loans above $144,000 to purchase or construct a home.
Most lenders require that a combination of the guaranty entitlement and any cash downpayment must equal at least 25 percent of the reasonable value or sales price of the property whichever is less. Thus in the example, the veteran's $23,500 remaining entitlement would probably meet a lender's minimum guaranty requirement for a no downpayment loan to buy the property valued at and selling for $94,000. The veteran could also combine a downpayment with the remaining entitlement for a larger loan amount.
Restoration of Entitlement
Veterans can have previously-used entitlement "restored" to purchase another home with a VA loan if:
- The property purchased with the prior VA loan has been sold and the loan paid in full, or
- A qualified veteran-transferee (buyer) agrees to assume the VA loan and substitute his or her entitlement for the same amount of entitlement originally used by the veteran seller. Remaining entitlement and restoration of entitlement can be requested through the nearest VA office by completing VA form 26-1880.
Five Steps to a VA Loan
1. Apply for a Certificate of Eligibility.
A veteran who does not have a certificate can obtain one by making application on VA Form 26-1880, Request for Determination of Eligibility and Available Loan Guaranty Entitlement to the local VA office.
2. Decide on a home the buyer wants to buy and sign a purchase agreement.
3. Order an appraisal from VA.
Most VA regional offices offer a "speed-up" telephone appraisal system. Call the local VA office for details.
4. Apply to a mortgage lender for the loan.
While the appraisal is being done, the lender (mortgage company, savings and loan, bank, etc.) can be gathering credit and income information. If the lender is authorized by VA to do automatic processing, the loan can be approved and closed without waiting for VA's review of the credit application. For loans that must first be approved by VA, the lender will send the application to the local VA office, which will notify the lender of its decision.
5. Close the loan and the buyer moves in.
VA Appraisal - Certificate of Reasonable Value
The CRV (certificate of reasonable value) is based on an appraiser's estimate of the value of the property to be purchased. Because the loan amount may not exceed the CRV, the first step in getting a VA loan is usually to request an appraisal. Anyone (buyer, seller, real estate personnel or lender) can request a VA appraisal by completing VA Form 26-1805, Request for Determination of Reasonable Value. After completing the form, it can either be mailed to the Loan Guaranty Division at the nearest VA office for processing or an appraisal can be requested by telephone from the Loan Guaranty Division for assignment of an appraiser. The local VA office may be contacted for information concerning its assignment procedures. The appraiser will send a bill for services to the requester according to a fee schedule approved by Veto simplify things, VA and HUD/FHA (Department of Housing and Urban Development/ Federal Housing Administration) use the same appraisal forms. Also, if the property was recently appraised under the HUD procedure, the HUD conditional commitment can usually be converted easily to a VA CRV. The local VA office can explain how this is done.
The application process for VA financing is no different from any other type of loan. In fact, the VA application form is the same as that used for HUD/FHA loans. The mortgage lender verifies the applicant's income and assets, and obtains a credit report to see that other obligations are being paid on time. If all is well and the appraised value of the property is enough to cover the loan needed, the lender, in most instances, can then close the loan under VA's automatic procedure. Only about 10 percent of VA loan applications have to be submitted to a VA office for approval before closing.
Requirements for Loan Approval
To obtain a VA loan, the law requires that:
- The applicant must be an eligible veteran who has available entitlement.
? The loan must be for an eligible purpose.
- The veteran must occupy or intend to occupy the property as a home within a reasonable period of time after closing the loan.
- The veteran must be a satisfactory credit risk.
The income of the veteran and spouse, if any, must be shown to be stable and sufficient to meet the mortgage payments, cover the costs of owning a home, take care of other obligations and expenses, and have enough left over for family support.
An experienced mortgage lender will be able to discuss specific income and other qualifying requirements.
Costs of Obtaining a VA Loan
- A funding fee of 1.25% must be paid to VA by all but certain exempt veterans. A down payment of 5% or more will reduce the fee to 0.75% percent and a 10% downpayment will reduce it to 0.50% .This fee does not have to be paid in cash, but may be included in the loan.
- No commission or brokerage fee may be charged to the veteran buyer.
- Reasonable closing costs may be charged by the lender. These may not be included in the loan.
Veterans may not be charged discount points except for loans
(1) Refinance an existing home loan on property owned and occupied by the veteran;
(2) Repair, alter or improve a home;
(3) Build a home on land purchased from someone other than the builder; or
(4) Buy a home from a seller who VA determines is legally precluded from paying discount points.
(The following is reprinted by permission from the CalBRE Reference Book, p.379-384)
Applicant must have served at least 90 days on active duty unless discharged because of a service-connected disability. At least one day of active duty must have been during a qualifying war period.
Military service solely for the purpose of processing, physical examination or training does not qualify.
A loan origination fee of $430 is charged on Cal-Vet loans, $25 of which must be paid at time of application and is non-refundable. The balance is collected at the close of escrow. Property taxes and insurance premiums as appropriate are also collected at the close of escrow. Appraisal fees are not included in the loan origination fee and must be paid by the applicant at the time the appraisal is performed.
There are no income restrictions or purchase price limitations on Cal-Vet loans funded with General Obligation Bonds.
To qualify for Revenue Bond funding, a veteran must be a "first-time homebuyer", defined as one who has not owned an interest in his/her principal residence for the past three years, or must be purchasing a property in a federally-designated "targeted area", generally defined as an area of low income or chronic economic distress.
Qualifying Maximum Loan
Properties Amount. Single family homes, including condominiums and townhouses $125,000; Working farm producing sufficient income to provide loan and tax payments $200,000.
In addition to the $5,000 which may be approved for solar energy heating devices, $5,000 more may be approved for structural modifications necessitated by the disability of the veteran or a member of the veteran's immediate family residing in the Cal-Vet property.
Where the purchase price is $35,000 or less, the Department may loan 97% of its appraised value of the property. Where the purchase price is greater than $35,000, the Department may loan 95% of its appraised value of the property, but in no event may the loan be more than the purchase price or the maximum stated above, whichever is less.
On farm properties, the loan amount cannot exceed 95% of the Department's appraised value which is based upon net income from agricultural production. Secondary Financing from Other lenders
The Department may consent to secondary financing to be obtained by the veteran from another lender to supplement the amount of the Cal-Vet loan. The total amount of secondary financing when combined with the Cal-Vet loan cannot exceed 90% of the Department's appraised value of the property. A Subordination Agreement must be obtained from the secondary lender. The Department also consents to interim financing for bridging the time-gap of sometimes up to 6 months necessary to process the application.
Rate and Term
The Cal-Vet interest rate on loans for single family dwellings, condominiums, farms and mobilehomes affixed to land is currently 8%. The interest rate for mobilehomes in parks in 9%, and has always been 1% higher than the rate for single family dwellings.
Most loans are based upon a 25-year maximum repayment period though the legal limit is 40 years.
A loan may be paid in full at any time. If a loan is repaid, in whole or in part, within five years of its date, the purchaser shall pay an additional sum as a prepayment penalty or service charge on the contract in an amount equal to the payment of six month's advance interest on the amount prepaid in excess of 20 percent of the original loan amount.
The transfer, assignment, encumbrance or rental of Cal-Vet property is prohibited without the written consent of the Department of Veterans Affairs.
The reader of this chapter should be warned that above numbers, whether they refer to maximum loan amounts or percentage rates are subject to change.
(End of from the CalBRE Reference Book excerpt)
Loan Terms Comparison Table
3% of 1st
3% up to
6 mo. pmt